Exhibit 13
Southern Financial Bancorp, Inc.
December 31, 2001 Annual Report to Stockholders
FINANCIAL HIGHLIGHTS
(dollars in thousands, except per share data) As of and for the
Years Ended December 31,
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2001 2000 1999 1998 1997
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Income Statement Data:
Interest income $ 54,179 $ 37,810 $ 29,756 $ 27,857 $ 25,536
Interest expense 27,147 20,009 14,308 14,220 12,626
Net interest income 27,032 17,801 15,448 13,637 12,910
Provision for loan losses 4,470 1,335 1,374 (2) 1,301 1,265
Net interest income after
provision for loan losses 22,562 16,466 14,074 (2) 12,336 11,645
Gain on sales of SBA loans 252 905 692 495 -
Other income 4,454 (1) 3,435 (1) 2,834 (2) 2,582 (1) 2,257
Other expense 16,992 13,440 12,152 (2) 10,687 9,762
Income before income taxes 10,276 (1) 7,366 (1) 5,448 (2) 4,726 (1) 4,140
Income taxes 3,360 (1) 2,361 (1) 1,678 (2) 1,442 (1) 1,332
Net income (excluding gains/losses on
securities and non-recurring items) 6,916 (1) 5,005 (1) 3,771 (2) 3,284 (1) 2,808
Net income 8,414 5,150 961 3,352 2,808
Per Share Data:
Earnings per share, basic $ 1.98 (3) $ 1.63 (3) $ 1.29 (4) $ 1.14 (3) $ 1.00
Earnings per share, diluted 2.32 1.65 0.32 1.11 0.96
Earnings per share, diluted (excluding gains/ 1.91 1.60 1.26 1.09 0.96
losses on securities and non-recurring items)
Cash basis diluted earnings per
share 2.00 (3) 1.65 (3) 1.27 (4) 1.09 (3) 0.96
Cash dividends 0.44 0.44 0.30 0.20 0.15
Book value per share (5) 15.01 11.97 9.88 10.56 9.72
Tangible book value per share (5) 14.31 10.79 9.70 10.47 9.64
Weighted average shares
outstanding (basic) 3,500,949 3,065,248 2,913,507 2,880,823 2,814,484
Weighted average shares
outstanding (diluted) 3,628,582 3,120,025 2,994,476 3,022,499 2,912,489
Shares outstanding at end of
period 4,284,594 3,316,192 2,921,816 2,899,874 2,830,387
Selected Performance Ratios and
Other Data:
Return on average assets 0.96% (6) 1.06% (6) 0.93% (7) 0.90% (6) 0.88%
Return on average stockholders'
equity 14.80% (6) 15.51% (6) 12.24% (7) 11.30% (6) 10.92%
Efficiency ratio (8) 53.54% 60.70% 64.04% 63.94% 64.36%
Net interest margin 3.98% 4.05% 4.07% 3.97% 4.26%
Dividend payout ratio 18.16% 25.99% 92.08% 17.78% 16.22%
Number of branches 20 19 17 15 13
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(1) Total other income for the years ended December 31, 2001, 2000 and 1998,
excludes non-recurring items, and gains/losses on securities. Gains on
sales of SBA loan are reported separately above. Management believes that
net income excluding non-recurring items and gains/loss on securities is
a useful measure of operating performance as it more closely reflects the
core operations of the bank on an ongoing basis. If these items had been
included in other income, the income statement data would have been as
follows (in thousands):
2001 2000 1998
--------- --------- ---------
Total other income $ 6,934 $ 4,553 $ 3,145
Income before taxes 12,504 7,579 4,794
Income taxes 4,090 2,429 1,442
Net income 8,414 5,150 3,352
(2) Certain income statement data for the year ended December 31, 1999 excludes
the following one-time charges related to the merger with Horizon: (a) a
special loan loss provision of $756 thousand, (b) a portfolio restructuring
expense of $781 thousand and (c) pretax merger-related expenses of $2.4
million (collectively, the one-time merger-related charges and expenses).
In addition, gains on securities of $89 thousand have also been excluded
from other income. If these one-time charges and expenses and gains on
securities were included the income statement data would have been as
follows (in thousands):
Provision for loan losses $ 2,130
Net interest income after provision for loan losses 13,318
Other income 2,834
Other expense 14,589
Income before income taxes 1,563
Income taxes 602
Net income 961
FINANCIAL HIGHLIGHTS
(dollars in thousands, except per share data)
As of and for the
Years Ended December 31,
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2001 2000 1999 1998 1997
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Period-End Balance Sheet Data:
Total assets $ 784,977 $ 609,936 $ 406,222 $ 404,254 $ 354,016
Total loans (net of deferred fees) 418,328 318,912 237,980 209,417 207,303
Allowance for loan losses 7,354 4,921 3,452 3,062 2,743
Total Securities 306,612 233,407 136,919 143,569 106,296
Total Deposits 633,326 515,112 367,188 366,905 320,364
Other Borrowings 55,500 34,000 5,000 3,500 4,000
Company-obligated mandatorily
redeemable preferred securities
of subsidiary trusts 13,000 13,000 - - -
Stockholders' equity 64,668 39,689 28,864 30,626 27,508
Period-end Consolidated Capital
Ratios:
Tier 1 risk-based capital 13.99% 11.39% 10.93% 12.77% 12.98%
Total risk-based capital 15.24% 12.55% 12.18% 14.09% 14.19%
Leverage 8.82% 8.37% 7.50% 7.84% 8.14%
Stockholders'equity to total
assets 8.24% 6.51% 7.11% 7.58% 7.77%
Asset Quality Ratios:
Net charge-offs to average loans 0.58% 0.17% 0.79% 0.48% .46%
Allowance for loan losses to
period-end loans 1.76% 1.54% 1.45% 1.46% 1.32%
Allowance for loan losses to
nonperforming loans 499.25% 262.87% 661.30% 105.37% 113.91%
Nonaccrual loans to total
loans 0.35% 0.59% 0.22% 1.39% 1.16%
Nonperforming assets to total
loans and other real estate
owned 0.35% 0.61% 1.20% 1.62% 1.50%
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(3) Earnings per share amounts for the years ended December 31, 2001,
2000 and 1998 exclude nonrecurring items, and gains/ losses on
securities. If these income items were included, basic earnings per
share would have $2.40, $1.68 and $1.16 for the ended December 31,
2001, 2000 and 1998, respectively and cash basis diluted earnings
per share would have been $2.41, $1.70 and $1.11 for the same
years.
(4) Earnings per share for the year ended December 31, 1999 exclude the
one-time merger-related charges and expenses, and gains on
securities. If these one-time merger-related charges and expenses
and gains on securities had been included, basic earnings
per share would have been $.33 and cash basis diluted earnings per
share would have been $.34.
(5) Calculated using shares of common stock outstanding plus 24,173
shares of common stock which were issuable upon the consversion of
preferred stock at period end.
(6) Selected performance ratios for the years ended December 31, 2001,
2000 and 1998 exclude nonrecurring gains, gains/losses on on
securities. If these income items had been included, return on
average assets would have been 1.16%, 1.09%, and .92% and return on
average equity would have been 18.00%, 15.96% and 11.62%.
(7) Selected performance ratios for the year ended December 31, 1999
exclude the one-time merger-related charges and expenses, and gains
on securities. If these one-time merger-related charges and
expenses were included, the return on average assets would have
been .24% and the return on average equity would have been 3.11%.
(8) Calculated by dividing total noninterest expense, net of goodwill
and intangible amortization, by net interest income plus
noninterest income, excluding securities gains and losses
Corporate Information
Corporate Address
37 East Main Street
Warrenton, Virginia 20186
540-349-3900
FAX: 540-349-3904
Form 10-K
The Bank's Annual Report on Form 10-K to the Securities and Exchange Commission
will be furnished without charge to stockholders upon written request to:
Investor Relations
37 East Main Street
Warrenton, Virginia 20186
Annual Meeting
The Annual Meeting of stockholders of Southern Financial Bancorp, Inc. will be
held on April 25, 2002 at Fauquier Springs County Club, Springs Road, Warrenton,
Virginia commencing at 2:00 pm.
Stock Data
As of December 14, 1993, the Common Stock of Southern Financial Federal Savings
Bank commenced trading on the NASDAQ Small Cap Stock Market under the symbol
SFFB. On February 21, 1995, the Common Stock commenced trading on the NASDAQ
National Market under the symbol SFFB. On December 1, 1995, Southern Financial
Federal Savings Bank merged into Southern Financial Bank, a wholly owned
subsidiary of Southern Financial Bancorp, Inc. The Bancorp's Common Stock
continues to be traded on the NASDAQ National Market under the symbol SFFB.
As of December 31, 2001, there were 618 stockholders of record, not including
the number of persons or entities whose stock is held in nominee or "street"
name through various brokerage firms or banks. The following table sets forth
the high and low stock prices for the periods indicated:
2001
High Low
1/st/ Quarter $16.65 $11.71
2/nd/ Quarter $23.18 $15.46
3/rd/ Quarter $24.10 $20.14
4/th/ Quarter $26.57 $19.74
Transfer Agent & Registrar
Inquiries regarding stock transfer, lost certificates or changes in name and/or
address should be directed to the stock transfer agent and registrar:
Mellon Investor Services, L.L.C.
Overpeck Centre
83 Challenger Road
Ridgefield Park, NJ 07660
800-851-9677
Market Makers
Scott & Stringfellow 800-552-7757
Ferris, Baker, Watts, Inc. 202-429-3545
Ryan, Hartley & Co., Inc. 703-847-3100
McKinnon & Company, Inc. 703-623-4636
Sandler O'Neill 212-466-7800
Anderson & Strudwick, Inc. 800-767-2424
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results
of Operations analyzes the major elements of our balance sheets and statements
of income. This section should be read in conjunction with the audited
consolidated financial statements and related notes as of December 31, 2001 and
2000 and for each of the three years ended December 31, 2001 included in this
annual report and the Form 10-K.
On October 1, 1999, we completed our merger with The Horizon Bank of
Virginia whereby Horizon was merged with the bank. As a result of the merger, we
issued 0.63 shares of our common stock for each share of Horizon stock
outstanding. Based on this exchange ratio, we issued a total of 1,045,523 shares
of our common stock to shareholders of Horizon. In connection with the merger,
we incurred approximately $3.9 million of pretax merger-related expenses and
other charges which were charged to operations during the year ended December
31, 1999, including a special loan loss provision of $756 thousand, a portfolio
restructuring expense of $781 thousand and expenses of $2.4 million. The merger
was accounted for as a pooling of interests and therefore, our historical
financial data has been restated to include the accounts and operations of
Horizon for all periods prior to the effective date of the merger.
Overview
2001 versus 2000
Net income for the year ended December 31, 2001 was $8.4 million
compared with $5.2 million for the year ended December 31, 2000, an increase of
63.4%. Diluted earnings per share were $2.32 for the year ended December 31,
2001 compared with $1.65 for the year ended December 31, 2000, an increase of
$0.67 or 40.6%. The increase was primarily due to growth in earning assets,
gains on securities, an increase in fee income, and gains on a non-recurring
real estate sale offset by a higher loan loss provision and increased operating
expenses. Net income excluding net gains and losses on securities, and
non-recurring items included in other income was $6.9 million for the year ended
December 31, 2001, an increase of 38.2% compared with $5.0 million for the year
ended December 31, 2000.
During the year ended December 31, 2001, we recognized gains on
securities sales totaling $1.3 million compared with losses on securities
totaling $167 thousand during the year ended December 31, 2000. During the first
quarter of 2001, in order to take advantage of opportunities in the small
business lending market created, in part, by the introduction of Small Business
Administration (SBA) loan prepayment penalties, we elected to no longer sell the
guaranteed portion of our SBA loans into the secondary market. For the year
ended December 31, 2001, 2000, and 1999 SBA loan sale gains totaled $252
thousand, $905 thousand, and $692 thousand, respectively. After the first
quarter of 2001, we have not sold any SBA loans and intend to retain the SBA
loans that we originate in order to build our loan portfolio and increase our
overall yield.
