U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
For the year ended: Commission File No.:
December 31, 1996 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1779978
(State or other jurisdiction (I.R.S. Employer or
of incorporation or organization) Identification Number)
37 East Main Street, Warrenton, Virginia 20186
(Address of principal executive office) (Zip Code)
(540) 349-3900
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12 (g) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or such shorter period that the
registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not considered herein, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form
10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates
of the registrant computed by reference to the last reported bid price of
such stock as of February 28, 1997 was $10,971,226 (783,659 shares @
$14 per share). For purposes of this computation, it is assumed that
directors, executive officers and persons beneficially owning more than
5% of the Common Stock of the registrant are affiliates. As of February
28, 1997, there were issued and outstanding 1,564,248 shares of the
registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
I. Portions of Annual Report to Stockholders for the Year Ended
December 31, 1996, incorporated by reference into certain items of
Parts I. and II.
II. Portions of Proxy Statement for the Annual Meeting of Stockholders
to be held on April 24, 1997 incorporated by reference into certain
items of Part III.
Item 1. Business
General
Southern Financial Bancorp, Inc. ("Southern Financial" or "the
Bank") is a Virginia corporation incorporated as a bank holding company
under the Bank Holding Company Act of 1956, as amended. On
December 1, 1995, Southern Financial Bancorp, Inc. acquired all of the
outstanding shares of Southern Financial Bank. Southern Financial Bank,
formerly Southern Financial Federal Savings Bank, converted from a
savings bank to a state chartered commercial bank effective December 1,
1995.
Headquartered in Warrenton, Virginia, Southern Financial serves
the retail and commercial financial market as a savings and mortgage loan
specialist from ten full service offices located in Warrenton, Herndon,
Middleburg, Winchester, Leesburg, Fairfax and Woodbridge, Virginia.
Southern Financial's defined market area forms a semi-circle to the west
of the Metropolitan Washington, D.C. area roughly centered on
Warrenton. The counties included in the defined market area where
Southern Financial currently operates branches include: Loudoun
(Middleburg and Leesburg branches), Fauquier (Warrenton branches),
Fairfax (Herndon and Fairfax branches), Frederick county (Winchester
branches) and Prince William (Woodbridge branch). Other counties in
the defined market area include: Spotsylvania, Culpepper, Rappahanock,
Clarke and the three counties in the West Virginia panhandle.
The inner ring of the semi-circle which comprises Southern
Financial's market area is the bedroom community for the close in greater
Metropolitan Washington commercial centers which have grown up in
Northern Virginia in the past 30 years. As the economy of the
Metropolitan Washington area has diversified away from its concentration
in government and government-related employment, the Dulles Corridor
has developed into a major center for communication and high-tech
activities. In the process, Reston, Herndon, Tysons Corner and Fairfax
have become important employment centers in their own right much as
Stamford and White Plains have done outside Manhattan. As a
consequence, the commutable radius has pushed west out to Loudoun and
Fauquier Counties and south and southwest to Stafford, Spotsylvania and
Prince William Counties. Residential real estate is much more affordable
for comparable quality housing in Leesburg, Middleburg, Warrenton and
Manassas and other suburban communities than in close-in suburbs. The
branch locations in these areas uniquely situate Southern Financial to take
advantage of this growth in these western and southwestern sectors.
The principal business of Southern Financial is the taking of
deposits from the general public through its home and branch offices and
using these deposits and other borrowed funds for the origination of
adjustable rate and, to a lesser extent, fixed rate first and second mortgage
loans for the purpose of constructing, financing, or refinancing one- to
four-family, owner-occupied residential real estate in northern Virginia
and the surrounding Washington, D.C. suburbs. Additionally, the Bank
is involved in commercial lending in conjunction with the Small Business
Administration ("SBA") 504 and 7(a) loan programs. The Bank also
invests funds in mortgage-backed securities, callable securities issued by
Agencies of the Federal Government, and preferred stock of the Federal
Home Loan Mortgage Corp.
The principal sources of funds for the Bank's lending activities are
deposits, amortization and repayment of loans, proceeds from the sales of
loans, prepayments from mortgage-backed securities, repayments of
maturing callable agency securities, FHLB advances and other borrowed
money.
Principal sources of revenue are interest and fees on real estate
mortgage loans and mortgage-backed securities and gains from the sale of
mortgage loans, as well as fee income derived from the maintenance of
deposit accounts. The Bank's principal expenses include interest paid on
deposits and advances from the FHLB and other borrowings, and
operating expenses.
Mortgage-backed Securities
The Bank invests in mortgage-backed securities ("MBS") that are
insured or guaranteed by Federal Home Loan Mortgage Corporation
("FHLMC"), Government National Mortgage Association ("GNMA") and
Federal National Mortgage Association ("FNMA"). To a lesser extent,
the Bank also invests in collateralized mortgage obligations. At
December 31, 1996, the portfolio consisted of $63.2 million in securities
classified as held-to-maturity and $0.9 million classified as available-for-
sale. Typically, the Bank invests the proceeds from the sale of its fixed
rate mortgages in 30-year adjustable rate mortgage-backed securities.
This helps control Southern Financial's exposure to rising interest rates.
These mortgage-backed securities are all placed in the held-to-maturity
category. In addition, from time to time the Bank may elect to purchase
fixed rate mortgage-backed securities when the yield spread between fixed
rate and adjustable rate securities substantially favors the former, and the
risk of substantial rises in interest rates is acceptably low. Approximately
86.6% of the MBS held-to-maturity adjust annually or more often. The
remainder have fixed rates of interest and original maturities of 15 years.
At December 31, 1996, the weighted average interest rate was 7.04% for
securities held-to-maturity and 7.50% for securities available-for-sale.
The contractual maturities of all mortgage-backed securities exceeded ten
years; however the actual average life could be shorter due to
prepayments of the underlying collateral. For further information as to
the composition of the portfolio, see footnote 3 to the Financial Statements
in Southern Financial's December 31, 1996 Annual Report.
LENDING
Lending Activities
The principal lending activity of Southern Financial is the
origination of conventional and government fixed and adjustable rate real
estate loans to enable borrowers to purchase or refinance one-to four-
family owner-occupied residential property. In addition, Southern
Financial makes owner-occupied residential construction loans secured by
first liens on the properties to which they relate. The Bank also makes
loans on commercial real estate primarily through various lending
programs of the U.S. Small Business Administration program.
Approximately 87.5% of the Bank's total loan portfolio, or $94.7 million,
consisted of loans secured by real estate. To a lesser extent, Southern
Financial also makes commercial business and secured and unsecured
consumer loans. Recently, Southern Financial became a certified SBA
lender.
Southern Financial makes fixed and adjustable rate, first mortgage
loans with terms from three to 30 years. It offers second mortgages in
conjunction with its own first mortgages or those of other lenders. These
second mortgages typically have terms of five to 15 years and have rates
2% to 3% above the prevailing rate for fixed rate and adjustable rate first
mortgages at the time of origination. Southern Financial makes
construction loans and permanent loans on individual single family
residences and on other residential properties up to $2.0 million.
Construction loans generally have interest rates of prime plus one to one
and a half percent and fees of one to three points, loan-to-value ratios of
80% or less based on current appraisals and terms of generally nine
months or less. In the case of conventional loans, Southern Financial
typically lends up to 80% of the appraised value of single-family
residences. Although it has lent up to 90% of appraised value, Southern
Financial requires private mortgage insurance for such loans.
