U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20459
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarter Ended: Commission File No.:
March 31, 2002 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
Virginia 54-1779978
- ------------------------------- -----------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
37 East Main Street
Warrenton, Virginia 20186
- --------------------------------------- -----------------------------------
(address of principal executive office) (Zip Code)
Registrant's Telephone Number, including area code: (540) 349-3900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO _____
------
As of May 3, 2002, there were 4,289,387 shares of the registrant's Common Stock
outstanding.
SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
March 31, 2002
TABLE OF CONTENTS
-----------------
Page
Number
------
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
Consolidated Balance Sheets
as of March 31, 2002 (Unaudited) and 3
December 31, 2001
Consolidated Statements of Income for the
Three Months Ended March 31, 2002 and 2001 4
(Unaudited)
Consolidated Statements of Comprehensive Income
for the Three Months Ended March 31, 2002 and 5
2001 (Unaudited)
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2002 and 2001 6
(Unaudited)
Notes to Consolidated Financial Statements
(Unaudited)
7 - 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 - 17
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
PART III. SIGNATURES 19
- --------- ----------
2
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
March 31,
2002 December 31,
(Unaudited) 2001
--------------- -------------
Assets
Cash and due from banks $ 20,449,150 21,290,594
Overnight earning deposits 5,243,160 7,167,963
Investment securities - available for sale 269,367,385 306,611,560
Loans held for sale 237,500 -
Loans receivable, net 442,932,676 410,973,260
Cash surrender value of life insurance 21,408,718 16,160,787
Premises and equipment, net 6,755,557 6,796,246
Other assets 25,397,659 15,976,548
--------------- --------------
Total assets $ 791,791,805 $ 784,976,958
=============== ==============
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 634,933,927 $ 633,325,894
Advances from Federal Home Loan Bank - short term 46,000,000 40,500,000
Advances from Federal Home Loan Bank - long term 15,000,000 15,000,000
Company-obligated mandatorily redeemable securities
of subsidiary holding solely parent debentures 13,000,000 13,000,000
Other liabilities 17,976,208 18,482,865
--------------- --------------
Total liabilities 726,910,135 720,308,759
--------------- --------------
Stockholders' equity:
Preferred stock 136 136
Common stock 42,846 42,846
Capital in excess of par 54,628,316 54,628,316
Retained earnings 9,691,413 7,986,380
Accumulated other comprehensive income 518,959 2,010,521
--------------- --------------
Total stockholders' equity 64,881,670 64,668,199
--------------- --------------
Total liabilities and stockholders' equity $ 791,791,805 $ 784,976,958
=============== ==============
The accompanying notes are an integral part of these consolidated
financial statements.
3
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31,
2002 2001
----------------------------------------
Interest Income
Loans $ 8,035,356 $ 7,588,501
Investment securities 4,784,886 4,792,296
--------------- --------------
Total interest income 12,820,242 12,380,797
--------------- --------------
Interest Expense
Deposits 3,718,160 5,817,229
Borrowings 972,502 1,294,486
--------------- --------------
Total interest expense 4,690,662 7,111,715
--------------- --------------
Net interest income 8,129,580 5,269,082
Provision for loan losses 1,500,000 520,000
--------------- --------------
Net interest income after provision for loan losses 6,629,580 4,749,082
--------------- --------------
Other Income
Account maintenance and electronic banking fees 643,781 558,097
Commercial service fees 116,689 67,159
Other loan fees 94,619 121,374
System maintenance and license fees 74,313 60,431
Income from bank owned life insurance 247,931 232,500
Gain on sale of loans 99,247 298,523
Gain (loss) on investment securities, net (385,474) 218,510
Other 2,499 100
--------------- --------------
Total other income 893,605 1,556,694
--------------- --------------
Other expenses
Employee compensation and benefits 2,351,932 2,014,684
Premises, equipment and data processing 1,221,021 1,063,733
Other 681,022 935,362
--------------- --------------
Total other expenses 4,253,975 4,013,779
--------------- --------------
Income before income taxes 3,269,210 2,291,997
Provision for income taxes 1,041,192 694,300
--------------- --------------
Net income $ 2,228,018 $ 1,597,697
=============== ==============
Earnings per common share:
Basic $ 0.52 $ 0.48
Diluted 0.50 0.47
Dividends declared per common share 0.12 0.11
Weighted average shares outstanding:
Basic 4,284,594 3,316,181
Diluted 4,465,849 3,388,571
The accompanying notes are an integral part of these consolidated
financial statements
4
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended
March 31,
2002 2001
------------------------------
Net income $ 2,228,018 $ 1,597,697
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain/(loss) 45,202 (488,947)
Reclassification adjustment for net interest
(income) expense included in net income 167,425 (18,955)