Our decision to sell some of our investment securities during 2001 is
directly related to our decision to retain our SBA loans. We used our investment
securities portfolio as a vehicle to fully leverage our balance sheet as we grew
our loan portfolio. During the first quarter of 2001, when interest rates were
declining, we sold primarily fixed rate securities and recognized net gains of
$1.3 million. During the fourth quarter of 2001 we did not replace all of the
securities that were sold or paid-off as a result of prepayments. Instead, the
investment securities balance declined in an effort to reduce the securities
balance to reduce our interest rate risk sensitivity in a rising interest rate
environment. During the fourth quarter of 2001, we also increased our loan
portfolio through originations and purchases, increasing interest income and
reducing our ratio of investment securities to loans.
Total assets increased $175.0 million or 28.7% to $785.0 million at
December 31, 2001, from $609.9 million at December 31, 2000 primarily due to
growth in loans and investment securities. Deposits and borrowings, as well as
the issuance of an aggregate of $13.0 million of trust preferred securities by
our subsidiary trusts in May and September of 2000, funded the earning asset
growth. The trust preferred securities, which qualify as regulatory capital,
provide us with the ability to grow our balance sheet while maintaining strong
capital ratios. Deposits increased 22.9% to $633.3 million at December 31, 2001
compared with December 31, 2000. Demand, interest checking, money market and
savings account balances increased $23.3 million, or 11.9% for the year ended
December 31, 2001 compared with the same period in 2000 and certificates of
deposits increased $94.9 million, or 29.8% to $413.6 million. Of the $94.9
million increase in certificates of deposits, $75 million, or 79.0% was
represented by callable certificates of deposits hedged by interest rate swaps
with the same maturities and call features. We posted returns on average assets
of .96%, and 1.09%, for the years ended December
1
31, 2001 and 2000, respectively, excluding merger-related charges and expenses
in 2000. Returns on average equity on the same basis were 14.80% and 15.51% for
the years ended December 31, 2001 and 2000, respectively.
2 Bar Graphs of net income and return on average equity
Net income* Return on Average Equity*
1997 $2,808 10.92%
1998 3,284 11.30
1999 3,771 12.24
2000 5,005 15.51
2001 6,916 14.80
*Net income and return on average equity excludes gains/losses on
securities and non-recurring items for all years presented, including
merger-related charges and expenses related to the Horizon merger in
1999.
2000 versus 1999
Net income for the year ended December 31, 2000 was $5.2 million, a
34.4% increase compared with net income of $3.8 million for the year ended
December 31, 1999, excluding charges and expenses related to the merger with
Horizon. Diluted earnings per share on the same basis were $1.60 for the year
ended December 31, 2000 compared with $1.26 for the year ended December 31,
1999, an increase of $0.34 or 27.0%. Net income, including merger-related
charges and expenses, was $961 thousand or $0.32 per diluted share for the year
ended December 31, 1999. The increase in net income before non-recurring charges
and expenses was primarily attributable to growth in earning assets which
increased net interest income. In addition, other income increased due to fees
generated both from our deposit and commercial product services, as well as
income generated by Southern WebTech.com, our wholly-owned subsidiary.
Total assets at December 31, 2000 were $609.9 million, an increase of
$203.7 million or 50.1% from total assets of $406.2 million at December 31,
1999. The increase was primarily due to the acquisition of First Savings
combined with growth in our earning assets associated with the issuance of trust
preferred securities. Deposits and borrowings funded the earning asset growth.
Not including merger-related charges and expenses, we posted returns on average
assets of 1.06% and 0.93% for the years ended December 31, 2000 and 1999,
respectively. Not including merger-related charges and expenses, returns on
average equity were 15.51% and 12.24% for the years ended December 31, 2000 and
1999, respectively.
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, deposit
insurance assessments and income taxes.
Net Interest Income
2001 versus 2000
Net interest income before the provision for loan losses for the year
ended December 31, 2001 was $27.0 million, an increase of 51.9% from $17.8
million for the year ended December 31, 2000. The increase in net interest
income was mainly due to the growth in earning assets resulting from loan
originations and purchases of investment securities. Average earning assets
increased 54.4% to $679.4 million for the year ended December 31, 2001 compared
with $440.1 million for the year ended December 31, 2000. The declining interest
rates during 2001 also contributed to the increase in net interest income as the
cost of funds declined at a faster rate than our yield on earning assets.
Our yield on total interest-earning assets was 7.97% for the year ended
December 31, 2001; a decrease compared with 8.60% for the year ended December
31, 2000. For the year ended December 31, 2001, the yield on average loans
receivable was 8.71%, down from 9.53% for the year ended December 31, 2000,
while the yield on average securities
2
increased from 7.13% for the year ended December 31, 2000 to 7.25% for the same
period in 2001 as a result of higher than normal discount accretion from
prepayments of securities in 2001.
Our net interest margin was 3.98% for the year ended December 31, 2001,
down slightly from 4.05% for the year ended December 31, 2000. The net interest
margin has improved each prospective quarter during 2001 due to a sharper
decline in our cost of funds versus the decline in yield on earning assets. The
net interest margin increased to 4.29% for the quarter ended December 31, 2001
from 3.51% for the quarter ended December 31, 2000. The cost of funds declined
to 3.56% from 6.45% for the quarters ended December 31, 2001 and 2000,
respectively. The yield on earning assets only declined to 7.42% from 8.66% for
the quarters ended December 31, 2001 and 2000, respectively.
2000 vs. 1999.
Net interest income before the provision for loan losses was $17.8
million for the year ended December 31, 2000, an increase of 15.2% over $15.4
million for the year ended December 31, 1999. The increase in net interest
income is primarily attributable to the income generated from the growth in the
average level of earning assets during 2000 and higher yields on loans and
investment securities compared with 1999. The average balance of total
interest-earning assets increased $59.3 million or 15.6% to $440.1 million for
2000 compared with $380.8 million for 1999 primarily due to the growth in loans
and investment securities as part of our leveraging strategy. Our yield on total
interest-earning assets was 8.60% for the year ended December 31, 2000, which
increased 78 basis points from 7.82% for 1999
Our net interest margin for the year ended December 31, 2000 was 4.05%
compared with 4.07% for the year ended December 31, 1999. While our capital
trust borrowings in the form of $13.0 million in trust preferred securities
issued by our subsidiary trusts in 2000 are a higher cost of debt, they allowed
us to grow our balance sheet, increasing primarily interest-earning assets. This
higher cost of debt, however, had an adverse impact on our net interest margin.
The cost of funds increased to 5.37% in 2000 from 4.52% in 1999. The cost of
borrowings, not including the trust preferred securities, increased from 5.56%
in 1999 to 6.49% in 2000. The cost of funds on total average deposits also
increased during the same period, from 3.83% in 1999 to 4.41% in 2000.
3
The following tables present for the periods indicated the average
balances, the interest earned or paid on such amounts and the weighted average
yields for each major category of interest-earning assets and interest-bearing
liabilities. Calculations for all periods ending after December 31, 1999 have
been made utilizing daily average balances. Calculations for the year ended
December 31, 1999 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 nonaccrual loans.
Years Ended December 31,
------------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------ -------------------------------- -------------------------------
Average Interest Average Average Interest Average Average Interest Average
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
---------- -------- --------- ---------- --------- ---------- ---------- -------- -------
(dollars in thousands)
Assets:
Interest-earning assets:
Loans ......................... $353,147 $30,760 8.71% $ 267,186 $ 25,501 9.53% $ 219,286 $19,982 9.11%
Securities .................... 320,007 23,189 7.25 169,248 12,074 7.13 159,013 9,676 6.09
Investments ................... 6,213 230 3.69 3,642 235 6.45 2,504 98 3.91
-------- ------- --------- -------- --------- --------
Total interest-earning
Assets ............... 679,367 54,179 7.97% 440,076 37,810 8.60% 380,803 29,756 7.82%
Less allowance for loan
losses ................ 5,696 4,186 3,257
-------- --------- ---------
Total interest-earning
assets, net of
allowance ................ 673,671 435,890 377,546
Noninterest-earning assets:
Bank owned life insurance .. 15,639 2,559 --
Other noninterest-earning
assets ................... 34,809 34,667 26,833
-------- --------- ---------
Total assets .................. $724,119 $ 473,126 $ 404,379
======== ========= =========
Liabilities and Stockholders'
Equity:
Interest-bearing liabilities:
Interest-bearing demand
deposits .................. $ 31,398 $ 383 1.22% $ 27,124 $ 184 0.68% $ 33,993 $ 326 0.96%
Savings and money
market accounts ........... 84,410 2,507 2.97 68,605 2,680 3.91 59,743 1,924 3.22
Time deposits ................ 377,680 18,742 4.96 242,706 14,600 6.00 209,993 11,336 5.39
Other borrowings ............. 95,209 4,084 4.29 28,974 1,911 6.49 13,159 732 5.56
Company-obligated
mandatorily redeemable
11.0% preferred securities
of Southern Financial Capital
Trust I ...................... 5,000 572 11.44 3,014 351 11.64 -- -- --
Company-obligated
mandatorily redeemable
10.60% preferred
securities of Southern
Financial Statutory
Trust I ...................... 8,000 859 10.74 2,517 272 10.81 -- -- --
-------- ------- --------- -------- --------- --------
Total interest-bearing
Liabilities .................. 601,697 27,147 4.51% 372,940 20,009 5.37% 316,888 14,308 4.52%
Noninterest-bearing
liabilities
Demand deposits .............. 66,305 58,188 50,501
Other liabilities ............ 9,378 9,730 6,174
------- --------- ---------
Total liabilities ......... 677,380 440,858 373,563
Stockholders' equity ........... 46,739 32,268 30,810
------- --------- ---------
Total liabilities and
stockholders' equity ...... $724,119 $ 473,126 $ 404,373
Net interest income ............ $27,032 $ 17,801 $ 15,448
======= ======== ========
Net interest spread ............ 3.46% 3.23% 3.30%
Net interest margin ............ 3.98% 4.05% 4.07%
4
The following tables present 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 rates (changes in rates 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.
Year Ended December 31, 2001 compared Year Ended December 31, 2000 compared
to Year Ended December 31, 2000 to Year Ended December 31, 1999
----------------------------------------- ---------------------------------------
Increase (decrease) Increase (decrease)
Due to Change in Due to Change in
-------------------------- --------------------------
Volume Rate Total Volume Rate Total
------------ ----------- ----------- ----------- ------------ -----------
(dollars in thousands)
Interest-earning assets:
Loans ............................. $ 7,607 $ (2,348) $ 5,259 $ 4,557 $ 962 $ 5,519
Securities and investments ........ 11,006 103 11,109 708 1,827 2,535
----------- ----------- ----------- ----------- ----------- -----------
Total increase (decrease)
in interest income .......... 18,613 (2,245) 16,368 5,265 2,789 8,054
Interest-bearing liabilities:
Interest-bearing deposits ......... 6,996 (2,972) 4,024 1,780 2,253 4,033
Other borrowings .................. 4,077 (963) 3,114 1,398 270 1,668
----------- ---------- ----------- ----------- ----------- -----------
Total increase (decrease)
in interest expense ......... 11,073 (3,935) 7,138 3,178 2,253 5,701
----------- ---------- ----------- ----------- ----------- -----------
Increase in net interest
income ............................ $ 7,540 $ 1,690 $ 9,230 $ 2,087 $ 266 $ 2,353
=========== ========== =========== =========== =========== ===========
Provision for Loan Losses
The provision for loan losses is a current charge to earnings made in
order to maintain the allowance for loan losses at a level deemed appropriate by
management based on an evaluation of the loan portfolio, current economic
conditions, changes in the nature and volume of lending, historical loan
experience and other relevant factors. The provision for loan losses for the
year ended December 31, 2001 was $4.5 million compared with $1.3 million for the
year ended December 31, 2000. Recognizing that we have evolved from a small
community bank to a larger, regional bank, during 2001 we refined our
methodology of estimating our allowance for loan losses by considering the
relevant loss experience since 1992 of banks headquartered in Virginia, D. C.
and Maryland, with over $1 billion in assets. The higher provision called for by
our refined methodology, combined with the loan growth during 2001 and the
increase in charge-offs, resulted in an increased loan loss provision in 2001
compared with 2000. As of and for the year ended December 31, 2001, the
allowance for loan losses was $7.4 million, or 1.76% of total loans receivable,
while net charge-offs to average loans receivable were .58%. We continue to
monitor the loan portfolio and make charge-offs we deems appropriate,
particularly given the uncertainty in the U.S. economy. Due to the uncertainty
of risks in the loan portfolio, management's judgment of the amount of the
allowance necessary to absorb loan losses is approximate; however, management
believes that the allowance for loan losses at December 31, 2001 is adequate to
absorb probable and inherent losses in the loan portfolio at that date.
