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.:
September 30, 1999 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
Virginia 54-1779978
- ------------------------------ -------------------------
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
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 October 31, 1999, there were 2,656,407 shares of the registrant's Common
Stock outstanding.
SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 1999
TABLE OF CONTENTS
-----------------
Page
PART I. FINANCIAL INFORMATION Number
- ------------------------------ ------
Item 1. Financial Statements
Consolidated Balance Sheets
as of September 30, 1999 (Unaudited) and
December 31, 1998 3
Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 1999 and 1998
(Unaudited) 4
Consolidated Statements of Comprehensive Income
for the Three and Nine Months Ended September 30, 1999 and
1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998
(Unaudited) 6
Notes to Consolidated Financial Statements
(Unaudited) 7 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 16
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 17 - 18
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
PART III. SIGNATURES 20
- --------- -----------
2
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
September 30,
1999 December 31,
(Unaudited) 1998
------------- ------------
ASSETS
Cash and due from banks $ 6,280,330 $ 5,374,945
Overnight earning deposits 1,255,541 928,435
Investment securities, available-for-sale 81,821,408 74,438,682
Investment securities, held-to-maturity 28,501,975 38,151,121
Loans held for sale 479,000 602,500
Loans receivable, net 157,213,169 131,645,482
Federal Home Loan Bank stock, at cost 1,500,000 1,082,500
Premises and equipment, net 2,930,285 2,370,711
Other assets 7,731,136 4,248,673
------------- -------------
Total assets $ 287,712,844 $ 258,843,049
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 236,852,768 $ 231,925,592
Advances from Federal Home Loan Bank 27,000,000 3,500,000
Other liabilities 2,525,871 2,494,717
------------- -------------
Total liabilities 266,378,639 237,920,309
------------- -------------
Commitments
Stockholders' equity:
Preferred stock 136 136
Common stock 16,405 16,331
Capital in excess of par value 15,724,465 15,648,527
Retained earnings 7,157,586 5,469,135
Accumulated other comprehensive income (loss) (1,093,300) 259,698
Treasury stock, at cost (471,087) (471,087)
------------- -------------
Total stockholders' equity 21,334,205 20,922,740
------------- -------------
Total liabilities and stockholders' equity $ 287,712,844 $ 258,843,049
============= =============
The accompanying notes are an intergral part of those
financial statements.
3
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------------ ---------- --------- ----------
Interest income:
Loans $ 3,476,608 $ 3,071,959 $ 9,807,464 $ 9,282,779
Investment securities 1,786,722 1,613,003 5,369,841 4,584,017
----------- ----------- ----------- -----------
Total interest income 5,263,330 4,684,962 15,177,305 13,866,796
----------- ----------- ----------- -----------
Interest expense:
Deposits 2,434,147 2,519,203 7,278,452 7,420,245
Borrowings 216,966 80,431 424,291 163,538
----------- ----------- ----------- -----------
Total interest expense 2,651,113 2,599,634 7,702,743 7,583,783
----------- ----------- ----------- -----------
Net interest income 2,612,217 2,085,328 7,474,562 6,283,013
Provision for loan losses 255,000 225,000 925,000 675,000
----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 2,357,217 1,860,328 6,549,562 5,608,013
----------- ----------- ----------- -----------
Other income:
Gain on sale of loans 325,716 266,618 866,484 486,296
Fee income 418,452 369,817 1,208,872 1,049,814
Other 8,537 31,057 253,688 59,028
----------- ----------- ----------- -----------
Total other income 752,705 667,492 2,329,044 1,595,138
----------- ----------- ----------- -----------
Other expense:
Employee compensation and benefits 1,020,023 740,063 2,860,074 2,111,088
Premises and equipment 356,112 287,547 1,006,935 807,943
Data processing expense 210,278 174,989 594,759 523,519
Deposit insurance assessments 34,569 31,818 102,171 92,903
Advertising 47,886 43,556 181,920 124,931
Other 305,508 293,133 936,803 808,265
----------- ----------- ----------- -----------
Total other expense 1,974,376 1,571,106 5,682,662 4,468,649
----------- ----------- ----------- -----------
Income before income taxes 1,135,546 956,714 3,195,944 2,734,502
Provision for income taxes 368,800 298,700 944,600 772,200
----------- ----------- ----------- -----------
Net income $ 766,746 $ 658,014 $ 2,251,344 $ 1,962,302
=========== =========== =========== ===========
Earnings per common share:
Basic $ 0.47 $ 0.41 $ 1.40 $ 1.22
Diluted 0.46 0.38 1.34 1.14
Weighted average shares outstanding:
Basic 1,610,673 1,602,066 1,606,352 1,595,993
Diluted 1,685,009 1,717,428 1,684,557 1,715,787
The accompanying notes are an integral part of these financial statements.