Available-for-sale securities:
Unrealized holding gain/(loss) (2,892,814) 4,311,284
Reclassification adjustment for net
(gains)/losses included in net income 385,474 (218,510)
------------- -------------
Other comprehensive income (loss) before tax (2,294,713) 3,584,872
Income tax expense (benefit) related to items
of other comprehensive income (803,151) 1,218,852
------------- -------------
Other comprehensive income (loss), net of tax (1,491,562) 2,366,020
Comprehensive income $ 736,456 $ 3,963,717
============= =============
The accompanying notes are an integral part of these consolidated
financial statements
5
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
---------------------------------
2002 2001
---------------------------------
Cash flows from operating activities:
Net Income $ 2,228,018 $ 1,597,697
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization 382,800 349,006
Amortization of discounts or premiums on investment securities
and loans, net 1,005,485 109,043
Provision for loan losses 1,500,000 520,000
Gain on sale of loans (99,247) (298,523)
(Gain) loss on sale of securities 385,474 (218,510)
Accretion of deferred loan fees (355,712) (191,762)
Loans originated - held for sale (2,329,350) (2,421,650)
Loans sold - held for sale 2,126,386 2,033,054
Increase in other assets (4,220,876) (814,012)
Increase (decrease) in other liabilities (7,709,701) 310,685
------------- ------------
Net cash provided by (used in) operating activities (7,086,723) 975,028
------------- ------------
Cash flows from investing activities:
Increase in loans receivable (32,207,394) (11,806,405)
Purchase of investment securities, available-for-sale (125,006,063) (91,398,314)
Sale of investment securities, available-for-sale 96,491,307 30,405,993
Paydowns of investment securities 62,289,195 15,869,083
Purchase of bank owned life insurance (5,000,000) -
Increase in premises and equipment, net (277,288) (312,117)
Increase in other equity securities (675,000) (1,244,950)
------------- ------------
Net cash used in investing activities (4,385,243) (58,486,710)
------------- ------------
Cash flows from financing activities:
Net increase in deposits 3,728,704 41,679,098
Increase in advances from FHLB - short term 5,500,000 21,000,000
Dividends on preferred and common stock (522,985) (364,728)
------------ ------------
Net cash provided by financing activities 8,705,719 62,314,370
------------- ------------
Net increase (decrease) in cash and cash equivalents (2,766,247) 4,802,688
Cash and cash equivalents, beginning of period 28,458,557 24,516,252
------------- ------------
Cash and cash equivalents, end of period $ 25,692,310 $ 29,318,940
============ ============
SUPPLEMENTAL DATA
Cash payments for interest on deposits and borrowings $ 892,296 1,541,582
Cash payments for income taxes $ 2,200,000 1,425,000
The accompanying notes are an integral part of these consolidated
financial statements
6
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q, and, therefore, do
not include all information or footnotes necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
accounting principles generally accepted in the United States of America.
However, all adjustments which are, in the opinion of management, necessary for
a fair presentation have been included. All adjustments are of a normal
recurring nature. The results of operations for the three -month period ended
March 31, 2002 are not necessarily indicative of the results of the full year.
These consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes included in Southern Financial
Bancorp, Inc.'s ("Southern Financial") Annual Report and Form 10-K for the year
ended December 31, 2001.
NOTE 2 - INVESTMENT SECURITIES
The following table sets forth the investment securities portfolio as
of the dates indicated:
March 31, 2002 December 31, 2001
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
--------- ---------- --------- ----------
Available-for-sale securities:
Mortgage-backed securities $ 85,235,769 $ 85,384,772 $ 41,493,040 $ 42,336,121
Collaterized mortgage obligations 151,898,721 152,976,317 235,061,327 238,074,675
Obligations of countries and municipalities 860,184 842,269 860,660 858,701
Corporate obligations 24,580,429 23,889,505 20,552,828 19,737,462
U.S. Treasury and agency securities 495,906 510,493 495,400 515,572
Federal Home Loan Bank stock 4,050,000 4,050,000 3,375,000 3,375,000
Federal Reserve Bank stock 1,229,950 1,229,950 1,229,950 1,229,950
Other equity securities 484,079 484,079 484,079 484,079
------------- ------------- ------------- -------------
Total classified as investment securities 268,835,038 269,367,385 303,552,284 306,611,560
Corporate obligations classified as loans 22,955,627 23,596,261 36,592,310 37,213,355
------------- ------------- ------------- -------------
$ 291,790,665 $ 292,963,646 $ 340,144,594 $ 343,824,915
============= ============= ============= =============
In December 2000, investment securities classified as held-to-maturity
were transferred to the available-for-sale classification in order to provide
more flexibility in managing the interest-rate risk in the investment security
portfolio. Because of the transfer, Southern Financial will be unable to
classify investment securities as held-to-maturity in the foreseeable future.