The provision for loan losses for the year ended December 31, 2000 was
$1.3 million compared with $2.1 million for the year ended December 31, 1999 The
decrease in the provision in 2000 compared with 1999 was primarily due to a
special provision of $756 thousand taken by Horizon in 1999 due to an enhanced
approach to establishing its allowance for loan losses. The allowance for loan
losses at December 31, 2000 was $4.9 million, or 1.54% of total loans
receivable, net of deferred fees, compared with $3.5 million, or 1.45% at
December 31, 1999.
5
Other Income
2001 versus 2000
Other income for the year ended December 31, 2001 was $6.9 million, an
increase from $2.4 million for the year ended December 31, 2000. During 2001,
gain on the sale of loans decreased by $671 thousand compared with 2000
primarily because we now retain the guaranteed portions of the SBA loans we
originate rather than sell them into the secondary market. Consequently, we will
no longer recognize gains on the sales of these loans, which averaged $205
thousand per quarter in 1999, 2000, and the first quarter of 2001. In part, to
offset the foregoing gains on the sale of SBA loans, during the year ended
December 31, 2001, we sold $224.4 million of investment securities and generated
net gains of $1.3 million. Other income in 2001 also included non-recurring
income related to the sale of real estate. Further, in October 2000, we
purchased $15.0 million of bank owned life insurance, which replaced certain
interest-earning assets and generated other noninterest income of $943 thousand
for the year ended December 31, 2001, representing the increase in its current
value. Account maintenance, electronic banking fees, and commercial service fees
increased 21.9% for the year ended, 2001 compared with the year ended December
31, 2000.
2000 versus 1999
Other income totaled $4.6 million for the year ended December 31, 2000,
an increase of 60.6% from $2.8 million for the year ended December 31, 1999.
Excluding the non-recurring portfolio restructuring expense of $781 thousand
related to the Horizon merger, the increase in other income was 25.9% compared
with 1999. The increase is partially due to an increase in fee income. In
addition, we had income totaling $218 thousand, which represents the increase in
the current value of bank owned life insurance.
Other Expense
2001 versus 2000
Other expense for the year ended December 31, 2001 was $17.0 million,
an increase of 26.4% compared with $13.4 million for the year ended December 31,
2000. 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 which opened in August and the loan production office in
Charlottesville which opened in October. The Georgetown and Charlottesville
operations as well as the acquisition of First Savings Bank in September of
2000, including goodwill amortization, accounted for most of the remaining
increase in other expenses. The increase also includes costs associated with
professional services related to audit and legal, advertising, telephone,
supplies and other general operating expense associated with a larger
organization. The efficiency ratio, the ratio of non-interest expense before
amortization of intangibles, divided by net interest income plus non-interest
income less gains and losses on securities and non-recurring items, improved to
53.5% from 60.7% for the year ended December 31, 2001 and 2000, respectively.
2000 versus 1999
Other expense for the year ended December 31, 2000 was $13.4 million, a
decrease of 7.9% from $14.6 million for the year ended December 31, 1999. Other
expense for the year ended December 31, 1999 included merger-related special
charges and expenses of $2.4 million. Excluding merger-related charges and
expenses, other expense for the year ended December 31, 2000 increased by 10.6%
when compared with other expense for the year ended December 31, 1999. The
increase in employee compensation reflects the cost of staffing the two branches
acquired from First Savings, normal wage increases for existing personnel and
the costs of the personnel infrastructure necessary to operate a larger and more
complex institution. Other expenses, including data processing and occupancy,
increased due to the addition of two branches from the First Savings
acquisition in addition to increases in deposit and loan accounts in the other
17 branches.
Bar Graph with efficiency ratio
Efficiency Ratio*
1997 64.36%
1998 63.94
1999 64.04
2000 60.70
2001 53.54
6
*Efficiency Ratio excludes gains/losses on securities and non-recurring
items for all years presented, including merger-related charges and
expenses related to the Horizon merger in 1999.
Financial Condition
Loan Portfolio
Loans receivable increased $100.1 million or 31.2% from $320.4 million
at December 31, 2000 to $420.4 million at December 31, 2001. This net increase
was comprised of $213.9 million in new loan originations and net purchases of
$36.5 million, offset by repayments totaling $150.8 million. Commercial mortgage
loans increased 43.8%, while commercial and industrial loans increased 31.9%,
representing most of the total increase in loans receivable. We continue to
pursue our niche lending of small to medium-sized business clients as we have
since our conversion from a federal savings bank to a commercial bank in 1995.
As a result, the composition of our loan portfolio has changed dramatically
since that time. At December 31, 1995, residential mortgage loans represented
32.2% of gross loans. By December 31, 2001, residential mortgage loans had
declined to 18.4% of gross loans. In contrast, commercial mortgage and
industrial loans, combined, which represented 47.8% of gross loans at December
31, 1995 have grown to 79.0% of gross loans at December 31, 2001.
Our commercial real estate lending program includes construction and
permanent loans closed both under the Small Business Administration (SBA) loan
programs and loans closed outside of the SBA programs that serve both the
investor and owner occupied facility markets. The 504 loan program under the SBA
is used to finance long-term fixed assets, primarily real estate and heavy
equipment and gives borrowers access to 90% financing for a project. Another SBA
program, 7(a), includes loans that may be used for the purchase of real estate,
construction, renovation or leasehold improvements, as well as machinery,
equipment, furniture, fixtures, inventory and in some instances, working capital
and debt refinancing. The SBA guarantees up to 80% of the loan balance in the
7(a) program and start-up businesses are eligible.
At December 31, 2001, commercial real estate loans totaled $198.7
million; of which $185.4 million were permanent loans and $13.3 million were
construction loans compared with $138.2 million at December 31, 2000, of which
$127.7 million were permanent loans and $10.5 million were construction loans.
The construction loans included owner occupied commercial real estate, low
budget hotels and a shopping center. Permanent and construction commercial real
estate loans made under the SBA 7(a) and 504 loan programs totaled $50.4 million
at December 31, 2001.
At December 31, 2001, we had $133.3 million in commercial and
industrial loans, which represented 31.7% of our total loans receivable at that
date compared with $101.0 million at December 31, 2000. Of the total commercial
and industrial loans at December 31, 2001, 14.8% are loans made under the SBA
7(a) program. Also included in commercial business loans are $14.7 million of
loans for equipment leases to small to medium-sized businesses. Commercial and
industrial loans also include loans originated under our Accounts Receivable
Tracking System, or ARTS. At December 31, 2001, $30.4 million, or 22.8% of
commercial business loans were part of this program.
Bar graph of commercial loan growth (in thousands)
Commercial Loan Growth
1997 $124,547
1998 $137,152
1999 $172,316
2000 $239,230
2001 $331,974
Investment Securities
Our securities portfolio is managed by our President and our Treasurer,
both of whom have significant experience in this area, with the concurrence of
our Asset/Liability Committee. Investment management is performed in accordance
with our investment policy, which is approved annually by the Asset/Liability
Committee and the
7
board of directors. Our investment policy addresses our investment strategies,
approval process, approved securities dealers and authorized investments. At
December 31, 2001 all of our investment securities were classified as
available-for-sale and may be sold as part of our asset/liability management
strategy in response to changes in interest rates and liquidity needs.
Investment securities classified as available-for-sale increased 31.4%
or $73.2 million during 2001, through purchases of $546.6 million, net of $224.4
million in sales and repayments totaling $253.7 million. The investment
securities purchased consisted primarily of collateralized mortgage obligations
and corporate bonds. During the year ended December 31, 2001, we recognized
gains totaling $1.3 million from the sale or maturity of available-for-sale
investment securities.
Deposits
Deposits, which represent 90% of our interest-rate sensitive
liabilities as of December 31, 2001, have historically been the primary source
of funding our asset growth. In addition to deposits, we obtain funds from loan
repayments, maturing investments, loan sales, cash flows generated from
operations, capital trust borrowings and Federal Home Loan Bank advances.
Borrowings may be used as an alternative source of lower cost funds or to fund
the origination of certain assets.
Total deposits increased to $633.3 million at December 31, 2001 from
$515.1 million at December 31, 2000, an increase of $118.2 million or 22.9%.
This increase was primarily a result of growth in certificates of deposit used
as an alternative source to fund earning assets. At December 31, 2001, we had
$73.8 million in noninterest-bearing deposits compared with $66.8 million at
December 31, 2000, an increase of $7.0 million. Interest-bearing deposits
totaled $559.5 million or 88.3% of total deposits at June 30, 2001 compared with
$446.3 million or 86.6% of total deposits at December 31, 2000.
8
Borrowings
Borrowings consist of short-term and long-term advances from the
Federal Home Loan Bank of Atlanta and capital trust borrowings. Long-term
borrowings totaled $15.0 million at December 31, 2001 and are comprised of three
$5.0 million advances from the Federal Home Loan Bank of Atlanta. The long-term
borrowings carry an average cost of 6.07% and have call dates ranging from
September 2002 to 2004, with maturity dates ranging from September 2009 through
2010
2 Bar graphs-total assets and Capital (in thousands)
Total Assets Total Capital*
1997 $ 354,016 27,508
1998 404,254 30,626
1999 406,222 28,864
2000 609,936 52,689
2001 784,977 77,668
*Total capital includes stockholders' equity and capital trust
borrowings
Interest Rate Sensitivity and 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 December 31, 2001 and 2000:
9
Sensitivity of Market Value of Portfolio Equity
As of December 31, 2001
(dollars in thousands)
Market Value of
Market Value of Portfolio Equity Portfolio Equity as a % of
------------------------------------------------------ -----------------------------------
Change in
Interest Rates Portfolio
In Basis Points $ Change % Change Equity
(Rate Shock) Amount From Base From Base Total 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 -- 0.00 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
Sensitivity of Market Value of Portfolio Equity
As of December 31, 2000
(dollars in thousands)
Market Value of
Market Value of Portfolio Equity Portfolio Equity as a % of
------------------------------------------
Change in
Interest Rates Portfolio
In Basis Points $ Change % Change Equity
(Rate Shock) Amount From Base From Base Total Assets Book Value
------------ ------ --------- --------- ------------ ----------
Up 300 $35,488 $(9,871) (21.76)% 5.82% 89.42%
Up 200 40,706 (4,653) (10.26) 6.67 102.56
Up 100 42,502 (2,857) (6.30) 6.97 119.71
Base 45,359 -- 0.00 7.44 107.09
Down 100 47,492 2,133 4.70 7.79 114.29
Down 200 48,809 3,450 7.61 8.00 119.66
Down 300 50,867 5,508 12.14 8.34 128.16
Our 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. The Federal Home Loan
Bank of Atlanta also prepares such analysis for us. Net interest income
represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities. 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 our 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.
10
Sensitivity of Net Interest Income
As of December, 2001
(dollars in thousands)
Adjusted Net Interest Income Net Interest Margin
----------------------------------------- --------------------------------
Change in
Interest Rates
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
------------ ------ --------- ------- ---------
Up 300 $24,998 (15.93)% 3.18% (16.09)%
Up 200 26,300 (11.55) 3.35 (11.61)
Up 100 22,653 (5.27) 3.59 (5.28)
Base 24,121 0.00 3.79 0.00
Down 100 25,618 4.93 3.97 4.75
Down 200 26,591 5.95 4.01 5.80
Down 300 26,925 4.08 3.94 3.96
Sensitivity of Net Interest Income
As of December, 2000
(dollars in thousands)
Adjusted Net Interest Income Net Interest Margin
------------------------------------------ ---------------------------------
Change in
Interest Rates
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
------------ ------ --------- ------- ---------
Up 300 $20,588 (3.66)% 3.38% (3.70)%
Up 200 21,069 (1.41) 3.46 (1.42)
Up 100 21,234 (0.64) 3.48 (0.85)
Base 21,370 0.00 3.51 0.00
Down 100 21,655 1.33 3.55 1.14
Down 200 21,936 2.65 3.60 2.56
Down 300 22,654 6.01 3.72 5.98
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. 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 and Sensitivity of Net Interest Income table provide an
indication of our 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 our worth and net interest
income.