4
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
--------- --------- ----------- ------------
Net income $ 766,746 $ 658,014 $ 2,251,344 $ 1,962,302
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain 147,176 - 848,321 -
Reclassification adjustment for net interest
expense included in net income 5,824 - 32,979 -
Available-for-sale securities:
Unrealized holding gain/(loss) (2,067,485) 359,577 (2,843,180) 264,215
Reclassification adjustment for gains
included in net income - - (88,117) -
----------- ----------- ----------- -----------
Other comprehensive income before tax (1,914,485) 359,577 (2,049,997) 264,215
Income tax expense related to items of other
comprehensive income 650,925 (122,256) 696,999 (89,833)
----------- ----------- ----------- -----------
Other comprehensive income, net of tax (1,263,560) 237,321 (1,352,998) 174,382
Comprehensive income $ (496,814) $ 895,335 $ 898,346 $ 2,136,684
=========== =========== =========== ===========
The accompanying notes are an integral part of these
financial statements
5
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended
September 30,
1999 1998
---------- ----------
Cash flows from operating activities:
Net Income $ 2,251,344 $ 1,962,302
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 683,424 693,002
Provision for loan losses 925,000 675,000
Gain on sale of loans (866,484) (486,296)
Gain on sale of securities (88,117) (22,716)
Amortization of deferred loan fees (420,792) (477,552)
Net change in loans held for sale 321,029 1,313,741
Increase in other assets (240,378) (925,893)
Increase in other liabilities 238,341 2,235,394
----------- ------------
Net cash provided by operating activities 2,803,367 4,966,982
----------- ------------
Cash flows from investing activities:
(Increase) decrease in loans receivable (27,187,813) 1,117,652
Purchase of investment securities, held-to-maturity - (1,959,970)
Purchase of investment securities, available-for-sale (33,464,570) (50,748,447)
Sale of investment securities available-for-sale 5,404,657 6,702,750
Paydowns of investment securities 27,035,189 25,364,188
Increase in overnight earning deposits, net (327,106) (5,537,128)
Increase in premises and equipment, net (881,135) (268,011)
Increase in Federal Home Loan Bank stock (417,500) (152,000)
----------- ------------
Net cash used in investing activities (29,838,278) (25,480,966)
----------- ------------
Cash flows from financing activities:
Net increase in deposits 4,927,176 24,409,262
Increase (decrease) in advances from FHLB 23,500,000 (4,000,000)
Proceeds from stock options exercised 76,013 91,739
Dividends on preferred and common stock (562,893) (432,842)
----------- ------------
Net cash provided by financing activities 27,940,296 20,068,159
----------- ------------
Net increase (decrease) in cash and due from banks 905,385 (445,825)
Cash and due from banks, beginning of period 5,374,945 4,559,266
----------- ------------
Cash and due from banks, end of period $ 6,280,330 $ 4,113,441
=========== ============
The accompanying notes are an integral part of these
statements
6
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - 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
generally accepted accounting principles. 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 nine-month period ended September 30, 1999 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 Annual Report for the year ended
December 31, 1998.
NOTE 2 - HEDGE ACCOUNTING
During the first quarter of 1999, the Bancorp entered into four
interest rate swap agreements that are accounted for as cash flow hedges. In
accordance with SFAS 133, the Bancorp records the change in fair value of the
swaps in comprehensive income. To the extent that the hedge is not completely
effective, the ineffective portion is charged or credited to other income or
expense. The amounts recorded in comprehensive income subsequently are
reclassified into interest expense as a yield adjustment in the same period in
which the related interest on the certificates of deposit (CD's) affects
earnings.
Each of the four swap agreements has a notional amount of $5 million,
and the Bancorp agreed to pay a rate fixed for the period of the swap and
receive 3 month LIBOR. Three of the swaps are for a period of five years and
have fixed rates ranging from 5.23% to 5.29%; the fourth swap is for a period of
ten years and has a fixed rate of 5.45%. The purpose of all four of these swaps
was to hedge the variability of cash flows resulting from changes in interest
rates in the Bancorp's floating rate liabilities, specifically the Bancorp's
CD's in amounts greater than $90,000, which have maturities of one month to six
months. The Bancorp performed a regression analysis using monthly averages of
both 3 month LIBOR and the Bancorp's hedged CD's and determined that there was a
highly effective correlation. The Bancorp designated CD's that were outstanding
on the inception dates of the swaps as being hedged by the swaps, and as the
hedged CD's mature, the Bancorp has identified other individual CD's to replace
them. During the year ending December 31, 1999, approximately $46 thousand of
gains in accumulated other comprehensive income related to the interest rate
swaps are expected to be reclassified into interest expense as a yield
adjustment of the hedged CD's.