NOTE 3 - DERIVATIVE FINANCIAL INSTRUMENTS
As part of our interest rate risk management, we make extensive use of
interest rate swaps. Some of them are accounted for as cash flow hedges and some
are accounted for as fair value hedges in accordance with SFAS 133. Cash flow
hedges are used to hedge variable interest rate assets or liabilities and fair
value hedges are used to hedge fixed rate assets or liabilities.
We use interest rate swaps that are accounted for as cash flow hedges
to hedge the interest rate risk associated with pools of certificates of deposit
(CD's) which reprice with changes in market interest rates. Under the terms of
these interest rate swaps, we are the fixed rate payer and the floating rate
receiver. The floating rate on the interest rate swaps is tied to three-month
LIBOR, which approximates the issuance rate on the pool of CD's. The combination
of the swaps and the issuance of the pool of CD's operates to produce long-term
rate deposits. Changes in the fair value of cash flow hedges are accounted for
in other comprehensive income.
We also use interest rate swaps that are accounted for as fair value
hedges to hedge the issuance of individual fixed
7
rate CD's. Under the terms of these interest rate swaps, we are the fixed rate
receiver and the floating rate payer. The floating rate on the interest rate
swaps is generally tied to three-month LIBOR. The combination of the swaps and
the issuance of individual CD's operates to produce long-term floating rate
deposits. The terms of the CD's and the interest rate swaps mirror each other
and were committed simultaneously. Changes in the fair value of the fair value
hedges are accounted for in the income statement, as are changes in the fair
value of the certificates of deposit.
During the quarter ended March 31, 2002, we entered into interest rate
swap agreements totaling $82.5 million in connection with the issuance of like
amounts of our certificates of deposit. These interest rate swap agreements are
accounted for as fair value hedges. During the quarter ended March 31, 2002, two
interest rate swaps with a notional amount of $20 million were terminated with
no resulting gain or loss. Total interest rate swaps outstanding as of March 31,
2002 had a notional amount of $227.5 million and an estimated fair value of
($4.9) million. Interest rate swaps accounted for as cash flow hedges had a
notional amount of $20 million and an estimated fair value of ($450) thousand.
Interest rate swaps accounted for as fair value hedges had a notional amount of
$207.5 million and an estimated fair value of ($4.5) million. These estimated
fair value amounts are offset by equal fair value amounts of the CD's that are
being hedged.
During the quarter ended March 31, 2001, we entered into interest rate
swap agreements totaling $20 million in connection with the issuance of like
amounts of our certificates of deposit. These interest rate swap agreements are
accounted for as fair value hedges. During the quarter ended March 31, 2001, one
interest rate swap with a notional amount of $10 million was terminated with no
resulting gain or loss. Total interest rate swaps outstanding as of March 31,
2001 had a notional amount of $110 million and an estimated fair value of $601
thousand. Interest rate swaps accounted for as cash flow hedges had a notional
amount of $20 million and an estimated fair value of ($82) thousand. Interest
rate swaps accounted for as fair value hedges had a notional amount of $90
million and an estimated fair value of $683 thousand.
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
March 31, December 31,
2002 2001
-------------- --------------
Construction and land development
Residential $ 18,699,616 $ 15,711,005
Commercial 17,789,790 13,349,270
Other 3,707,220 1,734,515
Mortgage
Residential 59,430,116 61,740,743
Multifamily residential 7,054,523 -
Commercial 210,942,344 185,367,072
Commercial and industrial 125,848,523 133,258,498
Consumer 9,255,435 9,271,808
------------- -------------
Total loans receivable 452,727,567 420,432,911
Less:
Deferred loan fees, net 2,233,257 2,105,362
Allowance for loan losses 7,561,634 7,354,289
------------- -------------
Loans receivable, net $ 442,932,676 $ 410,973,260
============= =============
Corporate obligations classified as loans are included in commercial and
industrial loans in the table above.