At December 31, 1996, Southern Financial's total loan portfolio,
before net items, was $110.2 million. Approximately 85.6% of these
loans, or $92.7 million, had adjustable rates of interest. Approximately
32.4% of the total outstanding loans consisted of loans secured by
permanent first mortgages on one-to-four family residential property.
Southern Financial sells virtually all of its newly originated, fixed rate
residential mortgage loans in the secondary market.
Residential Lending.
Southern Financial originates, for its portfolio and for sale in the
secondary market, both fixed and adjustable rate mortgage loans.
Southern Financial sells mainly fixed rate mortgages in the secondary
market and adjustable rate mortgages that do not meet Southern
Financial's portfolio criteria. Residential mortgage loans are secured by
single-family homes. At December 31, 1996, loans secured by residential
property, both permanent and construction, totaled $40.6 million, which
represented, before net items, approximately 36.9% of Southern
Financial's real estate loan portfolio.
Southern Financial principally originates residential real estate loans
through internal loan production personnel, some of whom work on a
commission basis. Once a borrower has applied for a loan, the complete
loan application package is reviewed by Southern Financial's salaried loan
processors. As part of the loan review process, qualified independent
appraisers inspect and appraise the property which would secure the loan.
In addition, information concerning income, financial condition,
employment and credit history of the borrower is reviewed and analyzed.
Loan applications are then evaluated at various levels of authority,
depending upon the amount and type of the loan. Mortgage loans
exceeding $250,000, unsecured consumer loans exceeding $100,000,
secured consumer loans exceeding $150,000 and commercial business
loans exceeding $150,000 all must be approved by Southern Financial's
Credit Committee. Loans of lesser amounts may be approved by
Chairman and Chief Executive Officer Georgia S. Derrico.
Income from residential lending activity includes loan origination
fees or points, underwriting fees, gain (or loss) from the sale of mortgage
loans and, to a lesser extent, loan servicing income. Earnings from this
activity depend on Southern Financial's ability to originate, profitably sell
and service mortgage loans. Ability to originate increasing volumes of
mortgage loans in the future in order to generate fee income will be
dependent on both competitive and economic factors. In particular,
higher interest rates tend to result in lower mortgage activity and, hence,
lower income.
Southern Financial also offers residential construction mortgage
loans in connection with permanent mortgage loans. These loans generally
provide for interest-only payments during the construction period and may
subsequently convert to a permanent mortgage loan. Depending on the
interest rate environment, the rates can be fixed or adjustable; however,
the term of these loans is usually no longer than nine months. With
respect to residential construction loans, independent appraisers inspect
the property periodically and prior to authorizing scheduled
disbursements. The application process is the same as that required for
permanent residential mortgage loans. Residential real estate construction
loans comprised approximately 5.1% of Southern Financial's loan
portfolio at December 31, 1996.
As described below, Southern Financial currently offers several
types of residential loans.
Adjustable Rate Mortgage Loans ("ARMs"). Southern Financial
currently offers ARMs with interest rate adjustments occurring at one-,
three- and five-year intervals. The ARMs have a 30-year amortization
period and provide for adjustment to the interest rate based upon one-
year, three-year and five-year U.S. Treasury Notes adjusted to constant
maturity, plus a margin which is determined at the time of application and
remains constant for the life of the loan. The margin for conforming
residential loans is generally 2.75%. For other types of loans, including
non-conforming residential loans and commercial loans, the margin may
range from 3.0% to 4.0% following market practices. Interest rate
increases are generally limited to a maximum of 2% per year and a
maximum of 5% or 6% over the life of the loan. The Bank structures all
of its residential loans to the standards of the secondary market and
classifies new loans to be held in the Bank's portfolio or to be held for
sale. By originating loans to the standards of the secondary market, the
uniformity and quality of the loan portfolio is enhanced.
In certain cases interest rates charged by Southern Financial during
the first year of an ARM may not reflect the full margin which will be
charged in later years. The practice of offering an initial rate below the
fully indexed market rate is commonly referred to as offering a "teaser
rate." The amount of the original discount from the fully indexed rate,
if a significant discount is employed, can have a dramatic impact on the
actual rate of the loan over the loan's contractual term. Most adjustable
rate mortgages have periodic and lifetime caps, and in many cases the
lifetime caps are a certain amount above the initial loan rate. To the
extent that the loan rate is discounted from the current market rate, the
lifetime cap is also impacted by the same amount of the discount.
Southern Financial, while at times employing an initial discount to the
fully indexed rate to remain competitive with other mortgage lenders in
the Bank's market, does not believe that the amount of discount employed
is significant enough to have a material impact on the overall profitability
of the loan. To ensure that the borrower has the capacity to repay the
loan, all adjustable rate mortgage loans are underwritten at the time of
origination based upon the fully indexed interest rate. In no cases are
adjustable mortgage loans originated where the scheduled payment is
insufficient to meet the borrowers interest due which would result in a
negative amortization of the loan. In short, Southern Financial's policy
is not to offer "teaser rates" which involve negative amortization.
Despite the benefits of ARMs to Southern Financial's asset/liability
management program, they do pose potential additional risks, primarily
because as interest rates rise, the underlying payments by the borrower
rise, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by
higher interest rates.
Fixed Rate Loans. Southern Financial also originates fixed rate
mortgage loans for sale in the secondary market and, to a limited extent,
for its portfolio. Southern Financial's fixed rate loans have terms ranging
from 3 to 30 years, with monthly payments which fully amortize the
principal and interest over the life of the loan or over 30 years with
balloon payments maturing in less than 30 years. Virtually all 30-year
fixed rate residential mortgages originated during recent fiscal years were
sold in the secondary market.
Commercial Real Estate Lending.
A large majority of Southern Financial's commercial real estate
lending is done in conjunction with the SBA 504 loan program. The SBA
504 Loan Program is an economic development program of the U.S.
Small Business Administration. The Small Business Administration, in
cooperation with banks and other lending institutions, finances the
expansion of small businesses. Costs can include purchase of land and
building, renovation, new construction, soft costs such as interim interest,
points on construction financing, professional fees (architect, engineer,
etc.), and machinery and equipment with a 10-year minimum useful life.
The minimum SBA 504 Loan amount is $50,000, and the maximum is
$750,000. Once the loan is approved at the Small Business
Administration, an "Authorization and Debenture Guarantee" is issued.
Signed by the small business and the Small Business Administration, it
provides authorization to lend to the small business under the terms and
conditions listed and constitutes a take-out commitment to the interim
lender (usually the same as the permanent lender). Once a project is
finished, two separate permanent loans are in place. One is the bank's
first trust loan, which is a conventional loan at market rates with a
minimum call of 10 years for real estate, and a 7-year call for machinery
and equipment. In addition, there is a second trust SBA 504 loan which
has a fixed rate of interest. The term of this second loan is 20 years for
real estate and 10 years for machinery and equipment. Those businesses
that qualify for the SBA 504 loan program must, in turn, create jobs as a
result of the expansion.