During the quarter ended September 30, 1999, no portion of the hedge
was "ineffective" as the spread between LIBOR (the denomination of the floating
rate side of the interest rate swaps) and the Bancorp's CD issuance costs
changed only minimally. Since there was no change in the net present value of
the favorable variance in the spread for the weighted average remaining life of
the interest rate swaps, the Bancorp recognized no income.
7
NOTE 3 - INVESTMENT SECURITIES
The following table sets forth the Bancorp's investment securities
portfolio as of the dates indicated:
September 30, 1999 December 31, 1998
Amortized Estimated Aortized Estimated
Cost Fair Value Cost Fair Value
--------- ---------- ---------- -----------
Available-for-sale securities:
FHLMC preferred stock $ - $ - $ 3,807,585 $ 3,888,524
FHLMC MBS 7,752,982 7,741,319 11,996,172 12,005,667
GNMA MBS 2,806,022 2,778,575 3,825,601 3,771,448
FNMA MBS 16,911,804 16,891,770 29,671,448 29,813,650
Collaterized mortgage obligations 27,382,895 26,337,408 1,526,527 1,529,095
Commercial MBS 24,105,888 23,025,000 18,043,819 18,246,250
Obligations of counties and
municipalities 3,916,909 3,625,447 3,234,489 3,220,498
Corporate obligations 990,494 945,482 989,319 992,300
U.S. Treasury securities 491,056 476,407 - -
U.S. Government agency obligations - - 949,066 971,250
---------- ---------- ---------- ----------
$ 84,358,050 $ 81,821,408 $ 74,044,026 $ 74,438,682
========== ========== ========== ==========
Held-to-maturity securities:
FHLMC MBS $ 3,064,456 $ 3,044,728 $ 4,091,316 $ 4,070,132
GNMA MBS 18,230,059 17,932,645 24,305,052 24,004,669
FNMA MBS 5,248,579 5,146,577 6,779,894 6,731,670
Collateralized mortgage
obligations - - 1,015,264 1,013,565
Obligations of counties
and municipalities 1,958,881 1,856,911 1,959,595 1,974,308
------------ ------------- ------------ ------------
$ 28,501,975 $ 27,980,861 $ 38,151,121 $ 37,794,344
============ ============ ============ =============
8
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
September 30, December 31,
1999 1998
------------- ------------
Mortgage:
Residential $ 23,932,826 $ 26,046,289
Nonresidential 86,016,842 64,890,406
Construction:
Residential 3,729,809 5,184,844
Nonresidential 11,244,078 11,213,848
Non-Mortgage:
Business 32,898,923 24,773,003
Consumer 2,416,957 2,424,602
------------- -------------
Total loans receivable 160,239,435 134,532,992
Less:
Deferred loan fees, net 764,528 836,898
Allowance for loan losses 2,261,738 2,050,612
------------- -------------
Loans receivable, net $ 157,213,169 $ 131,645,482
============= =============
The following sets forth information regarding the allowance for loan losses:
Nine Months Nine Months
Ended Ended
9/30/1999 9/30/1998
------------ -----------
Allowance at beginning of period $ 2,050,612 $ 2,036,532
Provision for losses charged
to income 925,000 675,000
Charge-offs (918,686) (546,610)
Recoveries 204,812 7,853
------------ ----------
Allowance at end of period $ 2,261,738 $ 2,172,775
============ ===========
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 dilutive common stock equivalents.
For the three months ended For the nine months ended
September 30, 1999 September 30, 1998 September 30, 1999 September 30, 1998
------------------ ------------------ ------------------ ------------------
Per Per Per Per
Share Share Share Share
Shares Amount Shares Amount Shares Amount Shares Amount
--------- ------- --------- ------- ------- ------- ------- -------
Basic EPS 1,610,673 $0.47 1,602,066 $0.41 1,606,352 $1.40 1,595,993 $1.22
======= ======= ======= ======
Effect of dilutive
Securities:
Stock Options 52,361 93,097 56,230 95,568
Convertible
Preferred Stock 21,975 22,265 21,975 24,226
-------- --------- --------- ---------
Diluted EPS 1,685,009 $0.46 1,717,428 $0.38 1,684,557 $1.34 1,715,787 $1.14
======== ====== ========= ====== ========= ====== ========= ======
NOTE 6 - OTHER SIGNIFICANT MATTERS
On October 1, 1999, Southern Financial Bancorp, Inc. (Southern Financial)
merged with the Horizon Bank of Virginia (Horizon). This transaction was
accounted for as a pooling-of-interests business combination. Under the terms
of the merger agreement, Horizon shareholders received .63 or 1,045,734 shares
of Southern Financial Bancorp common stock. Unaudited pro forma consolidated
financial information has been filed on Form 8-K of Southern Financial dated
October 1, 1999.