8
The following sets forth information regarding the allowance for loan
losses:
Three Months Three Months
Ended Ended
3/31/2002 3/31/2001
------------- ------------
Allowance at beginning of period $ 7,354,289 $ 4,921,342
Provision for losses charged to income 1,500,000 520,000
Charge-offs (1,580,857) (136,000)
Recoveries 288,202 89,380
----------- -----------
Allowance at end of period $ 7,561,634 $ 5,394,722
=========== ===========
The following table sets forth information regarding past due and nonperforming
assets as of the periods indicated:
At March 31, At December 31,
2002 2001
-------------- ---------------
Accruing loans 90 days
or more delinquent $ - $ -
=========== ===========
Nonperforming loans:
Mortgage-residential - 343,285
Mortgage-commercial 912,610 1,129,290
Commercial and industrial 964,140 -
----------- -----------
Subtotal 1,876,750 1,472,575
----------- -----------
Other real estate owned - -
----------- -----------
Total nonperforming assets $ 1,876,750 $ 1,472,575
=========== ===========
Nonperforming assets to total assets 0.24% 0.19%
=========== ===========
9
NOTE 5 - EARNINGS PER SHARE
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number of shares
of potential dilutive common stock. Income attributable to preferred stock was
$2,963 for the quarter ended March 31, 2002 and for the quarter ended March 31,
2001.
For the three months ended
March 31, 2002 March 31, 2001
-----------------------------------------------
Per Per
Share Share
Shares Amount Shares Amount
-----------------------------------------------
Basic earnings per share 4,284,594 $ 0.52 3,316,181 $ 0.48
======= =======
Effect of dilutive securities:
Stock options 157,082 48,217
Convertible preferred stock 24,173 24,173
--------- ----------
Diluted earnings per share 4,465,849 $ 0.50 3,388,571 $ 0.47
========= ======= ========== =======
NOTE 6 - NEW FINANCIAL ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," (SFAS 142) was issued in June 2001. It discontinues
amortization of intangible assets unless they have finite useful lives, and,
instead, requires that they be tested at least annually for impairment by
comparing their fair values with their recorded amounts. SFAS No. 142 also
requires disclosure of the changes in the carrying amounts of goodwill from
period to period, the carrying amounts of intangible assets by major intangible
asset class for those subject to and not subject to amortization, and the
estimated intangible asset amortization expense for the next five years. We
adopted SFAS No. 142 as of January 1, 2002, and therefore, discontinued the
amortization of goodwill on January 1, 2002. We have not yet evaluated
impairment of goodwill under SFAS No. 142, however, we do not anticipate that an
evaluation of goodwill under this statement will result in impairment of the
goodwill.
Data concerning various intangible assets is presented in the following
tables:
March 31, 2002 December 31, 2001 March 31, 2001
Gross Carrying Accumulated Gross Carrying Accumulated Gross Carrying Accumulated
Value Amortization Value Amortization Value Amortization
---------------------------------------------------------------------------------------
Amortizable core deposit intangibles $ 1,566,163 $ (248,900) $ 1,566,163 $ (209,600) $ 1,566,163 $ (60,900)
Amortizable other intangibles 361,300 (167,883) 442,763 (232,162) 646,734 (95,178)
Unamortizable goodwill 1,586,651 (145,200) 1,586,651 (145,200) 1,646,651 (72,100)
10
Amortization expense: Core Deposit
Other Intangibles Goodwill
----------------------------------------
Three months ended March 31, 2002 $ 17,184 $ 39,300 $ -
Three months ended March 31, 2001 19,083 26,100 30,900
Estimated amortization expense: Core Deposit
Other Intangibles Goodwill
----------------------------------------
Nine months ended December 31, 2002 $ 51,547 $ 117,900 $ -
Year ended December 31,
2003 $ 20,400 $ 157,200 $ -
2004 20,400 157,200 -
2005 20,400 157,200 -
2006 20,400 157,200 -
2007 20,400 157,200 -
For the three months ended
March 31, 2002 March 31, 2001
-------------------------------------
Reported net income $ 2,228,018 $ 1,597,697
Add back - goodwill amortization, net of tax - 30,900
-----------------------------------
Adjusted net income $ 2,228,018 $ 1,628,597
===================================
Reported basic earnings per share: $ 0.52 $ 0.48
Add back - goodwill amortization per share, net of tax - 0.01
-----------------------------------
Adjusted basic earnings per share $ 0.52 $ 0.49
===================================
Reported diluted earnings per share: $ 0.50 $ 0.47
Add back - goodwill amortization per share, net of tax - 0.01
-----------------------------------
Adjusted diluted earnings per share $ 0.50 $ 0.48
===================================
SFAS No. 143, "Accounting for Asset Retirement Obligations," was also
issued in June 2001. SFAS No. 143 addresses accounting and reporting for legal
obligations and related costs associated with the retirement of long-lived
assets. The Statement requires that the fair value of the liability for an asset
retirement obligation be recognized in the period incurred if a reasonable
estimate of fair value can be made. The estimated retirement costs are
capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143
is effective for financial statements issued for fiscal years beginning after
June 15, 2002. We have not determined the impact, if any, SFAS No. 143 will have
on the company.
SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets," was
issued in October 2001. SFAS No. 144 supercedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
and the accounting and reporting provisions of APB No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business. SFAS No. 144 retains
many of the provisions of SFAS No. 121, but addresses certain implementation
issues associated with that statement. We adopted SFAS No. 144 effective January
1, 2002, and the adoption of this standard had no impact on our financial
position or results of operations.
11
SOUTHERN FINANCIAL BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Financial Condition
- -------------------
Total assets of Southern Financial Bancorp, Inc. ("Southern Financial")
at March 31, 2002 increased to $791.8 million from $785.0 at December 31, 2001.
The net increase in gross loans receivable was comprised of $57.4 million in new
loan originations and net purchases of $13.3 million, offset by repayments
totaling $38.5 million. Investment securities decreased to $269.4 million at
March 31, 2002 from $306.6 million at December 31, 2001 due to sales of
securities and prepayments, which more than offset purchases. During the quarter
two other investments were made which are not included in earning assets. These
included the purchase of $5 million in bank owned life insurance and a $6.7
million investment in a low income housing partnership which is expected to
provide tax credits to us over the next ten years.
Results of Operations
- ---------------------
Our operating results depend primarily on our net interest income,
which is the difference between interest and dividend income on interest-earning
assets such as loans and investments, and interest expense on interest-bearing
liabilities such as deposits and borrowings. Operating results are also affected
by the level of our noninterest income, including income or loss from the sale
of loans and fees and service charges on deposit accounts, and by the level of
our operating expenses, including compensation, premises and equipment and
income taxes.
The following table presents, for the periods indicated, average
balances of and weighted average yields on interest-earning assets and average
balances of and weighted average effective rates paid on interest-bearing
liabilities. Calculations have been made utilizing daily average balances, and
the effect of the interest rate swaps is reflected in the average rate on
deposits. Loan balances do not include non-accrual loans.
12
Three Months Ended March 31,
-------------------------------------------------------------------------------
2002 2001
---------------------------------------- ------------------------------------
Average Interest Average Average Interest Average
Outstanding Earned/ Yield/Rate Outstanding Earned/ Yield/Rate
Balance Paid Rate Balance Paid Rate
-------------- ---------- ----------- ------------ -------- ---------
($ in thousands)
Assets:
Interest-earning assets:
Loans $ 421,969 $ 8,035 7.66 % $ 320,980 $ 7,589 9.40 %
Securities 326,669 4,753 5.82 258,821 4,739 7.32
Investments 7,993 32 1.58 3,743 53 5.75
------------ -------- ------------ -------
Total interest-earning assets 756,631 12,820 6.78 % 583,544 12,381 8.49 %
Less allowance for loan losses 7,758 5,065
------------ ------------
Total interest-earning assets, net of
allowance 748,873 578,479
Noninterest-earning assets:
Bank owned life insurance 18,017 15,298
Other noninterest-earning assets 37,848 51,868
------------ ------------
Total assets $ 804,738 $ 645,645
============ ============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Interest-bearing demand deposits $ 35,168 $ 101 1.16 % $ 30,802 $ 99 1.31 %
Savings and money market accounts 93,057 378 1.65 73,758 751 4.13
Time deposits 429,545 3,239 3.06 334,551 4,967 6.02
Other borrowings 92,860 614 2.65 65,204 937 5.83
Company-obligated mandatorily
redeemable 11.0% preferred securities
of Southern Financial Capital Trust I 5,000 143 11.44 5,000 143 11.44
Company-obligated mandatorily
redeemable 10.60% preferred securities
of Southern Financial Statutory Trust I 8,000 215 10.74 8,000 215 10.74
------------ -------- ------------ -------
Total interest-bearing liabilities 663,630 4,690 2.83 % 517,315 7,112 5.50 %
Noninterest-bearing liabilities:
Demand deposits 66,012 64,323
Other liabilities 9,850 23,144
------------ ------------
Total liabilities 739,492 604,782
Stockholders' equity 65,246 40,863
------------ ------------
Total liabilities and stockholder' equity $ 804,738 $ 645,645
============ ============
Net interest income $ 8,130 $ 5,269
======== =======
Net interest spread 3.95 % 2.99 %
Net interest margin 4.30 % 3.61 %
13
The following table presents information regarding changes in interest
income and interest expense for the periods indicated for each major category of
interest-earning asset and interest-bearing liability which distinguishes
between the changes attributable to changes in volume (changes in volume
multiplied by old rate) and changes in rate (changes in rate multiplied by old
volume). The dollar amount of changes in interest income and interest expense
attributable to changes in rate/volume (change in rate multiplied by change in
volume) have been allocated between rate and volume variances based on the
percentage relationship of such variances to each other.