As part of our interest rate risk management, we use interest rate
swaps that are accounted for as both cash flow and fair value hedges in
accordance with Statement of Financial Accounting Standards No. 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. At the
inception of the hedge, we determine and document the risk management objective
and strategy, the hedged risk, the derivative instrument, the hedged item and
how hedge effectiveness will be assessed initially and on an ongoing basis. At
the inception of the hedge and on an ongoing basis, the hedge must be deemed to
be highly effective in hedging the hedged risk in order to qualify for hedge
accounting. Effectiveness is measured by comparing the change in London
InterBank Offer Rate, or LIBOR (which the interest rate swap is priced from) to
the change in the rate underlying the hedged asset or liability. If high
correlation is not achieved, the hedging designation is discontinued with the
change in the fair value of the interest rate swap recorded as other income or
expense. In the event that any derivative or hedged item is terminated or sold,
the gain or loss on the derivative will be amortized over the remaining life of
the item hedged. Interest to be received or paid on the interest rate swap is
accrued monthly. Of our $165.0 million in interest rate swaps, $145.0 million
are fair value hedges that are perfectly correlated and therefore, require no
earnings adjustment.
11
Liquidity and Funds Management
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 year ended December 31, 2001, we funded our financial
obligations with deposits, borrowings from the Federal Home Loan Bank of Atlanta
and sales of investment securities. At December 31, 2001, we had $ 41.6 million
of unfunded lines of credit and undisbursed construction loan funds of $32.5
million. Approved loan commitments were $15.3 million at December 31, 2001.
Management anticipates that funding requirements for these commitments can be
met from the normal sources of funds.
Capital Resources
Capital management consists of providing equity to support both current
and future operations. We and the bank are subject to capital adequacy
requirements imposed by the Federal Reserve. The Federal Reserve has adopted
risk-based capital requirements for assessing bank holding company and member
bank capital adequacy. Under current Federal Reserve Board regulations, these
requirements are (a) leverage capital of 4.0% of adjusted average total assets;
(b) tier I capital of 4% of risk-weighted assets; (c) tier I and II capital of
8% of risk-weighted assets. At December 31, 2001, the Bank's capital ratios were
8.82% leverage capital; 13.97% tier I capital; and 15.22% tier I and tier II
capital.
Pursuant to FDICIA, each federal banking agency revised its risk-based
capital standards to ensure that those standards take adequate account of
interest rate risk, concentration of credit risk and the risks of nontraditional
activities, as well as reflect the actual performance and expected risk of loss
on multifamily mortgages. As a member of the Federal Reserve System, the bank is
subject to capital adequacy guidelines of the Federal Reserve. Also pursuant to
FDICIA, the Federal Deposit Insurance Corporation has promulgated regulations
setting the levels at which an insured institution such as the bank would be
considered "well capitalized," "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" and "critically undercapitalized." The Bank is
classified "well capitalized" for purposes of the FDIC's prompt corrective
action regulations.
Impact of Inflation and Changing Prices
Our financial statements and related notes included in this prospectus
have been prepared in accordance with generally accepted accounting principles.
These require the measurement of financial position and operating results in
terms of historical dollars, without considering changes in the relative
purchasing power of money over time due to inflation.
Unlike many industrial companies, substantially all of our assets and
virtually all of our liabilities are monetary in nature. As a result, interest
rates have a more significant impact on our performance than the effects of
general levels of inflation. Interest rates may not necessarily move in the same
direction or in the same magnitude as the prices of goods and services. However,
other expenses do reflect general levels of inflation.
12
Impact on New Accounting Pronouncements
In July 2001, Statement No. 141 (SFAS 141), Business Combinations, and
Statement No. 142 (SFAS 142), Goodwill and Other Intangibles, were issued. SFAS
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS 142 adopts a more aggregate
view of goodwill and bases the accounting for goodwill on the units of the
combined entity into which the acquired entity is integrated. Furthermore,
goodwill and intangible assets with indefinite useful lives will no longer be
amortized, but instead it will be tested for impairment at least annually using
specific guidelines. As a result of SFAS 142, we will no longer amortize
goodwill, but we will be required to determine if the value of the goodwill is
impaired. If such impairment exists, a write down of goodwill will be made at
that time. Management has not evaluated impairment under SFAS 142. Beginning
January 2002, annual amortization expense will be reduced by approximately $110
thousand.
13
Independent Auditors' Report
To the Board of Directors and Stockholders of
Southern Financial Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of
Southern Financial Bancorp, Inc. and subsidiaries (Bancorp) as of December 31,
2001 and 2000, and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity and cash flows for each of the years in
the three-year period ended December 31, 2001. These consolidated financial
statements are the responsibility of Bancorp's management. Our responsibility is
to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southern
Financial Bancorp, Inc. and subsidiaries as of December 31, 2001 and 2000, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
Richmond, VA,
January 23, 2002
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 and 2000
Assets 2001 2000
- --------------------------------------------------------------------------------------------------------------
Cash and due from banks $ 21,290,594 $ 22,036,524
Overnight earning deposits 7,167,963 2,479,728
Investment securities, available-for-sale 306,611,560 233,407,038
Loans held for sale - 220,000
Loans receivable, net 410,973,260 313,770,584
Cash surrender value of life insurance 16,160,787 15,217,987
Premises and equipment, net 6,796,246 6,687,190
Other assets 15,976,548 16,117,035
- --------------------------------------------------------------------------------------------------------------
Total assets $ 784,976,958 $ 609,936,086
==============================================================================================================
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits $ 633,325,894 $ 515,111,665
Advances from Federal Home Loan Bank - short term 40,500,000 19,000,000
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 18,482,865 8,135,260
- --------------------------------------------------------------------------------------------------------------
Total liabilities 720,308,759 570,246,925
- --------------------------------------------------------------------------------------------------------------
Commitments
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized, 13,621 shares of 6% cumulative convertible
peferred stock issued and outstanding 136 136
Common stock, $.01 par value, 5,000,000 shares authorized,
4,284,594 and 3,014,710 shares issued and outstanding,
respectively 42,846 30,147
Capital in excess of par 54,628,316 28,713,010
Retained earnings 7,986,380 10,709,742
Accumulated other comprehensive income 2,010,521 236,126
- --------------------------------------------------------------------------------------------------------------
Total stockholders' equity 64,668,199 39,689,161
- --------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 784,976,958 $ 609,936,086
==============================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Interest income:
Loans $ 30,759,954 $ 25,500,811 $ 19,982,224
Investment securities 23,418,623 12,309,257 9,773,796
- ----------------------------------------------------------------------------------------------------------------------
Total interest income 54,178,577 37,810,068 29,756,020
- ----------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 21,632,454 17,608,760 13,576,177
Borrowings 5,514,565 2,399,924 731,801
- ----------------------------------------------------------------------------------------------------------------------
Total interest expense 27,147,019 20,008,684 14,307,978
- ----------------------------------------------------------------------------------------------------------------------
Net interest income 27,031,558 17,801,384 15,448,042
Provision for loan losses 4,470,000 1,335,000 2,129,660
- ----------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 22,561,558 16,466,384 13,318,382
- ----------------------------------------------------------------------------------------------------------------------
Other income:
Account maintenance and electronic banking fees 2,199,027 1,924,395 1,758,765
Commercial service fees 329,730 150,900 15,674
Other loan fees 412,016 512,127 404,376
System maintenance and license fees 213,422 281,668 63,134
Income from bank owned life insurance 942,800 217,987 -
Gain on sale of loans 603,052 1,274,033 1,115,351
Gain (loss) on investment securities, net 1,265,774 (167,467) (692,419)
Other 968,152 358,938 169,136
- ----------------------------------------------------------------------------------------------------------------------
Total other income 6,933,973 4,552,581 2,834,017
- ----------------------------------------------------------------------------------------------------------------------
Other expense:
Employee compensation and benefits 8,775,143 7,019,287 6,448,960
Premises, equipment and data processing 4,477,086 3,740,679 3,362,410
Restructuring charges - - 685,336
Merger expenses - - 1,751,657
Other 3,739,302 2,679,997 2,340,607
- ----------------------------------------------------------------------------------------------------------------------
Total other expense 16,991,531 13,439,963 14,588,970
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes 12,504,000 7,579,002 1,563,429
Provision for income taxes 4,089,700 2,428,900 602,700
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 8,414,300 $ 5,150,102 $ 960,729
- ----------------------------------------------------------------------------------------------------------------------
Earnings per common share:
Basic $ 2.40 $ 1.68 $ 0.33
Diluted 2.32 1.65 0.32
Weighted average shares outstanding:
Basic 3,500,949 3,065,248 2,913,507
Diluted 3,628,582 3,120,025 2,994,476
- ----------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Net income $ 8,414,300 $ 5,150,102 $ 960,729
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain/(loss) (1,173,007) (689,079) 1,260,465
Reclassification adjustment for net interest
(income) expense included in net income 201,303 (229,589) (4,165)
Available-for-sale securities:
Unrealized holding gain/(loss) 4,925,955 3,385,998 (4,994,973)
Unrealized gain on transfer of held-to-
maturity securities - 334,770 -
Reclassification adjustment for net (gains)/losses
included in net income (1,265,774) 167,467 692,419
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) before tax 2,688,477 2,969,567 (3,046,254)
Income tax expense (benefit) related to items of other
comprehensive income (loss) 914,082 1,009,656 (1,035,726)
- ----------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 1,774,395 1,959,911 (2,010,528)
Comprehensive income (loss) $10,188,695 $ 7,110,013 $(1,049,799)
======================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
Convertible Capital in
Preferred Common Excess of
Stock Stock Par Value
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 136 $ 26,363 $ 23,490,506
Dividends on preferred and common stock ($0.87 per preferred share)
($0.30 per common share)
Options exercised, net 199 172,429
Change in other comprehensive loss
Net income
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 136 26,562 23,662,935
Dividends on preferred and common stock ($0.87 per preferred share)
($0.44 per common share)
Issuance of common stock 4,270 6,069,361
Repurchase of common stock (757) (1,073,590)
Options exercised, net 72 54,304
Change in other comprehensive income
Net income
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 136 30,147 28,713,010
Dividends on preferred and common stock ($0.87 per preferred share)
($0.44 per common share)
Stock dividend of 10% 3,847 9,572,008
Issuance of common stock 8,758 16,335,172
Options exercised, net 93 8,126
Change in other comprehensive income
Net income
- ---------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 $ 136 $ 42,846 $ 54,628,316
- ---------------------------------------------------------------------------------------------------------------------------
Accumulated
Other Total
Retained Comprehensive Stockholders'
Earnings Income (Loss) Equity
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 6,822,119 $ 286,743 $ 30,625,867
Dividends on preferred and common stock ($0.87 per preferred share) (884,599) (884,599)
($0.30 per common share)
Options exercised, net 172,628
Change in other comprehensive loss (2,010,528) (2,010,528)
Net income 960,729 960,729
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 6,898,249 (1,723,785) 28,864,097
Dividends on preferred and common stock ($0.87 per preferred share) (1,338,609) (1,338,609)
($0.44 per common share)
Issuance of common stock 6,073,631
Repurchase of common stock (1,074,347)
Options exercised, net 54,376
Change in other comprehensive income 1,959,911 1,959,911
Net income 5,150,102 5,150,102
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2000 10,709,742 236,126 39,689,161
Dividends on preferred and common stock ($0.87 per preferred share) (1,561,807) (1,561,807)
($0.44 per common share)
Stock dividend of 10% (9,575,855) -
Issuance of common stock 16,343,930
Options exercised, net 8,219
Change in other comprehensive income 1,774,395 1,774,395
Net income 8,414,300 8,414,300
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 $ 7,986,380 $ 2,010,521 $ 64,668,199
=================================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 8,414,300 $ 5,150,102 $ 960,729
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 1,510,826 1,062,788 706,159
(Accretion) amortization of discounts or premiums on investment
securities and loans, net (1,202,401) 88,880 213,218
Provision for loan losses 4,470,000 1,335,000 2,129,660
Gain on sale of loans (603,052) (1,274,033) (1,115,351)
(Gain) loss on sale of securities (1,265,774) 167,467 692,419
Accretion of deferred loan fees (880,761) (533,778) (787,294)
Loans originated - held for sale (7,224,176) (5,310,641) (12,559,282)
Loans sold - held for sale 7,738,296 5,738,099 13,143,102
Increase in other assets (1,292,074) (2,732,836) (2,362,142)
Increase in other liabilities 7,532,035 2,239,159 1,960,441
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 17,197,219 5,930,207 2,981,659
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Increase in loans receivable (99,562,516) (31,973,177) (28,513,323)
Purchase of investment securities, held-to-maturity - (7,776,346) (11,462,105)
Purchase of investment securities, available-for-sale (546,582,396) (116,457,714) (61,056,211)
Sale of investment securities available-for-sale 224,376,264 20,399,172 37,455,059
Paydowns of investment securities, held-to-maturity - 4,698,270 16,205,058
Paydowns of investment securities, available-for-sale 253,734,859 19,486,818 19,761,562
Purchase of bank owned life insurance - (15,000,000) -
Cash acquired from merger - 11,080,705 -
Increase in premises and equipment, net (1,232,120) (701,726) (1,628,444)
Increase in other equity securities (1,704,654) (1,055,450) (276,750)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (170,970,563) (117,299,448) (29,515,154)
- --------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposits 121,425,307 90,972,915 282,224
Increase in advances from FHLB 21,500,000 17,139,200 1,500,000
Proceeds from Capital Trust Borrowings - 13,000,000 -
Proceeds from issuance of common stock 16,352,149 54,376 172,628
Repurchase of common stock - (1,074,347) -
Dividends on preferred and common stock (1,561,807) (1,338,609) (884,599)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 157,715,649 118,753,535 1,070,253
- --------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 3,942,305 7,384,294 (25,463,242)
Cash and cash equivalents, beginning of period 24,516,252 17,131,958 42,595,200
- --------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 28,458,557 $ 24,516,252 $ 17,131,958
================================================================================================================================
SUPPLEMENTAL DATA
Cash payments for interest on deposits and borrowings $ 6,987,580 $ 7,447,731 $ 4,403,197
Cash payments for income taxes $ 5,325,000 $ 2,846,000 $ 1,218,000
Southern Financial purchased all the capital stock of First Savings Bank of
Virginia. In conjunction with the acquisition, liabilities were assumed as
follows:
Fair value of assets acquired $ 74,812,129
Capital stock issued 5,816,566
--------------
Liabilities assumed $ 68,995,563
==============
The accompanying notes are an integral part of these consolidated financial
statements.