The Bank has participated in the SBA 504 loan program since late
1991. The credit structure of the 504 program offers borrowers access to
90% financing of the entire project. Of the 90%, 50% is provided by the
financial institution (the first trust mentioned above), and 40% is provided
by the certified development company (the 504 representative) with a
second trust; the remaining 10% of the funds for the project is provided
by the borrower. Southern Financial approved SBA 504 loans of
approximately $18.3 million in the year ended December 31, 1996, $12.4
million in the six months ended December 31, 1995 and $25 million in the
fiscal year ending June 30, 1995. Southern Financial is also an approved
lender for Section 7(a) Small Business Administration loans. In addition
to financing fixed assets, this program can also be used to finance
working capital, inventory purchase and equipment. In the year ended
December 31, 1996, the six months ended December 31, 1995 and the
fiscal year ended June 30, 1995, Southern Financial originated
approximately $4.3 million, $1.3 million and $1 million, respectively, in
Section 7(a) loans.
Consumer and Commercial Business Lending.
Southern Financial offers various types of secured and unsecured
consumer and commercial business loans. In general, these loans involve
somewhat more credit risk than do residential mortgage loans and,
therefore, usually yield a higher return to Southern Financial. There is
increased credit risk for consumer and commercial loans due to the type
of collateral securing these loans. The increased risk also derives from
the expectation that commercial loans generally will be serviced
principally from the business operations conducted, and such operations
may not be successful and, hence, may lead to default on the loan.
Historical trends have shown these types of loans to have higher
delinquencies than residential loans. The residential loan, as a collateral
loan, is a stable asset. Additionally, since the collateral is typically a
principal residence, the borrower traditionally makes a conscious effort
to assure payments are made on the loan. At December 31, 1996,
Southern Financial had $15.5 million of consumer and commercial
business loans which represent 14.3% of Southern Financial's total loans
receivable.
Income From Lending Activities.
Southern Financial realizes interest and loan fee income from its
lending activities. In addition to loan origination fees (or points) and
commitment fees for making commitments to originate single-family
residential loans, Southern Financial receives late charges relating to loans
which it services. Interest on loans and mortgage-backed securities, gains
on sale of loans, loan fees and service charges together comprised
substantially all of Southern Financial's total revenues for year ended
December 31, 1996.
Typically, Southern Financial charges up to a maximum of 4.0%
loan origination fees (or points) on residential mortgage loans. In
accordance with Statement of Financial Accounting Standard No. 91,
"Accounting for Non-Refundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases"
("SFAS 91"), loan origination fees and direct loan origination costs are
deferred and amortized as an adjustment to loan yield over the contractual
life of the loan. Deferred loan fees and costs are classified as part of the
loan balances to which they relate on the balance sheets.
Income from loan origination and commitment fees and other fees
are sources of income which vary with the volume and type of loans and
commitments made and purchased and with competitive and economic
conditions.
Loan Portfolio Composition
The following table sets forth the composition of Southern
Financial's loan portfolio during the periods indicated.
Loans by Security
December 31, 1996 December 31, 1995 June 30, 1995
Amount Percent Amount Percent Amount Percent
(amounts in thousands)
Mortgages
Residential $35,033 32.35% $37,583 36.05% $40,123 43.57%
Nonresidential 46,549 42.99% 36,742 35.24% 29,216 31.73%
Construction
Residential 5,616 5.19% 8,516 8.17% 8,460 9.19%
Nonresidential 7,510 6.94% 11,028 10.58% 5,941 6.45%
Total Real Estate 94,708 87.47% 93,869 90.04% 83,740 90.94%
Other Loans
Consumer
Loans on Deposits 621 0.57% 561 0.54% 344 0.37%
Auto 1,113 1.03% 993 0.95% 991 1.08%
Other 1,560 1.44% 1,207 1.16% 868 0.94%
Total Consumer 3,294 3.04% 2,761 2.65% 2,203 2.39%
Business 12,198 11.26% 9,265 8.89% 7,636 8.29%
Total Other 15,492 14.30% 12,026 11.54% 9,839 10.68%
Gross Loans 110,200 101.77% 105,895 101.58% 93,579 101.62%
Less:
Deferred Fees 412 0.38% 454 0.44% 442 0.47%
Allowance/Loan Losses 1,501 1.39% 1,190 1.14% 1,057 1.15%
Tot Lns Receiv, Net $108,287 100.00% $104,251 100.00% $92,080 100.00%
Loans by Type
December 31, 1996 December 31, 1995 June 30, 1995
Amount Percent Amount Percent Amount Percent
(amounts in thousands)
Fixed Rate Loans
Mortgages
Residential $10,354 9.56% $9,347 8.97% $10,203 11.08%
Nonresidential 2,741 2.53% 1,289 1.24% 980 1.06%
Construction
Residential 0 0.00% 74 0.07% 19 0.02%
Nonresidential 0 0.00% 0 0.00% 149 0.16%
Total Mortgages 13,095 12.09% 10,710 10.28% 11,351 12.32%
Nonmortgages
Consumer 2,310 2.13% 2,596 2.49% 2,065 2.24%
Business 2,101 1.94% 5,505 5.28% 2,166 2.35%
Total Fixed Rate Loans 17,506 16.17% 18,811 18.05% 15,582 16.91%
Adjustable Rate Loans
Mortgages
Residential 24,679 22.79% 28,236 27.08% 29,920 32.49%
Nonresidential 43,808 40.46% 35,453 34.01% 28,236 30.66%
Construction
Residential 5,616 5.19% 8,442 8.10% 8,441 9.17%
Nonresidential 7,510 6.94% 11,028 10.58% 5,792 6.29%
Total Mortgages 81,613 75.37% 83,159 79.77% 72,389 78.61%
Nonmortgages
Consumer 984 0.91% 165 0.16% 138 0.15%
Business 10,097 9.32% 3,760 3.61% 5,470 5.94%
Tot Adj Rate Loans 92,694 85.60% 87,084 83.54% 77,997 84.70%
Gross Loans 110,200 101.77% 105,895 101.59% 93,579 101.61%
Less:
Deferred Fees 412 0.38% 454 0.44% 442 0.48%
Allowance Loan Losses 1,501 1.39% 1,190 1.15% 1,057 1.13%
Total Loans Receiv, Net $108,287 100.00% $104,251 100.00% $92,080 100.00%
Contractual Repayments
The following table sets forth the contractual principal repayments of the
total loan portfolio of Southern Financial as of December 31, 1996 by
categories of loans. Adjustable and floating rate loans are included in the
period in which such loans are contractually due. Contractual principal
repayments of loans do not necessarily reflect the actual term of Southern
Financial's loan portfolio. The average life of mortgage loans is
substantially less than their contractual terms because of loan payoffs and
prepayments. The total loans at December 31, 1996 are before net items.
Principal Repayments
Contractually
Principal Due in Years Ending
Balance 1998- 2002 and
12/31/96 1997 2001 Thereafter
(in thousands)
Real Estate Mortgage Loans $81,582 $7,116 $4,639 $69,827
Real Estate Construction Loans 13,126 13,126 0 0
Business & Consumer Loans 15,492 8,548 4,635 2,309
Total $110,200 $28,790 $9,274 $72,136
The following table sets forth the dollar amount of all loans before net
items, due after one year from December 31, 1996, which have
predetermined interest rates and have floating or adjustable interest rates.
Fixed Adjustable
(in thousands)
Real Estate Mortgage Loans $10,633 $59,581
Business and Consumer Loans 3,897 3,053
Total $14,530 $62,634
Originations, Sales and Repayments of Loans
The following table shows the loan origination, sales and repayment
activities of Southern Financial for the periods indicated, excluding loan
fees, premiums, discounts, and amortization.