10
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. (the "Bancorp") at
September 30, 1999 were $287.7 million, an increase of $28.9 million, or 11.2%,
from total assets of $258.8 million at December 31, 1998. Total liabilities
increased by $28.5 million, or 12%, to $266.4 million at September 30, 1999 from
$237.9 million at December 31, 1998. The growth in total assets resulted
primarily from an increase of $25.6 million in loans receivable.
Total loans receivable increased by $25.6 million to $157.2 million at
September 30, 1999 from $131.6 million at December 31, 1998, as new loan
originations more than offset loan sales and prepayments of residential mortgage
loans during the period. In this period the Bancorp sold the guaranteed portion
of some of the Small Business Administration (SBA) loans that it held in
portfolio. These sales totaled $5.8 million. Non-residential permanent mortgage
loans increased by $21.1 million to $86 million at September 30, 1999, from
$64.9 million at December 31, 1998. Non-mortgage business loans increased $8.1
million to $32.9 million at September 30, 1999, from $24.8 million at December
31, 1998. Residential construction loans decreased $1.5 million from $5.2
million at December 31, 1998, to $3.7 million at September 30, 1999. Residential
permanent mortgage loans decreased $2.1 million from $26 million at December 31,
1998, to $23.9 million at September 30, 1999.
Investment securities available-for-sale increased from $74.4 million
at December 31, 1998, to $81.8 million at September 30, 1999. There were
purchases of $33.5 million of investment securities, all of which were
designated as available-for-sale. There were repayments and amortization of
$17.7 million of investment securities available-for-sale during the period.
There were sales of $5.4 million of investment securities available-for-sale
during the nine months ended September 30, 1999.
Investment securities held-to-maturity decreased by $9.6 million to
$28.5 million at September 30, 1999, from $38.1 million at December 31, 1998.
This decrease resulted from repayments and amortization during the period.
Other assets increased by $3.5 million from $4.2 million at December
31, 1998, to $7.7 million at September 30, 1999. Most of the increase was due to
an addition to real estate owned of $2.1 million representing nonresidential
property. Management is confident of realizing the book value of this property.
The increase in total assets was funded by an increase of $23.5 million
in advances from the Federal Home Loan Bank of Atlanta. Customer deposits
increased $4.9 million, or 2.1%, to $236.8 million at September 30, 1999 from
$231.9 million at December 31, 1998.
RESULTS OF OPERATIONS
- ---------------------
The Bancorp's principal sources of revenue are interest on loans, gains
on sales of loans, fees and service charges on loans, interest and dividends on
investment securities, and service charges on deposit accounts. Net income is
affected by interest on deposits and borrowings and operating expenses.
The following table presents, for periods indicated, average balances
of and weighted average yields on interest-earning assets and average balances
of and weighted average effective rates paid on interest-bearing liabilities.
Calculations have been made utilizing month-end average balances for loans and
investment securities and daily average balances for borrowings and deposits,
and the effect of the interest rate swaps is reflected in the average rate on
deposits. Loan balances do not include non-accrual loans.
11
Nine Months Ended September 30,
1999 1998
-----------------------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
---------------------- ---------------------
($ in thousands)
Interest-earning assets
Loans receivable $143,165 9.13 % $127,689 9.72 %
Investment securities 116,839 6.13 100,569 6.08
-------- ----- -------- -----
Total interest-earning
assets 260,004 7.78 228,258 8.12
-------- ----- -------- -----
Interest-bearing liabilities
Deposits 237,095 4.10 210,253 4.72
Borrowings 10,458 5.35 3,807 5.68
-------- ----- -------- -----
Total interest-bearing
liabilities 247,553 4.15 214,060 4.74
-------- ----- -------- -----
Average dollar difference
between interest-earning assets
and interest-bearing
liabilities 12,451 14,198
======== ========
Interest rate spread 3.63 3.38
===== =====
Interest margin 3.83 3.67
===== =====
The following table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to changes in volume (changes in volume
multiplied by old rate) and changes in rate (changes in rate multiplied by old
volume). The dollar changes in interest income and interest expense attributable
to changes in rate/volume (change in rate multiplied by change in volume) have
been allocated between rate and volume variances based on the percentage
relationship of such variances to each other. The effect of the interest rate
swaps is reflected in interest expense on deposits.