Southern Financial Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2001, 2000 and 1999
1. Organization and Significant Accounting Policies
Southern Financial Bancorp, Inc. (the "Bancorp" or "Southern
Financial") was incorporated in the state of Virginia on December 1, 1995. On
December 1, 1995, the Bancorp acquired all of the outstanding shares of the
Southern Financial Bank (the "Bank"). The Bank, formerly Southern Financial
Federal Savings Bank, converted from a savings bank to a state chartered
commercial bank effective December 1, 1995.
On September 1, 2000, Southern Financial acquired all of the
outstanding common stock of First Savings Bank of Virginia for 409,906 shares of
Southern Financial common stock. The acquisition has been accounted for by the
purchase method, and accordingly, the results of operations of First Savings
Bank have been included in Southern Financial's consolidated financial
statements from September 1, 2000. Goodwill of $1,646,651 was recorded, which is
being amortized on a straight-line basis over 15 years, along with a core
deposit premium of $1,566,163, which is being amortized over 10 years.
The following unaudited pro forma financial information presents the
combined results of operations of Southern Financial and First Savings Bank as
if the acquisition had occurred as of the beginning of 1999 and 2000, after
giving effect to certain adjustments, including amortization of goodwill. The
pro forma financial information does not necessarily reflect the results of
operations that would have occurred had Southern Financial and First Savings
Bank constituted a single entity during both periods.
December 31,
2000 1999
--------------------------------
Total revenue $ 46,718,398 $ 39,261,124
Net income 2,898,179 1,097,239
Earnings per share:
Basic $ 0.92 $ 0.36
Diluted 0.90 0.35
On December 28, 1999, Southern Financial Capital Trust I, a
wholly-owned subsidiary of the Bancorp, was formed for the purpose of issuing
redeemable capital securities. On May 24, 2000, a $5 million offering of
redeemable capital securities was completed, and on September 7, 2000, $8
million of trust preferred securities were issued through a pooled underwriting
totaling approximately $300 million.
In October 1999, Southern Financial incorporated Southern WebTech.com,
100% of which is owned by Southern Financial. Ownership of Southern WebTech.com
was increased to 100% from 70% by December 31, 2000. The minority interest was
acquired by issuing 7,118 shares of Southern Financial Bancorp common stock
valued at $107,225 to Darien Consulting Group, Inc., who owned the minority
interest. The purchase method of accounting was used, and no goodwill was
recorded as a result of the transaction.
On October 1, 1999, Southern Financial completed its merger with The
Horizon Bank of Virginia ("Horizon"). The merger qualified as a tax-free
exchange and was accounted for as a pooling of interests. Southern Financial
issued .63 shares of its common stock for each share of Horizon stock
outstanding. A total of 1,045,523 shares (after adjustment for fractional
shares) of Southern Financial's common stock were issued as a result of the
merger. Horizon had no stock options outstanding prior to the merger. Southern
Financial and Horizon incurred $3,973,530 of merger-related costs that were
charged to operations during the year ended December 31, 1999.
The principal activities of the Bank are to attract deposits, originate
loans and conduct mortgage banking as permitted for state chartered banks by
applicable regulations. The Bank conducts full-service banking operations in
Fairfax, Herndon, Leesburg, Middleburg, Warrenton, Winchester, Woodbridge,
Sterling, Manassas, Fredericksburg, Fairfax City, Vienna, Annandale, Merrifield,
Charlottesville, and Springfield in Virginia, and Georgetown in the District of
Columbia. All the branches are managed as a single business segment.
The accounting and reporting policies of Southern Financial are in
accordance with accounting principles generally accepted in the United States of
America and conform to general practices within the banking industry. The more
significant of these policies are discussed below. Certain reclassifications
were made to the prior year financial statements to conform to the current year
presentation. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates. The allowance for loan losses is a material estimate that
is particularly susceptible to changes in the near term.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of Southern Financial and subsidiaries as of December 31, 2001 and 2000, and for
the years ended December 31, 2001, 2000 and 1999. All significant intercompany
accounts and transactions have been eliminated.
Cash and Cash Equivalents
Amounts represent actual cash balances held by or due to Southern
Financial. For purposes of the consolidated statements of cash flows, Southern
Financial defines cash, due from banks, and overnight earning assets as cash and
cash equivalents.
Investment Securities
Southern Financial accounts for its investment securities in three
categories: held-to-maturity, available-for-sale, and trading. Investments in
debt securities are classified as held-to-maturity when Southern Financial has
the positive intent and ability to hold those securities to maturity.
Held-to-maturity securities are measured at amortized cost. The amortization of
premiums and accretion of discounts are computed using a method that
approximates the level yield method. Investment securities classified as
available-for-sale are reported at fair value, with unrealized gains and losses
excluded from earnings and reported in a separate component of other
comprehensive income (loss) in stockholders' equity on an after-tax basis.
Trading securities are reported at fair value with unrealized gains and losses
included in earnings. The specific identification method is used to determine
gains or losses on sales of investment securities. Southern Financial currently
classifies all investment securities as available-for-sale.
Federal Home Loan Bank Stock
Southern Financial, as a member of the Federal Home Loan Bank (FHLB) of
Atlanta, is required to hold shares of capital stock in the FHLB in an amount
equal to at least 1% of the aggregate principal amount of its residential
mortgage loans or 5% of its borrowings from the FHLB, whichever is larger. This
investment is recorded at cost, and it is pledged as collateral for advances
from the FHLB. The amount of FHLB stock was $3,375,000 and $2,700,000 at
December 31, 2001 and 2000, respectively, and was included in investment
securities, available-for-sale in the consolidated balance sheets.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market
are carried at the lower of cost or estimated market value.
Loans Receivable
Interest income is accrued on loans as earned on the outstanding
principal balances on the level yield method. Nonrefundable loan fees and direct
origination costs are deferred and recognized over the lives of the related
loans as adjustments of yield. Accrual of interest is discontinued when
management believes, after considering economic and business conditions and
collection efforts, that the borrower's financial condition is such
2
that collection of interest is doubtful. Any accrued interest considered
uncollectible is charged against current income.
The allowance for loan losses is established through a provision for
loan losses, which is charged to expense. Loans are charged against the
allowance for loan losses when management believes that the collectibility of
the principal is unlikely. The allowance is a current estimate of the losses
inherent in the present portfolio based upon management's evaluation of the loan
portfolio. Estimates of losses inherent in the portfolio involve the exercise of
judgment and the use of assumptions. The evaluations take into consideration
such factors as changes in the nature, volume and quality of the loan portfolio,
prior loss experience, level of nonperforming loans, current and anticipated
general economic conditions and the value and adequacy of collateral. Changes in
the estimate of future losses may occur due to changing economic conditions and
the economic conditions of borrowers.
A loan is considered impaired when, based on all current information
and events, it is probable that the Bancorp will be unable to collect all
amounts due according to the contractual terms of the agreement, including all
scheduled principal and interest payments. Such impaired loans are measured
based on the present value of expected future cash flows, discounted at the
loan's effective interest rate or, as a practical expedient, impairment may be
measured based on the loan's observable market price, or if, the loan is
collateral - dependent, the fair value of the collateral. When the measure of
the impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Loans for which
foreclosure is probable continue to be accounted for as loans.
Each impaired loan is evaluated individually to determine the income
recognition policy. Generally, payments received are applied in accordance with
the contractual terms of the note or as a reduction of principal.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Expenditures for maintenance and repairs that do not
materially prolong the useful lives of the assets are charged to expense as
incurred.
Depreciation is computed using the straight-line method over estimated
useful lives of three to ten years for furniture and equipment and 30 years for
buildings. Amortization of leasehold improvements is computed using the
straight-line method over the shorter of ten years or the lease term.
Real Estate Acquired through Foreclosure
Southern Financial records and carries real estate acquired through
foreclosure at the lower of the recorded investment in the loan or fair value
less estimated selling costs. Costs relating to development and improvement of
property are capitalized, provided that the resulting carrying value does not
exceed fair value less estimated selling costs. Costs relating to holding the
assets are expensed as incurred.
Goodwill and Other Intangible Assets
Goodwill and the core deposit intangible assets are amortized on a
straight-line basis over 15 and 10 years, respectively. Unamortized goodwill and
other intangibles are periodically reviewed to determine that the recorded
amount is recoverable from projected undiscounted net operating cash flows. If
the projected undiscounted net operating cash flows are less than the carrying
amount, a loss is recognized to reduce the carrying amount to fair value, and
when appropriate, the amortization period is also reduced.
Derivative Financial Instruments
As part of its interest rate risk management, Southern Financial uses
interest rate swaps that are accounted for as both cash flow and fair value
hedges in accordance with Statement of Financial Accounting Standards No. 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. At the
inception of the hedge, the risk management objective and strategy, the hedged
risk, the derivative instrument, the hedged item and how hedge effectiveness
will be assessed initially and on an ongoing basis are documented. At inception
of the hedge and on an ongoing basis, the hedge must be deemed to be highly
effective in hedging the hedged risk in order to qualify for hedge accounting.
Effectiveness is measured by comparing the change in LIBOR (which the interest
rate swap is priced from) to the change in the rate underlying the hedged asset
or liability. If high correlation is not achieved, the hedging designation is
discontinued with the change in the fair value of the interest rate swap
recorded as other income or
3
expense. In the event that any derivative or hedged item is terminated or sold,
the gain or loss on the derivative will be amortized over the remaining life of
the item hedged. Interest to be received or paid on the interest rate swaps is
accrued monthly.
Southern Financial uses interest rate swaps that are accounted for as
cash flow hedges to hedge the issuance of pools of certificates of deposit
(CD's) which reprice with changes in market interest rates. Under the terms of
these interest rate swaps, Southern Financial is 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 fixed rate deposits. The fair value of the interest rate swap
is recorded in other assets in the consolidated balance sheets with changes in
the fair value included in other comprehensive income. To the extent that the
hedge is not completely effective, the ineffective portion is charged or
credited to other income or expense in the consolidated statements of income.