The Three Months Ended
March 31, 2002
Compared to
The Three Months Ended
March 31, 2001
--------------------------------------
Increase (Decrease) Due to Change in
--------------------------------------
Volume Rate Total
--------------------------------------
($ in thousands)
Interest-earning assets:
Loans 2,039 $ (1,593) 446
Securities and investments 1,157 (1,164) (7)
-------- -------- --------
Total increase (decrease) in
interest income 3,196 (2,757) 439
-------- -------- --------
Interest-bearing liabilities:
Interest-bearing deposits 1,325 (3,424) (2,099)
Other borrowings 303 (625) (322)
-------- -------- --------
Total increase (decrease) in
interest expense 1,628 (4,049) (2,421)
-------- -------- --------
Increase in net interest income $ 1,568 $ 1,292 $ 2,860
======== ======== ========
Our net income was $2.2 million for the three months ended March 31,
2002, an increase of 39.5% over the $1.6 million earned during the quarter ended
March 31, 2001. The increase in net income was primarily due to growth in
interest-earning assets and increased fee income offset by a higher loan loss
provision, net losses on sales of investment securities, and increased operating
expenses.
Net interest income before provision for loan losses for the quarter
was $8.1 million, an increase of 54.3% over the same quarter in the prior year.
The increase in net interest income was primarily due to growth in earning
assets resulting from loan originations and purchases, and an improved margin.
Average earning assets increased 29.7% to $757 million for the quarter ended
March 31, 2002 compared with 2001. Gross loans receivable increased $32.2
million, or 7.7%, over the December 31, 2001 balance due to loan originations
and purchases during the quarter. Conversely, investment securities decreased
$37.2 million, or 12.2% compared with December 31, 2001 due to security
repayments and sales. Deposits and borrowings combined with proceeds from
investment security repayments and sales funded the loan growth.
The net interest margin was 4.30% and 3.61% for the quarters ended
March 31, 2002 and 2001, respectively, as the ratio of average investment
securities to loans declined to 77% compared with the prior year when it was
81%. The continued reduction in the cost of funds also contributed to the
improved margin. The cost of funds declined to 2.83% from 5.50% for the quarters
ended March 31, 2002 and 2001, respectively. The yield on earning assets only
declined to 6.78% from 8.49% during the same periods.
The provision for loan losses for the quarter ended March 31, 2002 was
$1.5 million, an increase when compared to the first quarter of 2001, when it
was $520 thousand, but a decrease from the fourth quarter 2001 provision of $2.1
million. The higher provision compared with the first quarter of 2001 was the
result of loan growth, the refined methodology of estimating our allowance for
loan losses implemented during the fourth quarter of 2001, and higher
charge-offs during the quarter. During the quarter ended March 31, 2002,
annualized net charge-offs were 1.23% of average loans, or $1.3 million, higher
relative to prior quarters, due to deterioration of a few isolated credits. The
ratio of allowance to loans receivable outstanding at March 31, 2002 was 1.68%
compared with March 31, 2001, when it was 1.63%. At March 31, 2002, the ratio of
nonperforming assets to total assets was .24% and the allowance to nonperforming
assets ratio was 402.9% compared with March 31, 2001, when these ratios were
...29% and 278.2%, respectively. The improvement in both measurements indicates
continued sound asset quality. We continue to monitor the loan portfolio and
make charge-offs we deem appropriate, particularly given the uncertainty in the
U.S. economy. Due to the uncertainty of risks in the loan portfolio,
management's judgement of the amount of the allowance necessary to absorb loan
losses is approximate; however, management believes that
14
the allowance for loan losses at March 31, 2002 is adequate to absorb known and
inherent losses in the loan portfolio at that date.
Total other income decreased from $1.6 million to $894 thousand for the
quarters ended March 31, 2002 and 2001, respectively. During the first quarter
of 2002, we sold investment securities totaling $96.5 million, generating net
losses of $385 thousand. During the first quarter of 2001, net gains from
security sales totaled $219 thousand and gains on sales of SBA loans totaled
$252 thousand. Excluding these net gains and losses from sales of investment
securities, and gains on sales of SBA loans, other income increased to $1.3
million in 2002 from $1.1 million in 2001. Areas of increase included account
maintenance and electronic banking fees, fees generated from commercial service
products including lockbox fees, and system maintenance fees generated from
Southern WebTech.com, the wholly-owned bank software development company.
Additionally, income from bank owned life insurance increased as a result of an
additional investment of $5 million made during the first quarter of 2002.