Nine Months Ended
September 30, 1999
Compared to Nine Months Ended
September 30, 1998
-----------------------------------------
Volume Rate Total
-------- --------- --------
($ in thousands)
Interest income
Loans receivable $ 1,102 $ (578) $ 524
Investment securities 748 38 786
-------- -------- --------
Total interest income 1,850 (540) 1,310
-------- -------- --------
Interest expense
Deposits 891 (1,033) (142)
Borrowings 271 (11) 260
-------- -------- --------
Total interest expense 1,162 (1,044) 118
-------- -------- --------
Net interest income 688 504 1,192
======== ======== ========
12
The Bancorp's net income was $2.3 million for the nine months ended
September 30, 1999, compared to $2 million for the nine months ended September
30, 1998, an increase of $289 thousand, or 14.7%. Diluted earnings per share
were $1.34 and $1.14 for the nine months ended September 30, 1999 and 1998,
respectively. The weighted average number of diluted shares of common stock
outstanding were 1,684,557 and 1,715,787 for the same periods in 1999 and 1998,
respectively.
The Bancorp's net income was $767 thousand for the three months ended
September 30, 1999, compared to $658 thousand for the three months ended
September 30, 1998, an increase of $109 thousand, or 16.5%. Diluted earnings per
share were $0.46 and $0.38 for the three months ended September 30, 1999 and
1998, respectively. The weighted average number of diluted shares of common
stock outstanding were 1,685,009 and 1,717,428 for the same periods in 1999 and
1998, respectively.
Net interest income before provision for loan losses for the nine
months ended September 30, 1999 was $7.5 million, an increase of $1.2 million,
or 19%, from $6.3 million for the nine months ended September 30, 1998. The
increase resulted primarily from growth in average interest-earning assets, as
well as an increase in interest margin. Total interest-earning assets in the
nine months ended September 30, 1999 averaged $260 million as compared to $228.3
million for the same period in 1998. For the nine months ended September 30,
1999, the interest rate spread was 3.63%, an increase of 25 basis points from
3.38% for the nine months ended September 30, 1998. The yield on
interest-earning assets for the nine months ended September 30, 1999 was 7.78%,
a decrease of 34 basis points from the same period last year. The cost of
interest-bearing liabilities decreased by 59 basis points to 4.15% for the nine
months ended September 30, 1999 from 4.74% for the nine months ended September
30, 1998.
Net interest income before provision for loan losses for the three
months ended September 30, 1999 was $2.6 million, an increase of $527 thousand
from $2.1 million for the three months ended September 30, 1998. The increase
resulted primarily from growth in average interest-earning assets, as well as an
increase in interest margin. Total interest-earning assets in the three months
ended September 30, 1999 averaged $266.5 million as compared to $237.7 million
for the same period in 1998. For the three months ended September 30, 1999, the
interest rate spread was 3.74%, an increase of 50 basis points from 3.24% for
the three months ended September 30, 1998. The yield on interest-earning assets
for the three months ended September 30, 1999 was 7.90%, an increase of one
basis point from the same period last year. The cost of interest-bearing
liabilities decreased by 49 basis points to 4.16% for the quarter ended
September 30, 1999 from 4.65% for the three months ended September 30, 1998.
Total interest income increased by $1.3 million, or 9.5%, to $15.2
million for the nine months ended September 30, 1999 from $13.9 million for the
nine months ended September 30, 1998. This increase was due to an increase of
$15.5 million in average loans receivable to $143.2 million for the nine months
ended September 30, 1999 from $127.7 million for the nine months ended September
30, 1998, in spite of a decrease in the average yield on loans from 9.72% to
9.13% for the same periods. Average investment securities increased by $16.3
million from $100.1 million in the nine months ended September 30, 1998 to
$116.8 million in the nine months ended September 30, 1999. The yield on average
investment securities for the nine months ended September 30, 1999 was 6.13%, an
increase of five basis points from 6.08% for the nine months ended September 30,
1998.
Total interest income increased by $578 thousand to $5.3 million for
the quarter ended September 30, 1999 from $4.7 million for the three months
ended September 30, 1998. This increase was due to an increase of $22.6 million
in average loans receivable to $150.5 million for the three months ended
September 30, 1999 from $127.9 million for the three months ended September 30,
1998, in spite of a decrease in the average yield on loans from 9.61% to 9.24%
for the same periods. Average investment securities increased by $6.2 million
from $109.8 million in the three months ended September 30, 1998 to $116.1
million in the three months ended September 30, 1999. The yield on average
investment securities for the quarter ended September 30, 1999 was 6.16%, an
increase of 28 basis points from 5.88% for the three months ended September 30,
1998.