The ineffectivess charged to income during the years ended December 31, 2001,
2000 and 1999 was $107,890, $50,700, and $38,200, respectively. The amounts
recorded in other comprehensive income are subsequently reclassified into
interest expense as a yield adjustment in the same period in which the related
interest on the CD's affect earnings. The estimated net amount of the existing
gains or losses that are expected to be reclassified into earnings within the
next 12 months is approximately $308,000 based upon interest rates in effect
during December 2001.
Southern Financial also uses interest rate swaps that are accounted for
as fair value hedges to hedge the issuance of individual fixed rate CD's. Under
the terms of these interest rate swaps, Southern Financial is the fixed rate
receiver and the floating rate payer. The floating rate on the interest rate
swaps is generally tied to three-month LIBOR, which approximates the issuance
rate on the individual CD's. The combination of the swaps and the issuance of
the 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 to simultaneously. Both the interest rate swap (included in other
assets in the consolidated balance sheets) and the CD's are recorded at fair
value, with changes in fair value included in the statements of income as
interest expense. No ineffectiveness was recognized during the years ended
December 31, 2001 and 2000 (there were no fair value hedges during the year
ended December 31, 1999) as the hedge relationship is considered to be 100%
effective.
Southern Financial incorporates all items from its consolidated balance
sheet as well as off-balance sheet items such as derivative items used to hedge
balance sheet items in an overall assessment of its interest rate risk. All
on-balance sheet items and off-balance sheet items are incorporated in a report
that is generated quarterly by the Federal Home Loan Bank of Atlanta that
assesses the interest rate risk in different interest rate environments. The
report shows how the market value of Southern Financial's portfolio value of
equity changes when interest rates rise or fall 1%, 2%, and 3%. The report also
shows the change in net interest income in the same interest rate change
scenarios.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Earnings Per Share
Basic earnings per common share is computed by dividing net income,
less dividends on preferred stock, by the weighted average number of shares of
common stock outstanding during the periods. Diluted earnings per common share
is computed by dividing net income by the weighted average number of shares of
common stock and dilutive common stock equivalents outstanding during the
periods. Common stock equivalents include the number of shares issuable on
exercise of outstanding options less the number of shares that could have been
purchased with the proceeds from the exercise of the options based on the
average price of common stock during the period plus the number of shares
issuable on conversion of the convertible preferred shares to common shares.
Financial Instruments with Off-Balance Sheet Risk
Southern Financial is a party to financial instruments with off-balance
sheet risk in the normal course of business primarily to meet the financing
needs of its customers. These financial instruments involve, to varying degrees,
elements of credit risk that are not recognized in the balance sheet.
4
Exposure to credit loss in the event of nonperformance by the other party
to the financial instrument for commitments to extend credit and letters of
credit written is represented by the contractual amount of those instruments.
Southern Financial generally requires collateral to support such financial
instruments in excess of the contractual amount of those instruments and
essentially uses the same credit policies in making commitments as it does for
on-balance sheet instruments.
2. Investment Securities
The portfolio consists of the following securities:
December 31, 2001
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- ------------------------------------------------------------------------------------------------------------------------------
Available-for-sale:
FHLMC mortgage-backed securities $ 11,085,815 $ 224,296 $ 5,449 $ 11,304,662
GNMA mortgage-backed securities 4,513,930 90,085 1,285 4,602,730
FNMA mortgage-backed securities 25,893,295 542,806 7,372 26,428,729
Collateralized mortgage obligations 235,061,327 3,724,043 710,695 238,074,675
Obligations of counties and municipalities 860,660 4,888 6,847 858,701
Corporate obligations 20,552,828 34,649 850,015 19,737,462
U.S. Treasury and agency securities 495,400 20,172 - 515,572
Federal Home Loan Bank stock 3,375,000 - - 3,375,000
Federal Reserve Bank stock 1,229,950 - - 1,229,950
Other equity securities 484,079 - - 484,079
- ------------------------------------------------------------------------------------------------------------------------------
Total classified as investment securities 303,552,284 4,640,939 1,581,663 306,611,560
Corporate obligations classified as loans 36,592,310 833,137 212,092 37,213,355
- ------------------------------------------------------------------------------------------------------------------------------
$ 340,144,594 $ 5,474,076 $1,793,755 $ 343,824,915
- ------------------------------------------------------------------------------------------------------------------------------
December 31, 2000
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------------------------
Available-for-sale:
FHLMC mortgage-backed securities $ 31,913,818 $ 372,593 $ 158,892 $ 32,127,519
GNMA mortgage-backed securities 13,526,517 78,848 29,072 13,576,293
FNMA mortgage-backed securities 67,095,227 586,225 142,698 67,538,754
Collateralized mortgage obligations 95,666,261 986,802 888,366 95,764,697
Obligations of counties and municipalities 6,202,386 28,595 113,500 6,117,481
Corporate obligations 12,729,995 143,251 457,467 12,415,779
U.S. Treasury and agency securities 2,449,319 32,821 - 2,482,140
Federal Home Loan Bank stock 2,700,000 - - 2,700,000
Federal Reserve Bank stock 615,000 - - 615,000
Other equity securities 69,375 - - 69,375
- -----------------------------------------------------------------------------------------------------------------------------
Total classified as investment securities 232,967,898 2,229,135 1,789,995 233,407,038
Corporate obligations classified as loans 32,837,067 785,546 1,204,559 32,418,054
- -----------------------------------------------------------------------------------------------------------------------------
$ 265,804,965 $ 3,014,681 $2,994,554 $ 265,825,092
- -----------------------------------------------------------------------------------------------------------------------------
Gross gains of $3,210,045 and gross losses of $1,944,271 were realized on
the sale of investment securities during the year ended December 31, 2001. Gross
gains of $69,396 and gross losses of $236,863 were realized on the sale of
investment securities during the year ended December 31, 2000. Gross gains of
$88,117 and gross losses of $780,536 were realized on the sale of investment
securities during the year ended December 31, 1999. The losses realized during
1999 were related to the restructuring of the investment securities portfolio
following the merger with the Horizon Bank.
5
As of December 31, 2001 and December 31, 2000, securities having a book
value of $209,787,827 and $118,377,497, respectively, were pledged as collateral
for advances from the FHLB and as collateral for deposits in accordance with
Federal and state requirements.
In December 2000, investment securities classified as held-to-maturity with
an amortized cost of $48,269,175 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. These investment
securities had gross unrealized gains of $562,828 and gross unrealized losses of
$228,058. Subsequent to the transfer, investment securities with an amortized
cost of $9,557,649 were sold, and a loss of $158,970 was recognized in the
fourth quarter of 2000. Because of the transfer, Southern Financial will be
unable to classify investment securities as held-to-maturity in the foreseeable
future.
The following table sets forth information regarding contractual maturity
of the investment security portfolio:
December 31, 2001
Available-for-sale
Estimated Amortized
Fair Value Cost
---------------------------------------------------------------------------------------
Debt obligations:
One year or less $ 25,000 $ 25,000
After one through five years 2,513,222 2,485,504
After five through ten years 6,144,956 6,197,140
After ten years 12,428,557 13,201,243
--------------------------------------------------------------------------------------
Total 21,111,735 21,908,887
--------------------------------------------------------------------------------------
Mortgage-backed securities 42,336,121 41,493,040
Collateralized mortgage obligations 238,074,675 235,061,328
Equity securities 5,089,029 5,089,029
--------------------------------------------------------------------------------------
Total classified as investment securities 306,611,560 303,552,284
--------------------------------------------------------------------------------------
Debt obligations classified as loans:
After one through five years 6,093,640 5,954,476
After five through ten years 4,081,040 4,103,586
After ten years 27,038,675 26,534,248
--------------------------------------------------------------------------------------
Total classified as loans 37,213,355 36,592,310
--------------------------------------------------------------------------------------
$ 343,824,915 $ 340,144,594
======================================================================================
Contractual maturity of mortgage-backed securities and collaterized
mortgage obligations is not a reliable indicator of their expected life because
borrowers have the right to repay their obligations at any time.
6
3. Loans Receivable
Loans receivable consist of the following:
December 31,
2001 2000
- -----------------------------------------------------------------------------
Construction and land development
Residential $ 15,711,005 $ 17,815,735
Commercial 13,349,270 10,491,442
Other 1,734,515 2,534,779
Mortgage
Residential 61,740,743 53,164,832
Commercial 185,367,072 127,735,986
Commercial and industrial 133,258,498 101,002,182
Consumer 9,271,808 7,617,423
- -----------------------------------------------------------------------------
Total loans receivable 420,432,911 320,362,379
Less:
Deferred loan fees, net 2,105,362 1,670,453
Allowance for loan losses 7,354,289 4,921,342
- -----------------------------------------------------------------------------
Loans receivable, net $ 410,973,260 $ 313,770,584
=============================================================================
The following sets forth information regarding the allowance for loan
losses for the years ended December 31,
2001 2000 1999
- ---------------------------------------------------------------------------------------------------------
Allowance at beginning of period $ 4,921,342 $ 3,452,131 $ 3,061,631
Provisions for losses charged to income 4,470,000 1,335,000 2,129,660
Acquired from First Savings Bank of Virginia - 594,233 -
Recoveries 381,201 414,200 306,660
Charge-offs (2,418,254) (874,222) (2,045,820)
- ---------------------------------------------------------------------------------------------------------
Allowance at end of period $ 7,354,289 $ 4,921,342 $ 3,452,131
=========================================================================================================
Southern Financial's loan portfolio is concentrated in the Northern
Virginia area. The amount of loans being serviced for others was $28,961,771 and
$30,667,707 at December 31, 2001 and 2000, respectively. At December 31, 2001,
there were no loans that had payments ninety days or more past due on which
interest was still accruing. At December 31, 2000, there were 2 loans with
balances totaling approximately $9,236 that had payments ninety days or more
past due on which interest was still accruing. Loan balances transferred to
foreclosed properties were $137,817, $129,606, and $2,124,334 for the years
ended December 31, 2001, 2000, and 1999, respectively. Southern Financial had no
real estate owned at December 31, 2001. The amount of real estate owned was
$16,900 at December 31, 2000, and it was included in other assets in the
consolidated balance sheets. Corporate obligations classified as loans totaling
$37,213,355 and $32,418,054 as of December 31, 2001 and 2000, respectively, are
included in commercial and industrial loans.
Nonaccruing loans, all of which were impaired, were as follows:
December 31,
2001 2000
-----------------------------------------------------------------
Carrying value $ 1,472,575 $ 1,872,223
Allocation of general reserve 226,877 278,509
7
The average carrying balances and interest income earned on impaired
loans were as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Average carrying value $ 1,700,956 $ 879,080 $ 1,239,805
Income anticipated under
original loan agreements 114,514 54,989 21,845
Income recorded 106,811 - -
4. Premises and Equipment
Premises and equipment consists of the following:
December 31,
2001 2000
- ------------------------------------------------------------------------------
Land $ 1,096,244 $ 1,883,389
Building and improvements 2,358,125 2,335,525
Furniture and equipment 5,804,569 4,721,646
Leasehold improvements 3,475,263 2,559,864
- ------------------------------------------------------------------------------
12,734,201 11,500,424
Less: Accumulated depreciation
and amortization (5,937,955) (4,813,234)
- ------------------------------------------------------------------------------
Premises and equipment, net $ 6,796,246 $ 6,687,190
==============================================================================
Depreciation and amortization expense aggregated $1,123,064, $889,078,
and $706,159 for the years ended December 31, 2001, 2000 and 1999, respectively.
5. Intangible Assets
The following sets forth information regarding intangible assets:
2001 2000
- ----------------------------------------------------------------------
Balance at beginning of year $ 3,639,078 $ 283,500
Additions - 3,507,673
Amortization (371,167) (152,095)
Other, net (259,296) -
- ----------------------------------------------------------------------
Balance at end of year $ 3,008,615 $ 3,639,078
======================================================================
Accumulated amortization
at end of year $ 505,499 $ 152,095
======================================================================
Intangible assets include core deposit premiums totaling $1,356,563
and $1,531,363 at December 31, 2001 and 2000, respectively.