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
1996 1995 1995
(in thousands)
Originations by Type:
Residential Real Estate $26,618 $13,917 $30,634
Nonresidential Real Estate 29,573 16,104 41,449
Consumer 2,156 1,094 1,993
Business 6,632 3,521 8,711
Total Loans Originated 64,979 34,636 82,787
Purchase of Real Estate Loans 0 0 3,943
Sales of Real Estate Loans 10,232 4,328 20,145
Principal Repayments 50,442 17,316 41,020
Total Increase in Gross Loan $ 4,305 $12,992 $25,565
Loan Underwriting Policies
Because future loan losses are so closely intertwined with its
associated underwriting policy, Southern Financial has instituted what it
believes is a stringent loan underwriting policy. Its underwriting
guidelines are tailored for particular credit types, including lines of credit,
revolving credit facilities, demand loans, term loans, equipment loans,
real estate loans, SBA loans, stand-by letters of credits and unsecured
loans.
More specifically, it is Southern Financial's policy to encourage all
loan applicants for sound and lawful purposes, regardless of race, religion
or creed. Extensions of credit will be made if the criteria of
creditworthiness, likelihood of repayment and proximity to market areas
served indicate that such extensions of credit will provide acceptable
profitability to Southern Financial.
Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All property valuations are performed by independent
outside appraisers who are approved annually by Southern Financial's
Board of Directors.
It is Southern Financial's policy to retain a mortgage creating a valid
lien on real estate and to obtain a title insurance policy that insures the
property is free of encumbrances. Also required from the borrower are
hazard and flood insurance where the property is in a flood plain as
designated by the Department of Housing and Urban Development. Most
borrowers are also required to advance funds on a monthly basis from
which Southern Financial makes disbursements for items such as real
estate taxes, private mortgage insurance (required when the loan to value
ratio exceeds 80%) and hazard insurance.
Under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA"), the aggregate amount of loans that
Southern Financial may make to one borrower is limited to 15% of
Southern Financial's unimpaired capital and surplus. The maximum
amount of loans which Southern Financial could have made to one
borrower as of December 31, 1996 was approximately $2.4 million based
on 15% of its unimpaired capital and surplus. As of December 31, 1996,
the largest aggregate amount of such loans by Southern Financial to any
one borrower was $2.3 million.
All commercial loans must be approved by the Chief Executive
Officer and one other authorized officer prior to disbursement of funds.
In cases where the loan amount exceeds $250,000 as to real estate or
$150,000 on other loans, the commercial loan must be approved by the
Credit Committee and further reported to the full Board of Directors.
The information regarding the loan and its borrower must include
financial statements (audited in all credit applications of $500,000 or
more). Supporting financial data must be verified by bank references,
trade credit checks and similar procedures. In addition, all commercial
loan files are reviewed on an annual basis to ensure both the quality and
timeliness of the information contained.
Interest rates charged by Southern Financial are affected primarily
by competitive market factors. These factors include general economic
conditions, monetary policies of the Federal Reserve Bank, legislative tax
policies and government budgetary matters.
The Credit Committee, which consists of two outside members of
the Board of Directors and the Chief Executive Officer, is responsible for
the qualitative review of the loan portfolio, for approving all loans
exceeding lending officers' authorities ($250,000 on real estate loans and
$150,000 on other loans) and for assuring compliance with all of the
Board's policies and procedures as well as all applicable state and federal
laws, rules and regulations. All loans approved by the Credit Committee
are reported to the full Board of Directors at its next regularly
scheduled meeting.
Individual lending authorities are determined by the Chief Executive
Officer based on the individual's technical ability and must be agreed to
by the Credit Committee. All authorities are reviewed at least annually
by the full Board of Directors.
When a borrower fails to make a required payment, Southern
Financial attempts to cause the deficiency to be cured by contacting the
borrower. After 17 days, a reminder notice is sent indicating that a late
charge has been levied. After 30 days delinquency, the borrower is
contacted by phone and responses are documented. After 90 days, if the
loan has not been brought current or an acceptable arrangement is not
worked out with the borrower, Southern Financial will institute measures
to remedy the default, including commencing foreclosure action with
respect to mortgage loans and repossessions of collateral in the case of
consumer loans.
If foreclosure is effected, the property is sold at a public auction in
which Southern Financial may participate as a bidder. If Southern
Financial is the successful bidder, the acquired real estate property is then
included in its real estate owned account until it is sold. Such assets are
carried at the lower of cost or fair value net of estimated selling costs. To
the extent there is a decline in value, that amount is charged to operating
expense.
Past Due Nonperforming Loans and Investment in Real Estate
The following table sets forth information regarding past due
nonperforming loans and investment in real estate held by Southern
Financial at the dates indicated.
Dec. 31 Dec. 31 June 30,
1996 1995 1995
(amounts in thousands)
Accruing Loans 90 Days or More Delinquent
Residential Real Estate $ 0 $878 $607
Nonresidential Real Estate 28 0 196
Business & Consumer 0 3 2
Total 28 881 805
Nonperforming Loans
Residential Real Estate 321 541 0
Nonresidential Real Estate 1,257 0 0
Business 49 0 39
Consumer 7 50 15
Subtotal 1,634 591 54
Real Estate Owned
Residential 340 357 387
Total Nonperforming Assets $1,974 $948 $441
Total Nonperforming Assets to Total Assets 1.03% 0.58% 0.28%
At December 31, 1996, Southern Financial owned one property for
$340,023 secured by residential real estate.
In general, loans are placed on non-accrual status when management
believes, after considering economic and business conditions and
collection efforts, that the borrower's financial condition is such that
collection of interest is doubtful. At December 31, 1996 Southern
Financial had approximately $1.9 million in non-performing loans which
consisted of six mortgage loans and two nonmortgage loans. Five of the
mortgage loans were secured by residential real estate, and one was
secured by commercial real estate. One non-mortgage loan for $49,000
was a business loan which was 80% guaranteed by the Small Business
Administration. As of December 31, 1996, there was only one loan in the
amount of $28,000 which was delinquent 90 days or more and still on
accrual status, and as of February 28, 1997 this loan was current. This
compares to December 31, 1995 when there were seven loans with a total
balance of $881,000 which were delinquent 90 days or more and still on
accrual status.
If the nonperforming loans at December 31, 1996 had been current
in accordance with their terms, for the year ended December 31, 1996 (or
from the date of origination if originated during such period), the total
interest income on such loans for such period would have been $220,461.
Southern Financial's loss and delinquency experience on its
residential real estate loan portfolio has been limited by a number of
factors, including Southern Financial's underwriting standards. Whether
Southern Financial's loss and delinquency experience will increase
significantly depends upon the value of the real estate securing its loans,
economic factors such as an increase in unemployment as well as the
overall economy of the region. As a result of economic conditions and
other factors beyond its control, Southern Financial's future loss and
delinquency experience cannot be accurately predicted. However,
management has provided an allowance for loan losses which it believes
will be adequate to absorb future losses.
Allowance for Loan Losses
The total allowance for loan losses amounted to $1.5 million at
December 31, 1996, as compared to $1.2 million and $1.1 million at
December 31, 1995 and June 30, 1995 respectively. Management
evaluates the adequacy of the allowance at least quarterly. As a result of
that process, loans are categorized as to doubtful, substandard and/or
special mention. Each quarter the Board of Directors considers a review
of the loans in Southern Financial's portfolio and conducts a periodic
evaluation of the credit quality and reviews the adequacy of the loan loss
provision, recommending changes as may from time to time be required.