Total interest expense increased by $119 thousand, or 1.9%, to $7.7
million for the nine months ended September 30, 1999 from $7.6 million for the
nine months ended September 30, 1998. Customer deposits averaged $237.1 million
for the nine months ended September 30, 1999, up $26.8 million from $210.3
million for the nine months ended September 30, 1998. The average effective rate
paid on deposits decreased by 62 basis points to 4.10% in the 1999 period from
4.72% in the 1998 period. Average borrowings were $10.5 million for the nine
months ended September 30, 1999, an increase of $6.7 million from $3.8 million
for the nine months ended September 30, 1998. The average effective rate paid on
borrowings decreased to 5.35% for the nine months ended September 30, 1999 from
5.68% for the same period in 1998.
13
Total interest expense increased by $51 thousand to $2.7 million for
the three months ended September 30, 1999 from $2.6 million for the quarter
ended September 30, 1998. Customer deposits averaged $237.6 million for the
three months ended September 30, 1999, up $21.1 million from $216.5 million for
the three months ended September 30, 1998. The average effective rate paid on
deposits decreased by 56 basis points to 4.06% in the 1999 period from 4.62% in
the 1998 period. Average borrowings were $14.5 million for the quarter ended
September 30, 1999, an increase of $9 million from $5.5 million for the three
months ended September 30, 1998. The average effective rate paid on borrowings
increased to 5.85% for the three months ended September 30, 1999 from 5.75% for
the same period in 1998.
The provision for loan losses for the nine months ended September 30,
1999 was $925 thousand, as compared to $675 thousand for the nine months ended
September 30, 1998. The provision for loan losses is a current charge to
earnings to increase the allowance for loan losses. The Bancorp has established
the allowance for loan losses to absorb the inherent risk in lending after
considering an evaluation of the loan portfolio, current economic conditions,
changes in the nature and volume of lending, past loan experience and other
relevant factors. During the nine months ended September 30, 1999, the Bancorp's
volume of non-residential mortgage loans and non-mortgage business loans has
increased, and these loans tend to carry a higher risk classification. The
increase in the provision for loan losses reflects the growth in the portfolio
of non-residential mortgage loans and business loans. It is the opinion of the
Bancorp that the allowance for loan losses at September 30, 1999 remains
adequate. Although the Bancorp believes that the allowance is adequate, there
can be no assurances that additions to such allowance will not be necessary in
future periods, which would adversely affect the Bancorp's results of
operations. The allowance for loan losses at September 30, 1999 was $2.3
million, or 1.41% of total loans receivable, versus $2.05 million at December
31, 1998, which was 1.52% of total loans receivable.
During the nine months ended September 30, 1999 charge-offs amounted to
$919 thousand compared to $547 thousand during the same period last year. These
charge-offs were related primarily to non-mortgage business loans and
nonresidential mortgage loans. Recoveries amounted to $205 thousand during the
nine months ended September 30, 1999, most of which was related to one
non-residential mortgage loan that was charged off in 1996.
Other income for the nine months ended September 30, 1999 was $2.3
million as compared to $1.6 million for the nine months ended September 30,
1998, an increase of $734 thousand, or 46%. Gain on sale of loans increased by
$380 thousand from $486 thousand during the nine months ended September 30,
1998, to $866 thousand for the nine months ended September 30, 1999. This
increase was primarily the result of the sale of the guaranteed portion of SBA
loans on which gains have been recognized. Fee income increased $159 thousand
during the nine months ended September 30, 1999, compared to the same period
last year, because of more income related to both loans and deposits. Other
income increased by $195 thousand during the nine months ended September 30,
1999, compared to the same period last year. This increase resulted from an
increase of $65 thousand in realized gain on the sale of investment securities
available-for sale and the unrealized gain on the ineffective portion of the
interest rate swaps in the amount of $139 thousand.
Other expense increased by $1.2 million, or 27%, to $5.7 million for
the nine months ended September 30, 1999 from $4.5 million for the nine months
ended September 30, 1998, primarily because of expenses related to operating
three new branches that have been open since April 1998. Employee compensation
and benefits increased by $749 thousand, or 35.5%, reflecting normal wage
increases for existing personnel and the cost of staffing the three new
branches. Expenses for premises and equipment increased by $199 thousand, or
24.6%, primarily because of the new branches. Advertising expense increased by
$57 thousand, or 45.6%, primarily because the Bancorp commenced its internet
banking promotion.
Other expense increased by $403 thousand, or 26%, to $2 million for the
three months ended September 30, 1999 from $1.6 million for the quarter ended
September 30, 1998, primarily for the same reasons described in the previous
discussion of the nine-month period.