8
6. Deposits
Deposits consist of the following:
December 31,
2001 2000
--------------------------------------------------------------------------------------
Demand accounts $ 73,823,525 $ 66,820,526
Interest checking accounts 33,394,397 35,415,714
Money market and savings accounts 112,463,214 94,167,967
Certificates of deposit 413,644,758 318,707,458
--------------------------------------------------------------------------------------
$ 633,325,894 $ 515,111,665
======================================================================================
As of December 31, 2001, certificates of deposit mature as follows:
2002 $ 244,310,858
2003 16,433,842
2004 15,806,130
2005 4,153,517
2006 704,634
Thereafter 132,235,777
----------------
$ 413,644,758
================
Deposits with balances greater than $100,000 totaled $394,902,243 and
$239,719,966 at December 31, 2001 and 2000, respectively, of which $265,626,301
and $128,797,552 represented certificates of deposit.
9
The following table presents information regarding the interest rate
swaps used to hedge certain certificates of deposit as of December 31, 2001:
12/31/2001 Pay Receive
Notional Estimated Maturity Call Fixed Floating
Amount Fair Value Date Date Rate Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flow hedges: $ 5,000,000 $ (209,725) 1/8/04 None 5.27% 3 month LIBOR
5,000,000 (209,406) 1/15/04 None 5.29% 3 month LIBOR
5,000,000 (197,019) 1/29/04 None 5.23% 3 month LIBOR
5,000,000 (46,695) 2/2/09 None 5.45% 3 month LIBOR
- -----------------------------------------------------
20,000,000 (662,845)
- -----------------------------------------------------
12/31/2001 Receive Pay
Notional Estimated Maturity Call Fixed Floating
Amount Fair Value Date Date Rate Rate
- ----------------------------------------------------------------------------------------------------------------------------------
Fair value hedges: 10,000,000 14,439 2/22/08 2/22/2002 6.00% 3 month LIBOR less 1 basis point
10,000,000 (214,290) 3/7/11 3/7/2002 6.25% 3 month LIBOR less 2 basis points
10,000,000 (90,232) 12/26/08 6/26/2002 6.00% 3 month LIBOR plus 1.5 basis points
10,000,000 (225,010) 6/28/11 6/28/2002 6.25% 3 month LIBOR
10,000,000 (179,549) 7/26/11 7/26/2002 6.50% 3 month LIBOR plus 1 basis point
10,000,000 207,880 2/27/04 None 4.50% 3 month LIBOR plus 2 basis points
10,000,000 (139,602) 8/28/09 8/28/2002 6.00% 3 month LIBOR plus 2 basis points
10,000,000 122,361 3/12/07 9/12/2002 5.00% 3 month LIBOR plus 2 basis points
5,000,000 (37,524) 9/19/16 9/19/2004 6.50% 3 month LIBOR plus 2 basis points
10,000,000 (532,766) 10/24/16 4/24/2003 6.00% 3 month LIBOR
10,000,000 (535,472) 10/26/16 4/26/2003 6.00% 3 month LIBOR
10,000,000 (274,952) 4/26/07 10/26/2002 4.00% 3 month LIBOR less 2 basis points
10,000,000 (73,892) 6/19/07 12/19/2002 5.00% 3 month LIBOR less 3 basis points
10,000,000 (224,266) 12/19/16 12/19/2002 6.50% 3 month LIBOR less 3 basis points
10,000,000 (165,709) 12/28/16 12/28/2002 6.75% 3 month LIBOR
- -----------------------------------------------------
145,000,000 (2,348,584)
- -----------------------------------------------------
Total $ 165,000,000 $ (3,011,429)
==================================================================================================================================
10
7. Borrowings
Southern Financial's borrowings consist of the following:
December 31,
2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Maturity Call Average Maturity Call Average
Amount Date Date Rate Amount Date Date Rate
- ---------------------------------------------------------------------------------------------------------------------------
Advances from FHLB of Atlanta:
Overnight borrowings $ 35,500,000 1.83 % $ 19,000,000 6.35 %
Term borrowings: 5,000,000 Jan-02 - 5.38 5,000,000 Sep-09 Sep-04 6.32
5,000,000 Sep-09 Sep-04 6.32 5,000,000 Sep-10 Sep-03 6.04
5,000,000 Sep-10 Sep-03 6.04 5,000,000 Sep-10 Sep-02 5.84
5,000,000 Sep-10 Sep-02 5.84
- ---------------------------------------------------------------------------------------------------------------------------
Total advances from FHLB of Atlanta 55,500,000 3.35 34,000,000 6.23
- ---------------------------------------------------------------------------------------------------------------------------
Trust preferred borrowings:
5,000,000 Jul-30 Jul-05 11.00 5,000,000 Jul-30 Jul-05 11.00
8,000,000 Sep-30 Sep-10 10.60 8,000,000 Sep-30 Sep-10 10.60
- ---------------------------------------------------------------------------------------------------------------------------
Total trust preferred borrowings 13,000,000 10.75 13,000,000 10.75
- ---------------------------------------------------------------------------------------------------------------------------
Total borrowings $ 68,500,000 4.80 % $ 47,000,000 7.48 %
===========================================================================================================================
8. Stockholders' Equity
Each share of Southern Financial's outstanding 6% cumulative
convertible preferred stock is convertible to 1.77 shares of common stock. The
preferred stock has an annual dividend rate of six percent. Dividends are
payable quarterly and are cumulative.
In 1987, Southern Financial's stockholders approved an incentive stock
option plan under which options to purchase up to 83,660 shares of common stock
could be granted. During each of the years 1994 and 1997, this plan was amended
to allow an additional 100,000 shares of common stock to be granted. In 1999 and
2001, the plan was amended to allow an additional 150,000 and 70,000 shares,
respectively, of common stock to be granted. In accordance with the plan
agreement, the exercise price for stock options equals the stock's market price
on the date of grant. The maximum term of all options granted under the plans is
ten years and vesting occurs after one year.
Southern Financial accounts for its stock option plan under APB Opinion
No. 25, under which no compensation cost has been recognized. Had compensation
cost for the plan been determined consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation," Southern Financial's net income and earnings per
share in the Consolidated Statements of Income, would have been reduced to the
following pro forma amounts:
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Net income:
As reported $ 8,414,300 $ 5,150,102 $ 960,729
Pro forma 7,857,338 5,006,489 668,412
- -------------------------------------------------------------------------------------------------
Basic earnings per share:
As reported 2.40 1.68 0.33
Pro forma 2.24 1.63 0.23
Diluted earnings per share:
As reported 2.32 1.65 0.32
Pro forma 2.17 1.61 0.23
- -------------------------------------------------------------------------------------------------
Weighted-average assumptions:
Expected lives (years) 10 10 10
Risk-free interest rate (%) 5.02% 6.12% 6.48%
Expected volatility (%) 27.00% 23.00% 21.43%
Expected dividends (annual per share) 0.13% 0.13% 0.13%
=================================================================================================
During 2001 Southern Financial issued a 10% stock dividend to
stockholders. All share amounts and per share data are adjusted to reflect the
stock dividend.
11
Southern Financial did not record any compensation costs in 2001, 2000
or 1999 related to its stock option plan. In addition, no significant
modifications to the plan were made during these periods. The fair values of the
stock options outstanding used to determine the pro forma impact of the options
were calculated using an acceptable option pricing model using the key
assumptions detailed above.
A summary of the status of Southern Financial's stock option plan as of
December 31, 2001, 2000 and 1999, and changes during the years ended December
31, 2001, 2000 and 1999 is presented below. Average prices and shares subject to
options have been adjusted to reflect the 2001 stock dividend.
2001 2000 1999
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of period 364,155 $ 14.86 317,966 $ 14.69 259,478 $ 12.30
Granted 79,420 17.13 54,175 14.72 97,350 18.46
Exercised 14,367 8.44 7,986 6.81 21,890 5.82
Expired 13,537 20.67 - - 16,972 16.31
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at end of period 415,671 15.44 364,155 14.86 317,966 14.69
- ---------------------------------------------------------------------------------------------------------------------------
Options exercisable at end of period 336,251 15.05 309,980 14.89 220,616 13.02
===========================================================================================================================
Weighted average fair value of
options granted during the period $ 13.51 $ 4.93 $ 6.57
===========================================================================================================================
The following table summarizes information about stock options
outstanding at December 31, 2001:
Weighted Weighted Weighted Average
Average Average Remaining
Exercise Price Options Exercise Options Exercise Contractual Life
Range Outstanding Price Exexcisable Price (months)
- -----------------------------------------------------------------------------------------------
$ 8.03 - $ 11.57 77,271 $ 9.79 77,271 $ 9.79 37
12.40 - 16.25 195,950 14.37 138,530 14.14 85
18.18 - 23.64 142,450 19.99 120,450 19.45 87
- -----------------------------------------------------------------------------------------------
415,671 $15.44 336,251 $15.05
===============================================================================================
There were 32 option holders at December 31, 2001. Options exercised
during 2001 had exercise prices ranging from $8.03 to $16.44. Options exercised
during 2000 had an exercise price of $7.49. Options exercised during 1999 had
exercise prices ranging from $9.30 to $16.00. The closing price of Southern
Financial's stock at December 31, 2001 was $26.47 per share.
In 2000, Southern Financial acquired 65,760 shares of its own stock
under its stock repurchase plan.
9. Regulatory Matters
Southern Financial's primary supervisory agent is the Federal Reserve
Bank. The Federal Reserve Bank has mandated certain minimum capital standards
for the industry. In addition, the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA") outlines various levels of capital adequacy
for the industry.
Failure to meet minimum capital requirements can initiate certain
mandatory - and possibly additional discretionary - actions by regulation that,
if undertaken, could have a direct material effect on Southern Financial's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Southern Financial must meet specific
capital guidelines that involve quantitative measures of its assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. Southern Financial's capital amounts and classification
are also subject to qualitative judgements by the regulators about components,
risk weightings, and other factors.
12
Quantitative measures established by regulation to ensure capital
adequacy require Southern Financial to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined).
As of December 31, 2001, the most recent notification from the Federal
Reserve Bank categorized Southern Financial as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
adequately capitalized Southern Financial must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
table. There are no conditions or events since that notification that management
believes have changed the institution's category.
Southern Financial's actual capital amounts and ratios are also
presented in the tables below. (All dollar amounts are in thousands.)
For To Be Well Capitalized
Captial Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
- ----------------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- ----------------------------------------------------------------------------------------------------------------------------
As of December 31, 2001
Total Capital $ 79,089 15.24% $ 41,514 8.00% $ 51,892 10.00%
(to risk-weighted assets)
Tier I Capital 72,603 13.99 20,757 4.00 31,135 6.00
(to risk-weighted assets)
Tier I Capital 72,603 8.82 32,941 4.00 41,177 5.00
(to average assets)
As of December 31, 2000
Total Capital 53,679 12.55 34,230 8.00 42,787 10.00
(to risk-weighted assets)
Tier I Capital 48,716 11.39 17,115 4.00 25,672 6.00
(to risk-weighted assets)
Tier I Capital 48,716 8.37 23,294 4.00 29,117 5.00
(to average assets)
13
10. Parent Company Activity
The Bancorp owns all of the outstanding shares of the Bank. Summary
financial statements of the Bancorp follow:
BALANCE SHEETS
December 31,
2001 2000
- ---------------------------------------------------------------------------------------------------------
Assets:
Cash $ 1,803,153 $ 19,457
Investment in subsidiaries 75,071,491 52,497,891
Other assets 1,596,333 987,182
- ---------------------------------------------------------------------------------------------------------
Total assets $ 78,470,977 $ 53,504,530
=========================================================================================================
Liabilities:
Capital trust borrowings $ 13,000,000 $ 13,000,000
Other liabilities 802,778 815,369
- ---------------------------------------------------------------------------------------------------------
Total liabilities 13,802,778 13,815,369
- ---------------------------------------------------------------------------------------------------------
Total stockholders' equity 64,668,199 39,689,161
- ---------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 78,470,977 $ 53,504,530
=========================================================================================================
STATEMENTS OF INCOME
Year Ended December 31,
2001 2000 1999
- -----------------------------------------------------------------------------------------------------------------------
Income:
Equity in earnings of Southern Financial Bank $ 9,828,578 $ 5,617,473 $ 955,539
Equity in earnings (loss) of Southern Web Tech (455,973) 30,064 5,190
Other 24,760 (75,000) -
- -----------------------------------------------------------------------------------------------------------------------
Total income 9,397,365 5,572,537 960,729
- -----------------------------------------------------------------------------------------------------------------------
Expense:
Interest expense 1,431,265 623,159 -
Other 126,800 82,676 -
- -----------------------------------------------------------------------------------------------------------------------
Total expense 1,558,065 705,835 -
- -----------------------------------------------------------------------------------------------------------------------
Income before income taxes 7,839,300 4,866,702 960,729
Income tax benefit (575,000) (283,400) -
- -----------------------------------------------------------------------------------------------------------------------
Net income $ 8,414,300 $ 5,150,102 $ 960,729
=======================================================================================================================
14
STATEMENTS OF CASH FLOWS
Year Ended December 31,
- ----------------------------------------------------------------------------------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------
Operating activities:
Net income $ 8,414,300 $ 5,150,102 $ 960,729
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed income of subsidiaries (6,824,205) (4,700,386) 202,446
Other operating activities (321,741) 25,274 (200,050)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,268,354 474,990 963,125
- ----------------------------------------------------------------------------------------------------------------
Investing activities:
Investment in subsidiaries (14,000,000) (11,000,000) (249,950)
Advance to subsidiary (275,000) (100,000) -
- ----------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (14,275,000) (11,100,000) (249,950)
- ----------------------------------------------------------------------------------------------------------------
Financing activities:
Increase in borrowings - 13,000,000 -
Issuance of common stock 16,352,149 54,376 172,628
Repurchase of common stock - (1,074,347) -
Dividends on preferred and common stock (1,561,807) (1,338,609) (884,599)
- ----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 14,790,342 10,641,420 (711,971)
- ----------------------------------------------------------------------------------------------------------------
Increase in cash 1,783,696 16,410 1,204
Cash, beginning of period 19,457 3,047 1,843
- ----------------------------------------------------------------------------------------------------------------
Cash, end of period $ 1,803,153 $ 19,457 $ 3,047
================================================================================================================
SUPPLEMENTAL DATA
Cash payments for interest on borrowings $ 1,431,265 $ 216,944 $ -
11. Estimated Fair Value of Financial Instruments
The assumptions used and the estimates disclosed represent management's
best judgment of appropriate valuation methods. These estimates are based on
pertinent information available to management as of December 31, 2001. In
certain cases, fair values are not subject to precise quantification or
verification and may change as economic and market factors, and management's
evaluation of those factors change.