Total other expenses for the quarter were $4.3 million, an increase of
6.0% when compared to the first quarter of 2001. Employee compensation accounted
for most of the increase and was primarily due to normal pay increases and a
larger employee base resulting from the new Georgetown branch and the loan
production office in Charlottesville. The efficiency ratio, the ratio of
non-interest expenses before amortization of intangibles divided by net interest
income and non-interest income less gains on securities and non-recurring items,
was 44.6% for the quarter ended March 31, 2002, an improvement compared with
62.0% for the quarter ended March 31, 2001.
Regulatory Capital Requirements
- -------------------------------
At March 31, 2002 we exceeded all regulatory capital standards.
Liquidity
- ---------
The objective of our liquidity management is to assure the ability to
meet our financial obligations. These obligations include the payment of
deposits on demand or at maturity, the repayment of borrowings at maturity, and
the ability to fund loan commitments and other new business opportunities. We
obtain funding from a variety of sources, including customer deposit accounts,
customer certificates of deposit and payments on our loans and investments.
Historically, our level of core deposits has been insufficient to fully fund our
lending activities. Therefore, we must seek funding from additional sources,
including brokered certificates of deposit, available-for-sale investment
securities, lines of credit from the Federal Home Loan Bank of Atlanta and
reverse repurchase agreement borrowings from approved securities dealers. In
addition, we use derivative products such as interest rate swaps to enhance our
liquidity through the issuance of long-term liabilities to match with our
long-term assets. We also enhance our liquidity by monitoring unfunded loan
commitments, which reduces unexpected funding requirements.
During the three months ended March 31, 2002, we funded our financial
obligations with deposits, borrowings from the Federal Home Loan Bank of
Atlanta, and sales of investment securities. At March 31, 2002, we had $47.2
million of unfunded lines of credit and undisbursed construction loan funds of
$28.2 million. Approved loan commitments were $13.3 million at March 31, 2002.
It is anticipated that funding requirements for these commitments can be met
from the normal sources of funds.
Other Significant Matters
- -------------------------
Southern Financial signed a definitive merger agreement providing for
the merger of Metro-County Bank of Virginia, Inc. into Southern Financial Bank,
a wholly-owned subsidiary of Southern Financial. We have agreed to pay $7.25 for
each outstanding share of Metro-County's common stock. The purchase price will
be paid in a combination of Southern Financial common stock and cash. The
transaction is expected to close in the third quarter of 2002, and the agreement
is subject to customary conditions, including shareholder and regulatory
approval.
15
Special Note Regarding Forward-looking Information
- --------------------------------------------------
Certain statements under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
Quarterly Report and the documents incorporated herein by reference constitute
"forward-looking statements" within the meaning of the United States Private
Securities Litigation Reform Act of 1995. Such forward looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of Southern Financial, or
industry results, to be materially different from any future results,
performance, or achievements expressed or implied by such forward-looking
statements. Such factors include, among others, the following: general economic
and business conditions in Southern Financial's market area, inflation,
fluctuations in interest rates, changes in government regulations and
competition, which will, among other things, impact demand for loans and banking
services; the ability of Southern Financial to implement its business strategy;
and changes in, or the failure to comply with, government regulations.
Forward-looking statements are intended to apply only at the time they
are made. Moreover, whether or not stated in connection with a forward-looking
statement, Southern Financial undertakes no obligation to correct or update a
forward-looking statement should Southern Financial later become aware that it
is not likely to be achieved. If Southern Financial were to update or correct a
forward-looking statement, investors and others should not conclude that
Southern Financial would make additional updates or corrections thereafter.
Item 3 - Quantitative and Qualitative Disclosure about Market Risk
We are engaged primarily in the business of investing funds obtained
from deposits and borrowings into interest-bearing loans and investments.
Consequently, our earnings depend to a significant extent on our net interest
income, which is the difference between the interest income on loans and
investments and the interest expense on deposits and borrowing. To the extent
that our interest-bearing liabilities do not reprice or mature at the same time
as our interest-bearing assets, we are subject to interest rate risk and
corresponding fluctuations in net interest income. We have employed
asset/liability management policies that attempt to manage our interest-earning
assets and interest-bearing liabilities, thereby attempting to control the
volatility of net interest income, without having to incur unacceptable levels
of credit or investment risk.
We actively manage our overall exposure to changes in interest rates.
In managing our funding, we first attempt to gauge the direction of interest
rates, which will determine how much sensitivity we are willing to take. If
rates are decreasing, we seek to fund with liabilities that reprice in the near
future. If rates are rising, we attempt to do the opposite. When necessary, we
will enter into interest rate swaps, financial options or forward delivery
contracts for the purpose of reducing interest rate risk.