In establishing the appropriate classification for specific assets,
management takes into account, among other factors, the estimated value
of the underlying collateral, the borrower's ability to repay, the
borrower's payment history and the current delinquent status. The
remaining loan portfolio is evaluated for potential loss exposure by
examining the growth and composition of the portfolio, previous loss
experience, current delinquency levels, industry concentration and the
general economic condition.
The allowance for loan losses represents management's estimate of
an amount adequate to provide for potential losses inherent in the loan
portfolio, including certain large commercial credits in the normal course
of business. However, there are additional risks of future losses that
cannot be quantified precisely or attributed to particular loans or classes
of loans. Because those risks include general economic trends as well as
conditions affecting individual borrowers, management's judgement of the
allowance necessary is approximate. The allowance is also subject to
regulatory examinations and determination as to the adequacy of the
allowance in comparison to peer institutions identified by the regulatory
agencies. The allowance for loan losses as a percent of loans outstanding
was 1.39% at December 31, 1996, as compared to 1.14% at December
31, 1995.
The following table summarizes activity in Southern Financial's
allowance for loan losses during the periods indicated.
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
1996 1995 1995
(in thousands)
Allowance at Beginning of Period $1,190 $1,057 $1,008
Provision for Losses Charged to 695 150 60
Charge-offs
Residential Real Estate (8) 0 0
Nonresidential Real Estate (300) 0 0
Business Loans (38) (16) 0
Consumer Loans (43) (1) (11)
Total Charge-offs (389) (17) (11)
Recoveries 5 0 0
Net Charge-offs (384) (17) (11)
Allowance at End of Period $1,501 $1,190 $1,057
Loans at End of Period $108,287 $104,251 $92,080
Ratio of Allowance to Loans 1.39% 1.14% 1.15%
The following table summarizes the composition of the Allowance
for Loan Losses.
At December 31, At December 31, At June 30,
1996 1995 1995
Amount Percent Amount Percent Amount Percent
(amounts in thousands)
Real Estate Mortgage
Residential $ 152 10.13% $ 413 34.70% $ 79 7.47%
Nonresidential 708 47.17% 249 20.92% 188 17.79%
Real Estate Construction
Residential 23 1.53% 123 10.34% 254 24.03%
Nonresidential 131 8.73% 133 11.18% 227 21.48%
Business & Consumer 487 32.45% 272 22.86% 309 29.23%
Total Allow. for Loan Loss $1,501 100.00% $1,190 100.00% $1,057 100.00%
The Bank has allocated the allowance according to the amount
deemed to be reasonably necessary to provide for the possibility of losses
being incurred within each of the above categories of loans. These
figures are based on gross loans. The allocation of the allowances as
shown in the table above should not be interpreted as an indication that
loan losses in future years will occur in the same proportions or that the
allocation indicates future loan loss trends. Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories since the total allowance is
a general allowance applicable to the entire portfolio.
Investment Activities
Commercial banks, such as Southern Financial, have authority to
invest in various types of liquid assets, including short-term U.S.
Treasury obligations and securities of various federal agencies, certificates
of deposit at insured banks, bankers' acceptances, federal funds,
commercial paper and corporate debt securities. Investment decisions are
made by authorized officers, in conjunction with the Asset/Liability
Management Committee of Southern Financial within policies established
by the Board of Directors.
The following table sets forth Southern Financial's investment
portfolio at carrying value at the dates indicated.
December 31, December 31, June 30,
1996 1995 1995
(in thousands)
Interest-Earning Deposits $2,396 $1,796 $2,900
FHLB Stock 868 950 868
Investments Available-for-Sale 4,205 2,828 1,024
Investments Held-to-Maturity 2,000 0 0
Total $9,469 $5,574 $4,792
At December 31, 1996, interest-earning deposits consisted of
overnight deposits with the Federal Home Loan Bank of Atlanta.
Investments classified as available-for-sale consisted of FHLMC preferred
stock.
Source of Funds
Deposits. Deposit accounts have been a principal source of
Southern Financial's funds for use in lending and for other general
business purposes. In addition to deposits, Southern Financial obtains
funds from loan repayments, loan sales, cash flows generated from
operations and FHLB advances. Borrowings may be used as an
alternative source of lower costing funds or to fund the origination of
certain assets.
The following table shows the deposit activity for Southern
Financial for the periods indicated.
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
1996 1995 1995
(in thousands)
Net Deposits $ 15,661 $ 3,987 $ 33,763
Interest Credited 4,804 2,147 3,355
Net Increase in Deposits $ 20,465 $ 6,134 $ 37,118
The following table sets forth at December 31, 1996 deposit account
balances (excluding accrued interest payable) by account type, scheduled
maturity and weighted average interest rate.
Percent of Weighted
Total Average
Type of Account Total Deposits Interest Rate
(in thousands)
Checking Accounts $ 23,424 14.27% 0.65%
Savings Accounts 3,918 2.38% 2.64%
Money Market Accounts 17,585 10.70% 3.37%
Subtotal 44,927 27.35% 1.89%
Time Deposits Maturing in:
Year Ended December 31, 1997 101,212 61.61% 5.52%
Year Ended December 31, 1998 10,791 6.57% 5.88%
Year Ended December 31, 1999 4,337 2.64% 6.02%
Thereafter 3,012 1.83% 6.21%
Total Time Deposits 119,352 72.65% 5.59%
Total Deposits $ 164,279 100.00% 4.57%
The following table sets forth the amount of scheduled maturities of
time deposits at December 31, 1996.
Year Ended December 31,
2000 and
1997 1998 1999 thereafter Total
(in thousands)
Rate
4% or less $ 607 $ 0 $ 0 $ 0 $ 607
4.01% - 5.00% 4,016 324 0 8 4,348
5.01% - 6.00% 93,582 8,057 2,901 1,789 106,329
6.01% - 7.00% 3,004 2,406 1,412 819 7,641
7.01% and Above 3 4 24 396 427
Total Maturities $101,212 $10,791 $4,337 $3,012 $119,352
The following table shows maturity information of Southern Financial's
certificate of deposit accounts with balances of $100,000 or more at December
31, 1996.
Certificates
Maturity Period of Deposit
(in thousands)
Three Months or Less $17,368
Three Through Twelve Months 13,700
Greater Than One Year 3,593
Total $34,661
Borrowings.
The following table summarizes the borrowings of Southern
Financial at the dates indicated.
December 31, December 31, June 30,
1996 1995 1995
(in thousands)
FHLB Advances $8,500 $4,000 $3,000
Total Borrowings $8,500 $4,000 $3,000
The following table summarizes the average amount and maximum
amount of borrowings, as well as average interest rate paid, for the year
ended December 31, 1996 and for the year December 31, 1995.
Six Months
Year Ended Ended
December 31, December 31,
1996 1995
(amounts in thousands)
Maximum Month End Balance
FHLB Advances $12,000 $19,000
Average Balance
FHLB Advances $ 6,875 $6,016
Weighted Average Interest Rate
FHLB Advances 5.57% 5.85%
For further information about the borrowings of Southern Financial,
see footnote 9 to Southern Financial's December 31, 1996 Annual Report.
Competition
Southern Financial experiences substantial competition in attracting
and retaining savings deposits and in lending funds. The primary factors
in competing for savings are convenient office locations and rates offered.