14
REGULATORY CAPITAL REQUIREMENTS
- -------------------------------
At September 30, 1999 the Bancorp exceeded all regulatory capital
standards, which were as follows:
ACTUAL CAPITAL REQUIRED CAPITAL EXCESS CAPTIAL
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------------- ------------------- ------------------
(Dollars in thousands)
Leverage capital $ 22,395 8.13% $ 11,015 4.00% $ 11,380 4.13%
(to average assets)
Tier 1 capital 22,395 11.86% 7,554 4.00% 14,841 7.86%
(to risk-weighted assets)
Tier 1 and Tier 2 capital 24,657 13.06% 15,109 8.00% 9,548 5.06%
(to risk-weighted assets)
LIQUIDITY
- ---------
The Bancorp's primary sources of funds are deposits, loan repayments,
proceeds from the sale of loans and investment securities, repayments and
maturities of investment securities, and borrowings from the Federal Home Loan
Bank of Atlanta under a credit availability in the amount of $45 million. At
September 30, 1999, the Bancorp had $9.4 million of unfunded lines of credit and
undisbursed construction loan funds of $5.4 million. Approved loan commitments
were $14.7 million at September 30, 1999, and the Bancorp had commitments from
investors to purchase loans in the amount of $520 thousand. It is anticipated
that funding requirements for these commitments can be met from the normal
sources of funds.
YEAR 2000
- ---------
Until recently, many companies had operating computer applications
which used only two digits to identify a year in the date field. These
applications were designed and developed without considering the potential
impact of the rapidly approaching millennium. If these fields were not corrected
computer applications could fail or create a magnitude of erroneous results in
the Year 2000. Therefore, in order to effectively address the Year 2000
concerns, Southern Financial Bank's Board of Directors approved a Plan to
mitigate the risks associated with the Year 2000.
This Plan, which is managed as outlined by the Federal Financial
Institutions Examination Council ("FFEIC") addresses the essential five phases:
Awareness, Assessment, Renovation, Validation and Implementation.
The Awareness and Assessment phases of the Plan were completed in 1998.
The Bank has ensured that customers received statement stuffers and newsletters
apprising them of the status of the Plan. Year 2000 status updates have been
incorporated into the Bank's website, www.southernfinancialbank.com and are
regularly updated. The Bank contacted its significant business partners to
determine their state of readiness and the potential impact on the Company by
sending letters to them requesting updates on their own year 2000 initiatives.
Through these endeavors, systems were upgraded and tested to ensure meeting Year
2000 Readiness. Those systems that do not meet Year 2000 requirements have been
replaced.
The phases of the Plan which include Renovation, Validation and
Implementation were completed by December 31, 1998. The Bank completed upgrading
and/or replacements of the entire Bank's branch operating computer systems ahead
of schedule. The upgrades and/or replacements of the computers were necessitated
by the requirement to perform end-to-end testing with Intrieve, Inc, the Bank's
data processing system provider, on November 8, 1998. All Intrieve-related
systems passed the Year 2000 performance test. Additionally, the EFT operating
systems have been tested to confirm the capability to receive and send account
information. EFT systems include the ATM Network and Direct Teller System.
Through a partnership with Intrieve, Inc., OnLine Resources Corporation,
("ORCC"), based in McLean, Va., manages Southern OnLine, the bank's remote
banking service, with all transactions flowing through the EFT system. ORCC
received Year 2000 certification in February 1999. Testing between Intrieve and
ORCC was successfully completed in March 1999. Since Intrieve, Inc. is
responsible for the major portion of the Bank's Year 2000 Plan, continued focus
will be directed throughout 1999. Intrieve is actively addressing all issues
associated with this time critical issue. Intrieve has completed the upgrades
for its mission critical system for Year 2000 Readiness. Additionally,
throughout 1999, Intrieve, Inc., will continue to test and further develop their
systems.
15
The Bank, as well as Intrieve, Inc., has completed its Year 2000
Contingency Plan. The Bank's Business Resumption and Contingency Planning was
reviewed by the Board of Directors at the Bank's July 16, 1999 board meeting.
The Business Recovery Plan for Intrieve, Inc. was received by the Bank in June
and has been incorporated into its Plan. Intrieve has also updated their
Disaster Recovery Plan, which will enable them to continue to provide the Bank
with data processing services in the event of a Year 2000 disaster. The Bank has
completed its installation of backup generators and all final testing was
successful. The Bank will also continue to prepare the branches for processing
in an "off-line mode" through the month of December. Intrieve conducted a final
end-to-end test on October 24, 1999, which was successful. This will insure
smooth operations with little or no adverse affect on our customers. The Bank
has also contracted with Monarch Security to provide each of the Bank branches
with a security guard from December 27, 1999 through January 8, 2000. These
guards will be on site during regular lobby hours. Additionally, Intrieve, Inc.
has implemented two additional services, the first being a special trial balance
run on December 25, 1999. This information will prove to be critical if systems
communications are affected on the first day of business in the Year 2000.