Management uses a duration gap of equity approach to manage our
interest rate risk and reviews quarterly interest sensitivity reports prepared
for us by the Federal Home Loan Bank of Atlanta. This approach uses a model
which generates estimates of the change in our market value of portfolio equity
("MVPE") over a range of interest rate scenarios. MVPE is the present value of
expected cash flows from assets, liabilities and off-balance sheet contracts
using standard industry assumptions about estimated loan prepayment rates,
reinvestment rates and deposit decay rates.
With respect to our residential mortgage loan portfolio, it is our
policy to retain those mortgage loans which have an adjustable interest rate and
to sell most fixed rate mortgage loans originated into the secondary market. In
addition, our commercial loans generally have rates that are tied to the prime
rate, the one-year Constant Maturity Treasury ("CMT") rate as reported by the
Federal Reserve Board, or the three-year CMT rate. Both of these actions help
control our exposure to rising interest rates.
The following table prepared by the Federal Home Loan Bank of Atlanta
sets forth an analysis of our interest rate risk as measured by the estimated
change in MVPE resulting from instantaneous and sustained parallel shifts in the
yield curve (plus or minus 300 basis points, measured in 100 basis point
increments) as of March 31, 2002 and December 31, 2001:
16
Sensitivity of Market Value of Portfolio Equity
As of March 31, 2002
(amounts in thousands)
Market Value of
Portfolio Equity as a % of
Change in Market Value of Portfolio Equity -------------------------
Interest Rates -------------------------------- Portfolio
In Basis Points $ Change % Change Total Equity
(Rate Shock) Amount From Base From Base Assets Book Value
- --------------------------------------------------------------------------------
Up 300 $ 78,388 $ (29,026) (27.02)% 9.90% 120.82%
Up 200 89,285 (18,129) (16.88) 11.28 137.61
Up 100 99,976 (7,438) (6.92) 12.63 154.09
Base 107,414 - - 13.57 165.55
Down 100 108,959 1,545 1.44 13.76 167.93
Down 200 118,842 11,428 10.64 15.01 183.17
Down 300 132,791 25,377 23.63 16.77 204.67
Sensitivity of Market Value of Portfolio Equity
As of December 31, 2001
(amounts in thousands)
Market Value of
Portfolio Equity as a % of
Change in Market Value of Portfolio Equity -------------------------
Interest Rates -------------------------------- Portfolio
In Basis Points $ Change % Change Total Equity
(Rate Shock) Amount From Base From Base Assets Book Value
- --------------------------------------------------------------------------------
Up 300 $ 53,137 $ (29,175) (35.44)% 6.77% 82.14%
Up 200 65,736 (16,576) (20.14) 8.37 101.62
Up 100 77,441 (4,871) (5.92) 9.87 119.71
Base 82,312 - - 10.49 127.24
Down 100 83,473 1,161 (1.41) 10.63 129.04
Down 200 92,335 10,023 12.18 11.76 142.74
Down 300 103,921 21,609 26.25 13.24 160.65
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurement. Modeling changes in MVPE requires the making of
certain assumptions that may or may not reflect the manner in which actual
yields and costs respond to changes in market interest rates. Accordingly,
although the MVPE table provides an indication of our interest rate risk
exposure at a particular point in time, such measurement is not intended to and
does not provide a precise forecast of the effect of changes in market interest
rates on our worth.
17
SOUTHERN FINANCIAL BANCORP, INC.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
------------------
We and the bank from time to time are involved in legal
proceedings arising in the normal course of business.
Management believes that neither we nor the bank are a party
to, nor is any of our property the subject of, any material
pending or threatened legal proceedings which, if determined
adversely, would have a material adverse effect upon our
consolidated position, results of operations or cash flows.
Item 2. CHANGES IN SECURITIES
---------------------
Not applicable
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
Not applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
Not applicable
Item 5. OTHER INFORMATION
-----------------
Not applicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
Exhibits Required
None
Reports on Form 8-K
No reports on Form 8-K were filed during the three months
ended March 31, 2002.
18
SOUTHERN FINANCIAL BANCORP, INC.
Part III. SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
SOUTHERN FINANCIAL BANCORP, INC.
--------------------------------------
(Registrant)
Date 5/14/2002 /s/ Georgia S. Derrico
---------- --------------------------------------
Georgia S. Derrico
Chairman and
Chief Executive Officer
(Duly Authorized Representative)
Date 5/14/2002 /s/ William H. Lagos
---------- --------------------------------------
William H. Lagos
Senior Vice President and Controller
Principal Accounting Officer
(Duly Authorized Representative)
19