Direct competition for savings deposits comes from other commercial
banks and thrift institutions. Additional significant competition for
savings deposits comes from money market mutual funds and corporate
and government securities which may yield more attractive interest rates
than insured depository institutions are willing to pay. The primary
factors in competing for loans are interest rate and loan origination fees
and the range of services offered. Competition for origination of real
estate loans normally comes from other commercial banks, thrift
institutions, mortgage bankers, mortgage brokers and insurance
companies.
Employees
At December 31, 1996, Southern Financial employed 61 full-time
equivalent persons. Management considers its relations with its
employees to be good. The employees are not covered by a collective
bargaining agreement.
EXECUTIVE OFFICERS OF THE REGISTRANT
At December 31, 1996, the executive officers of the Bank who were
not also directors were as follows:
Name Age Position
William H. Lagos 46 Senior Vice President
William H. Lagos joined the Bank in 1986 as Vice President. In
1993 he was promoted to Senior Vice President of Operations.
REGULATION
Set forth below is a brief description of certain laws and regulations
which relate to the regulation of Southern Financial. The description of
these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is
qualified in its entirety by reference to applicable laws and regulations.
General
Southern Financial is a bank holding company within the meaning
of the Bank Holding Company Act of 1956 as amended. As a bank
holding company, Southern Financial is supervised by the Board Of
Governors of the Federal Reserve System ("FRB") and is required to file
reports with the FRB and provide such additional information as the FRB
may require. Southern Financial is also subject to Virginia laws
regarding financial institution holding companies administered by the
Bureau of Financial Institutions of the State Corporation Commission of
Virginia. The Bank is also affected by rules and regulations of the
Federal Deposit Insurance Corporation ("FDIC"). Southern Financial is
a member of the Federal Reserve System and the FHLB of Atlanta. The
various laws and regulations administered by the regulatory agencies
affect corporate practices, expansion of business, and provisions of
services. Also, monetary and fiscal policies of the United States directly
affect bank loans and deposits and thus may affect Southern Financial's
earnings. The future impact of these policies and of the continuing
regulatory changes in the financial services industry cannot be predicted.
FIRREA
Under the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 ("FIRREA"), certain independent appraisal
requirements are imposed upon a bank's real estate lending activities and
further imposes certain loan-to-value restrictions on a bank's real estate
lending activities. The bank regulators have promulgated regulations in
these areas. Further, under FIRREA the failure to meet capital guidelines
could subject a bank to a variety of enforcement remedies available to
federal regulatory authorities, including termination of deposit insurance
by the FDIC.
FDICIA
The Federal Deposit Insurance Corporation Act of 1991
("FDICIA"), which became law in December, 1991, required each federal
banking agency to revise 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 non-traditional activities. In addition,
pursuant to FDICIA, each federal banking agency has promulgated
regulations, specifying the levels at which a financial institution would be
considered "well capitalized", "adequately capitalized", "under
capitalized", "significantly under capitalized", or "critically under
capitalized", and to take certain mandatory and discretionary supervisory
actions based on the capital level of the institution.
Under the FRB's regulations implementing the prompt corrective
action provisions, an institution shall be deemed to be (i) "well
capitalized" if it has total risk-based capital of 10% or more, has a Tier
I risk-based capital ratio of 6% or more, has a leverage capital ratio of
5% or more and is not subject to any order or final capital directive to
meet and maintain a specific capital level for any capital measure,
(ii)"adequately capitalized" if it has a total risk-based capital ratio of 8%
or more, a Tier I risk-based ratio of 4% or more and a leverage capital
ratio of 4% or more (3% under certain circumstances) and does not meet
the definition of "well capitalized", (iii) "undercapitalized" if it has a
total risk-based capital ratio that is less than 8%, a Tier I risk-based
capital ratio that is less than 4% or a leverage capital ratio that is less
than 4% (3% in certain circumstances), (iv) "significantly undercapitalized"
if it has a total risk-based capital ratio that is less than 6%, a Tier I
risk-based capital ratio that is less than 3% or a leverage
capital ratio that is less than 3% and (v) "critically
undercapitalized" if it has a ratio of tangible equity
to total assets that is equal to or less than 2%. In addition, under certain
circumstances, a federal banking agency may reclassify a well capitalized
institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category (except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized). Immediately upon becoming
undercapitalized, or upon failing to submit or implement a capital plan as
required, an institution shall become subject to various regulatory
restrictions.
FDICIA also contained the Truth in Savings Act, which requires
certain disclosures to be made in connection with deposit accounts offered
to consumers. The FRB has adopted regulations implementing the
provisions of the Truth in Savings Act.
In addition, significant provisions of FDICIA required federal
banking regulators to draft standards in a number of other important areas
to assure bank safety and soundness, including internal controls,
information systems and internal audit systems, credit underwriting, asset
growth, compensation, loan documentation and interest rate exposure.
FDICIA also required the regulators to establish maximum ratios of
classified assets to capital, and minimum earnings sufficient to absorb
losses without impairing capital. The legislation also contained other
provisions which restricted the activities of state-chartered banks,
amended various consumer banking laws, limited the ability of "under
capitalized" banks to borrow from the Federal Reserve's discount
window, and required federal banking regulators to perform annual onsite
bank examinations and set standards for real estate lending.
Regulatory Capital Requirement
The Federal Reserve Board mandates minimum capital requirements
for bank holding companies. In 1990, the FRB adopted a risk based
capital measure to determine capital adequacy. Under this system all
balance sheet assets are assigned a certain risk category with a prescribed
weight. Off-balance sheet items, such as loan commitments and letters of
credit, also are classified by risk with duly assigned weights. The sum of
the balance sheet and off balance sheet amounts multiplied by their
respective risk weight factors must then meet a required minimum capital
test. Tier 1 capital is defined as stockholders' equity minus certain
intangible assets. Tier 2 capital includes a certain amount of the
allowance for loan losses. At December 31, 1996, the minimum total
capital ratio (Tier 1 plus Tier 2) required was 8 percent. Southern
Financial's Tier 1 ratio of 15.4% and its total capital ratio of 16.6% were
well in excess of minimum requirements. The FRB also utilizes a Tier
1 leverage ratio in conjunction with its risk based capital standard. This
ratio measures Tier 1 capital as a percent of total average assets less
intangible assets. The minimum leverage ratio is 3 percent. At
December 31, 1996, the Bank's leverage ratio was 8.7%.
Insurance of Deposit Accounts
Southern Financial is a member of the Bank Insurance Fund ("BIF")
of the FDIC. The FDIC also maintains another insurance fund, the
Savings Association Insurance Fund ("SAIF"), which primarily covers
savings and loan association deposits but also covers deposits that are
acquired by a BIF insured institution from a savings and loan association.
Since Southern Financial converted to a commercial bank from a federal
savings bank on December 1, 1995, the deposits held by Southern
Financial as of the opening of business on December 1, 1995 will be
covered by SAIF. Therefore, Southern Financial has approximately
$164.3 million of deposits at December 31, 1996, with respect to which
Southern Financial pays SAIF insurance premiums.