Secondly, Intrieve will provide a communications connectivity test opportunity
on January 1, 2000 from 11:00 a.m. to 1:00 p.m. EST. The purpose of this test is
to verify transmission functionality before opening the doors for business on
January 3, 2000. All branches will participate in this critical test as a means
of preventative action.
As of September 30, 1999, the Bank had incurred approximately $60
thousand of costs to become Year 2000 compliant, and additional costs are not
expected to have a significant impact on the results of operations., Intrieve,
Inc., the Bank's data processing system provider, has made substantial
investments in software and hardware to become Year 2000 compliant. Costs
related to these investments have not been passed on to Southern Financial.
The costs of the project and the date on which the Bank plans to
complete the Year 2000 testing are based on management's best estimates. There
can be no assurance that these estimates will be achieved and actual results
could differ from those plans.
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 the Bancorp, 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 the Bancorp'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 the
Bancorp 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, the Bancorp undertakes no obligation to correct or update a
forward-looking statement should the Bancorp later become aware that it is not
likely to be achieved. If the Bancorp were to update or correct a
forward-looking statement, investors and others should not conclude that the
Bancorp will make additional updates or corrections thereafter.
16
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
During the first quarter of 1999, the Bancorp entered into four swap
agreements, each for a notional amount of $5 million, in which the Bancorp
agreed to pay a rate fixed for the period of the swap and receive 3 month LIBOR
for the period of the swap. In addition, in the months of January and February
1999 the Bancorp purchased $20 million of residential and commercial CMO's. A
sustained shift in interest rates could have an impact on the market value of
these securities. A rise in interest rates would decrease their market value,
and a decline in interest rates would increase their market value.
As a result of entering into the swap agreements and purchasing the
CMO's, the Bancorp's interest sensitivity as reported in its Form 10K for the
year ended December 31, 1998 has changed. The Bancorp's interest rate
sensitivity is primarily monitored by management through the use of a model
which generates estimates of the change in the Bancorp's market value of
portfolio equity ("MVPE") over a range of interest rate scenarios. Such analysis
was prepared by a third party for the Bancorp. 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. The following table sets forth an
analysis of the Bancorp's 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 September 30, 1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------------------------
Up 300 22,785 (6,519) -21.52% 7.42% 107.09%
Up 200 25,119 (4,185) -13.82% 8.73% 118.34%
Up 100 27,369 (1,935) -6.39% 9.52% 128.43%
Base 29,304 - 0.00% 10.19% 138.05%
Down 100 31,135 1,831 2.81% 10.83% 146.68%
Down 200 32,731 3,427 11.32% 11.38% 154.20%
Down 300 34,892 5,588 18.45% 12.13% 164.38%
17
The Bancorp's interest rate sensitivity is also monitored by management
through the use of a model that generates estimates of the change in the
adjusted net interest income over a range of interest rate scenarios. Such
analysis was also prepared by a third party for the Bancorp. Net interest income
represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities including the effect of the interest rate swaps.
Net interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them. In this regard, the model assumes that the composition of the Bancorp's
interest sensitive assets and liabilities existing at the beginning of a period
remains constant over the period being measured and also assumes that a
particular change in interest rates is reflected uniformly across the yield
curve regardless of the duration to maturity or repricing of specific assets and
liabilities.
Sensitivity of Net Interest Income
(amounts in thousands)
Change in Adjusted Net
Interest Rates Interest Income Net Interest Margin
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
- --------------------------------------------------------------------------------
Up 300 8,837 -9.10% 3.07% -9.17%
Up 200 9,249 -4.87% 3.22% -4.73%
Up 100 9,616 -1.09% 3.34% -1.18%
Base 9,722 0.00% 3.38% 0.00%
Down 100 9,821 1.02% 3.41% 0.89%
Down 200 9,986 2.72% 3.47% 2.66%
Down 300 10,273 5.67% 3.57% 5.62%
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in MVPE and in Sensitivity of
Net Interest Income require the making of certain assumptions which 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 and Sensitivity of
Net Interest Income table provide an indication of the Bancorp's interest rate
risk exposure at a particular point in time, such measurements are not intended
to and do not provide a precise forecast of the effect of changes in market
interest rates on the Bancorp's worth and net interest income.
18
SOUTHERN FINANCIAL BANCORP, INC.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
-----------------
Not applicable
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 September 30, 1999.
19
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 11/15/99 By:
-------------- --------------------------------
Georgia S. Derrico
Chairman and
Chief Executive Officer
(Duly Authorized Representative)
Date 11/15/99 By:
-------------- --------------------------------
William H. Lagos
Senior Vice President
and Controller
Principal Accounting Officer
(Duly Authorized Representative)