Although management uses its best judgment in estimating the fair value
of these financial instruments, there are inherent limitations in any estimation
technique. Therefore, these fair value estimates are not necessarily indicative
of the amounts that Southern Financial would realize in a market transaction.
Because of the wide range of valuation techniques and the numerous estimates
which must be made, it may be difficult to make reasonable comparisons of
Southern Financial's fair value information to that of other financial
institutions. It is important that the many uncertainties discussed above be
considered when using the estimated fair value disclosures and to realize that
because of these uncertainties, the aggregate fair value amount should in no way
be construed as representative of the underlying value of Southern Financial.
The estimated fair values of Southern Financial's financial instruments at
December 31, 2001 and 2000 are as follows (all dollar amounts are in thousands):
15
December 31, 2001 December 31, 2000
Carrying Amount Fair Value Carrying Amount Fair Value
- ---------------------------------------------------------------------------------------------------------------------
Financial assets:
Cash and cash equivalents $ 28,459 $ 28,459 $ 24,516 $ 24,516
Available-for-sale securities 306,612 306,612 233,407 233,407
Loans receivable, net of allowance 410,973 412,938 313,771 315,561
Loans held for sale - - 220 220
Other 4,551 4,551 4,933 4,933
Financial liabilities:
Deposits:
Checking accounts 107,218 107,218 102,236 102,236
Money market and savings accounts 112,463 112,463 94,168 94,168
Certificates of deposit 413,645 423,130 318,708 328,426
Borrowings:
FHLB advances - short term 40,500 40,500 19,000 19,000
FHLB advances - long term 15,000 16,353 15,000 14,483
Trust preferred borrowings 13,000 13,402 13,000 15,014
Off balance sheet instruments:
Interest rate swaps (3,011) (3,011) 1,288 1,288
The following methods and assumptions were used to estimate the fair
value amounts at December 31, 2001 and 2000:
Cash and Cash Equivalents
Carrying amount approximates fair value.
Available-for-Sale Securities
Fair value is based on quoted market prices.
Loans Receivable, Net of Allowance
Fair value of loans is estimated using discounted cash flow analyses
based on contractual repayment schedules. The discount rates used in these
analyses are based on either the interest rates paid on U.S. Treasury securities
of comparable maturities adjusted for credit risk and non-interest operating
costs or the interest rates currently offered by Southern Financial for loans
with similar terms to borrowers of similar credit quality.
Loans Held for Sale
Fair value is based on selling prices arranged by arms-length contracts
with third parties.
Other
Other financial assets consist of accrued interest receivable. Carrying
amount approximates fair value.
Deposits
The carrying amount of deposit liabilities payable on demand,
consisting of NOW accounts, money market deposits, statement savings and other
deposit accounts approximates fair value. Fair value of fixed-rate certificates
of deposit is estimated based on discounted cash flow analyses using the
remaining maturity of the underlying accounts and interest rates currently
offered on certificates of deposit with similar original maturities.
Borrowings
The carrying amount of short-term FHLB advances approximates fair
value. Fair value of all other borrowings is estimated based on discounted cash
flow analyses using the remaining maturity of the borrowings and interest rates
currently in effect on borrowings with similar original maturities.
Off-Balance Sheet Instruments
Fair value of the interest rate swaps reflects the estimated current
replacement cost of the instrument as determined by a third party.
The difference between the original fees charged by the Bank for
commitments to extend credit and letters of credit and the current fees charged
to enter into similar agreements is immaterial.
16
12. Savings Plan
Southern Financial has an employee savings plan (the "Savings Plan")
that qualifies as a deferred salary arrangement under Section 401(k) of the
Internal Revenue Code. Under the Savings Plan, participating employees may defer
a portion of their pretax earnings, up to the Internal Revenue Service annual
contribution limit. Southern Financial matches one half of each employee's
contributions on a discretionary basis based on its profit; such match is not to
exceed 3 percent of the employee's earnings. Southern Financial's matching
contributions to the Savings Plan were $119,458, $96,758, and $70,275 for the
years ended December 31, 2001, 2000 and 1999, respectively.
13. Provision for Income Taxes
The provision for income taxes consists of the following:
Year Ended
December 31,
2001 2000 1999
- -------------------------------------------------------------------------------
Current (benefit) provision:
Federal $ 4,981,379 $ 4,337,338 $ (463,160)
- -------------------------------------------------------------------------------
Deferred (benefit) provision:
Federal (891,679) (1,908,438) 1,065,860
- -------------------------------------------------------------------------------
$ 4,089,700 $ 2,428,900 $ 602,700
===============================================================================
Deferred income taxes reflect temporary differences in the recognition
of revenue and expenses for tax reporting and financial statement purposes,
principally because certain items, such as the allowance for loan losses and
loan fees, are recognized in different periods for financial reporting and tax
return purposes. A valuation allowance has not been established for deferred tax
assets. Realization of the deferred tax asset is dependent on generating
sufficient taxable income. Although realization is not assured, management
believes it is more likely than not that all of the deferred tax asset will be
realized.
Deferred tax assets and liabilities were comprised of the following
significant components as of December 31, 2001 and 2000:
2001 2000
- --------------------------------------------------------------------------------
Assets:
Provision for losses on loans $ 1,743,190 $ 1,100,323
Net operating loss carryforward 663,684 749,684
Depreciation 238,966 184,081
FHLB dividends 256,096 -
Unrealized loss on interest rate swaps 231,996 -
Nonaccrual interest 154,521 93,981
Lease 13,545 11,573
Real estate owned 53,371 37,592
Stock based compensation 70,140 34,068
Other - 6,844
- --------------------------------------------------------------------------------
Gross deferred tax assets 3,425,509 2,218,146
- --------------------------------------------------------------------------------
Liabilities:
Deferred loan fees 653,077 457,257
Unrealized gain on interest rate swaps - 144,715
FHLB dividends - 70,152
Other 47,365 8,678
- --------------------------------------------------------------------------------
Gross deferred tax liabilities 700,442 680,802
- --------------------------------------------------------------------------------
Net deferred tax assets $ 2,725,067 $ 1,537,344
================================================================================
17
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory Federal income tax rate to
pretax income as a result of the following differences:
Year Ended
December 31,
2001 2000 1999
- --------------------------------------------------------------------------------
Statutory Federal income tax rate 35% 34% 34%
Merger expenses - - 12
Prior year adjustment - - -4
Life insurance -3 -1 -
Municipal interest - -1 -
Other 1 - -3
- --------------------------------------------------------------------------------
Effective tax rate 33% 32% 39%
================================================================================
14. Commitments
The Bank leases its corporate headquarters and most of its branch
facilities under non-cancelable lease agreements. Most of these leases provide
for the payment of property taxes and other costs by the Bank and include one or
more renewal options ranging up to ten years. Annual rental commitments under
all long-term non-cancelable operating lease agreements consist of the following
at December 31, 2001:
Real
Property Sublease
Leases Income Total
- --------------------------------------------------------------------------------
2002 $ 1,541,944 $ 204,824 $ 1,337,120
2003 1,494,662 210,166 1,284,496
2004 1,260,052 126,036 1,134,016
2005 934,910 1,652 933,258
2006 811,761 - 811,761
2007 and Thereafter 3,177,151 - 3,177,151
- --------------------------------------------------------------------------------
$ 9,220,480 $ 542,678 $ 8,677,802
================================================================================
Rent expense aggregated $1,340,221, $1,129,939, and $1,071,905 for the
years ended December 31, 2001, 2000 and 1999, respectively.
Outstanding loan commitments amounted to $15,327,580 (of which
$1,358,000 had fixed interest rates) and $17,173,149 (of which $67,900 had fixed
interest rates) at December 31, 2001 and 2000, respectively. The Bank had
commitments from investors of $1,245,000 and $478,700 to purchase loans from the
Bank at December 31, 2001 and 2000, respectively.
At December 31, 2001, the Bank had commercial letters of credit
outstanding in the amount of $3,465,589.
At December 31, 2001, the Bank had unfunded lines of credit of
$41,643,667 and undisbursed construction loan funds of $32,457,766.
18
15. 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 diluted common stock. Potential dilutive common
stock has no effect on income available to common stockholders. Income
attributable to preferred stock was $11,850, $11,850, and $11,850 for the
years ended December 31, 2001, 2000, and 1999, respectively.
2001 2000 1999
Per Per Per
Share Share Share
Shares Amount Shares Amount Shares Amount
- -------------------------------------------------------------------------------------------------------------------------
Basic earnings per share 3,500,949 $ 2.40 3,065,248 $ 1.68 2,913,507 $ 0.33
====== ====== ======
Effect of dilutive securities:
Stock options 103,460 30,604 56,796
Convertible preferred stock 24,173 24,173 24,173
- -------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 3,628,582 $ 2.32 3,120,025 $ 1.65 2,994,476 $ 0.32
=========================================================================================================================
16. Quarterly Financial Information (Unaudited - in thousands, except share
data)
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
Dec. 31, 2001 Sep. 30, 2001 Jun. 30, 2001 Mar. 31, 2001
- ------------------------------------------------------------------------------------------------------------------
Interest income $ 14,437 $ 14,338 $ 13,059 $ 12,345
Net interest income 8,354 7,298 6,147 5,233
Provision for loan losses 2,050 1,150 750 520
Income before income taxes 3,711 3,339 3,162 2,292
Net income 2,381 2,277 2,158 1,598
Earnings per share:
Basic 0.59 0.68 0.65 0.48
Diluted 0.57 0.65 0.63 0.47
==================================================================================================================
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
Dec. 31, 2000 Sep. 30, 2000 Jun. 30, 2000 Mar. 31, 2000
- ------------------------------------------------------------------------------------------------------------------
Interest income $ 11,747 $ 9,455 $ 8,569 $ 8,039
Net interest income 4,759 4,442 4,402 4,198
Provision for loan losses 360 300 325 350
Income before income taxes 2,014 1,912 1,903 1,750
Net income 1,414 1,288 1,272 1,176
Earnings per share:
Basic 0.42 0.42 0.44 0.40
Diluted 0.42 0.41 0.43 0.40
==================================================================================================================
19