For the first three quarters of 1995, both SAIF member institutions
and BIF member institutions paid deposit insurance premiums based on
a schedule from $0.23 to $0.31 per $100 of deposits. In August, 1995,
the FDIC, in anticipation of the BIF's imminent achievement of a required
1.25% reserve ratio, reduced the deposit insurance premium rates paid by
BIF insured banks to a range of $0.04 to $0.31 per $100 of deposits. On
November 14, 1995, the FDIC voted to reduce annual assessments for the
semi-annual period beginning January 1, 1996 to the legal minimum of
$2,000 for BIF insured institutions, except for institutions that are not
well capitalized and are assigned to the higher supervisory risk categories.
On September 30, 1996 the Board of Directors of the FDIC
imposed a special assessment on the SAIF assessable deposits of each
insured institution of 65.7 basis points calculated as of March 31, 1995.
BIF assessments will continue to range from 0 to 27 Basis Points on
insured deposits. Exemptions are provided for weak and newly charterd
institutions. Institutions facing significant threats to their fiscal solvency
may elect to pay the assessment in installments subject to the approval of
the FDIC.
The BIF and SAIF will be merged into the Deposit Insurance Fund
effective January 2, 1999, if all savings associations have converted to
either a Federal or State bank charter by that time.
Beginning January 1, 1997 banks will help to pay the Financing
Corporation interest debt. Banks will be assessed at a rate equal to 1/5 of
the rate that Thrifts are assessed on their deposit base. SAIF insured
institutions will pay at a rate of 6.44 basis points, and BIF insured
institutions will pay at a rate of 1.29 basis points. Federal banking
regulators are given specific authority to take any action they deem
appropriate to prevent deposit shifting designed to side-step any
differences in assessments. Beginning January 1, 2000 and continuing
through the year 2017 there will be pro-rata cost sharing at the rate of
2.43 basis points.
The FDIC Board of Directors voted on November 26, 1996 to retain
the existing BIF assessment schedule of 0 to 27 basis points (annual rates)
for the first semiannual period of 1997, and to collect an assessment
against BIF-assessable deposits to be paid to FICO. In addition, the Board
eliminated the $2,000 minimum annual assessment and authorized the
refund of the fourth-quarter minimum assessment of $500 paid by certain
BIF-insured institutions on September 30, 1996.
Based on June 30, 1996 data the upcoming assessment would reflect
a FICO rate of approximately 1.29 basis points, on an annual basis, for
BIF-assessable deposits, and 6.44 basis points for SAIF-assessable
deposits.
Liquidity Requirements
Liquidity measures the ability to satisfy current and future cash flow
needs as they become due and meet customers' demands for loans and
deposit withdrawals without impairing profitability. To meet these needs,
Southern Financial maintains cash reserves and readily marketable
investments in addition to funds provided from loan repayments and
maturing securities. Funds also can be obtained through increasing
deposits or short-term borrowings.
Federal Home Loan Bank System
Southern Financial is a member of the Federal Home Loan Bank
System which consists of 12 district Federal Home Loan Banks
("FHLBs") with each subject to supervision and regulation by the Federal
Housing Finance Board. The FHLBs provide a central credit facility for
member institutions. Southern Financial, as a member of the FHLB of
Atlanta, is required to acquire and hold shares of capital stock in that
FHLB in an amount equal to at least 1% of the aggregate principal
amount of its unpaid residential mortgage loans, home purchase contracts
and similar obligations at the beginning of each year, or 5% of its
advances (borrowings) from the FHLB of Atlanta, whichever is greater.
At December 31, 1996, Southern Financial had an inveastment of
$867,600 in the stock of the FHLB of Atlanta and was in compliance with
these requirements.
Advances from the FHLB of Atlanta are secured by mortgage-
backed securities. Interest rates charged for advances vary depending
upon maturity, the cost of funds to the FHLB of Atlanta and the purpose
of the borrowing. At December 31, 1996, Southern Financial had $8.5
million in borrowings from the FHLB of Atlanta outstanding.
Federal Reserve System
The Federal Reserve Board of Governors requires all depository
institutions to maintain reserves against their transaction accounts
(primarily NOW and Super NOW checking accounts) and non-personal
time deposits. Because required reserves must be maintained in the form
of vault cash or a noninterest-bearing account at a Federal Reserve Bank,
the effect of this reserve requirement is to reduce the earning assets of
Southern Financial.
TAXATION
Federal Taxation
General. Southern Financial is subject to federal income taxation
under the Internal Revenue Code of 1986, as amended (the "Code"), in
the same general manner as other corporations with some exceptions,
including particularly the reserve for bad debts discussed below. The Tax
Reform Act of 1986 ("1986 Act"), made major changes in the provisions
of the Code which are applicable to insured institutions, generally
effective for tax years beginning after December 31, 1986. The Revenue
Act of 1987 (the "1987 Act") made certain further changes in the Code
which affect insured institutions and their borrowers. The following
discussion of federal taxation is a summary of certain pertinent federal
income tax matters as affected by the 1986 Act and the 1987 Act.
Accrual Method of Accounting. For federal income tax purposes,
Southern Financial currently reports its income and expenses on the
accrual basis method of accounting.
Bad Debt Reserves. Banks such as Southern Financial having
assets with a tax basis of $500 million or less and which meet certain
definitional tests primarily relating to their assets and the nature of their
businesses, are permitted to establish a reserve for bad debts and to make
annual additions to the reserve using the experience method. These
additions may, within specified formula limits, be deducted in arriving at
Southern Financial's taxable income.
Under the experience method, the deductible annual addition to
Southern Financial's bad debt reserves is the amount necessary to increase
the balance of the reserve at the close of the taxable year to the greater of:
(a) the amount which bears the same ratio to loans outstanding at the
close of the taxable year as the total net bad debts sustained during the
current and five preceding taxable years bear to the sum of the loans
outstanding at the close of those six years or (b) the lower of (i) the
balance in the reserve account at the close of the last taxable year prior to
the most recent adoption of the experience method (the "base year"), or
(ii) if the amount of loans outstanding at the close of the taxable year is
less than the amount of loans outstanding at the close of the base year, the
amount which bears the same ratio to loans outstanding at the close of the
taxable year as the balance of the reserve at the close of the base year
bears to the amount of loans outstanding at the close of the base year.
Alternate Minimum Tax. For taxable years beginning after
December 31, 1986, corporations are subject to an alternative minimum
tax which is imposed to the extent that it exceeds the corporation's regular
income tax for the year. The alternative minimum tax will generally
apply at a rate of 20% to a base of regular taxable income plus certain tax
preferences ("alternative minimum taxable income" or "AMTI") and will
be payable to the extent such AMTI is in excess of an exemption amount.
The Code provides that items of tax preference that constitute AMTI
include (a) tax-exempt interest on newly issued (generally, issued on or
after August 8, 1986) private activity bonds other than certain qualified
bonds and (b) a tax preference item generally equal to 75% of the excess
(if any) of (i) adjusted current earnings as defined in the Code, over (ii)
AMTI (determined without regard to this preference and prior to reducing
by net operating losses). For any taxable year beginning after 1986, net
operating losses can offset no more than 90% of AMTI. Certain
payments of alternative minimum tax may be used as credits against
regular tax liabilities in future years. In addition, for taxable years after
1986 and before 1996, the Code provides for an environmental tax equal
to 0.12% of the excess of AMTI for the taxable year (determined without
regard to net operating losses and the deduction for the environmental tax)
over $2.0 million.
Net Operating Loss Carryovers. Under the 1986 Act, a financial
institution may carry back net operating losses ("NOLs") to the preceding
three taxable years and forward to the succeeding 15 taxable years. This
provision applies to losses incurred in taxable years beginning after 1986.
As of December 31, 1996, Southern Financial had no net operating loss
carry forwards for federal income tax purposes.
Capital Gains and Corporate Dividends-Received Deduction.
The capital gains income tax which was previously imposed at a tax rate
of 28% on a corporation's net long-term capital gains was repealed
effective December 31, 1986. Consequently, corporate net capital gains
generally will be taxed at a maximum rate of 34% after December 31,
1986. Effective January 1, 1993, a new 35% tax bracket is applied to
corporate taxable income (including net capital gains) in excess of $10
million. The 1986 Act reduced the corporate dividends-received
deduction from 85% to 80% in the case of dividends received from
corporations with which a corporate recipient does not file a consolidated
tax return. The 1987 Act further amended the dividends-received
deduction provisions of the Code to provide that corporations which own
less than 20% of the stock of a corporation distributing a dividend may
deduct only 70% of dividends received or accrued on their behalf.
However, the 1986 Act and the 1987 Act preserved prior law which
allows a corporation to deduct 100% of dividends from a member of the
same affiliated group of corporations. In addition to the foregoing general
rules, certain additional exceptions to the dividends-received deduction
may be applicable to Southern Financial under the Code in certain
circumstances.
IRS Examinations. The consolidated federal income tax returns of
Southern Financial and the Bank for their tax years beginning after June
30, 1993 are open under the statute of limitations and are subject to
review by the Internal Revenue Service.
State Taxation
Virginia imposes a franchise tax on every incorporated bank,
banking association or trust company organized by or under the laws of
the state of Virginia or which is doing business or has an office in the
state of Virginia, including the Bank. The franchise tax rate is $1.00 per
$100 of net taxable capital as defined in Virginia state statutes.
Item 2. Properties.
Offices and Other Material Properties
At December 31, 1996, Southern Financial conducted its business
from its main office in Warrenton, Virginia and nine branch offices.
The following table sets forth certain information with respect to the
offices of Southern Financial as of December 31, 1996.
Lease Date Net
Owned or Expiration Facility Book Value
Office Location Leased Date Opened (in thousands)
Home Office:
37 E. Main Street Leased September February 228
Warrenton, VA 1998 1989
Branch Offices:
362 Elden Street Leased June April 57
Herndon, VA 2000 1986
101 W. Washington S Leased July November 41
Middleburg, VA 1997 1987
33 W. Piccadilly St Owned N/A Novemeber 356
Winchester, VA 1990
526 E. Market Stree Leased June March 28
Leesburg, VA 1997 1992
11180 Lee Highway Leased September September 17
Fairfax, VA 1998 1993
322 Lee Highway Leased August August 211
Warrenton, VA 2001 1994
2545 Q-18 Centreville Rd. Leased September April 65
Herndon, VA 2001 1995
13542 Minnieville Rd. Leased December April 109
Woodbridge, VA 1998 1995
1095 Millwood Pike Owned N/A July 379
Winchester, VA 1996
Item 3. Legal Proceedings.
Southern Financial has, since inception, never been the subject of
any civil, administrative or criminal actions nor is it currently or has it
ever been involved in any legal proceedings other than non-material
proceedings in the ordinary course of business.
Item 4. Submission of Matters to Vote of Security Holders.
The Annual Meeting of Stockholders was held on April 18, 1996 at
3:00 p.m. at Fauquier Springs Country Club, Warrenton, Virginia. The
following is a summary of items voted upon at the meeting:
1. The following Directors were elected to serve three year terms:
Virginia Jenkins
Michael P. Rucker
2. The appointment of Arthur Andersen, LLP as independent
auditors for the year ending December 31, 1996 was ratified by
the following vote: For - 1,183,735; Against - 673; Abstain -
220.
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.
The information required herein is incorporated by reference from
the back page on the outside of the Registrant's 1996 Annual Report.
Item 6. Selected Financial Data.
The information required herein is incorporated by reference from
page 1 of the Annual Report.
Item 7. Management's Discussion and Analysis.
The information required herein is incorporated by reference from
pages 4 to 10 of the Annual Report.
Item 8. Financial Statements.
The information required herein is incorporated by reference from
pages 11 to 29 of the Annual Report.
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.
None.
PART III.
Item 10. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act.
The information required herein is incorporated by reference from
pages 3 to 4 and 10 to 11 of the definitive proxy statement of Southern
Financial Bancorp, Inc. filed on March 17, 1997 ("Definitive Proxy
Statement"). For additional information concerning executive officers of
the Registrant who were not also directors, see "Item 1 - Business -
Executive Officers of the Registrant" herein, which is incorporated by
reference.
Item 11. Executive Compensation.
The information required herein is incorporated by reference from
pages 8 to 9 of the Definitive Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and
Management.
The information required herein is incorporated by reference from
pages 6 to 8 of the Definitive Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required herein is incorporated by reference from
pages 5 of the Definitive Proxy Statement.
PART IV.
Item 14. Exhibits, Financial Statements, Schedules, and Reports on
Form 8-K.
(a) Documents filed as a part of the report:
(1) The following is an index to the financial statements of the
Registrant included in the Annual Report to Stockholders for the
year ended December 31, 1996, and incorporated herein
by reference in Item 8. The remaining information appearing in
the Annual Report to Stockholders is not deemed to be filed as
part of this Report, except as expressly provided herein.
Page(s) in
Annual Report
Independent Auditors' Report. 11
Balance Sheets:
December 31, 1996 and December 31, 1995. 12
Statements of Income:
Year Ended December 31, 1996,
Six Months Ended December 31, 1995 and
Year Ended June 30, 1995. 13
Statements of Changes in Stockholders' Equity:
Year Ended December 31, 1996,
Six Months Ended December 31, 1995 and
Year Ended June 30, 1995. 14
Statements of Cash Flows:
Year Ended December 31, 1996
Six Months Ended December 31, 1995 and
Year ended June 30, 1995. 15
Notes to Consolidated Financial Statements. 16 - 29
(2) All other schedules have been omitted as the required
information is either inapplicable or included in the Notes to
Financial Statements.
(3) Exhibits (listed numbers correspond to item 601 of Regulation S-
K)
(3) Articles of Incorporation of Southern Financial Bancorp,
Inc., by reference to the Form S-4 Registration Statement
filed with the Securities and Exchange Commission on
August 4, 1995, and By-Laws, by reference to Form S-4
Registration Statement filed with the Securities and
Exchange Commission on August 4, 1995.
(4) Instruments Defining the Rights of Security Holders,
Including Indentures--Reference is made to Exhibit (3)
above.
(9) Voting Trust Agreement--Not applicable.
(10) Employment Contracts--Reference is made to Form S-4
Registration Statement filed with Securities and Exchange
Commission on August 4, 1995.
(11) Statement re Computation of Per Share Earnings--
Reference is made to Note 1 to Financial Statements,
Page 18 in Annual Report.
(12) Statement re Computation of Ratios--Not applicable.
(13) Pages 11-29 of Annual Report to Stockholders for the Year Ended
December 31, 1996.
(18) Letter re Change in Accounting Principles--Not
applicable.
(21) Subsidiaries of the registrant:
Percentage of Voting
Jurisdiction of Securities Owned by
Name Incorporation the Parent
Southern Financial Bank Virginia 100%
(22) Published Report Regarding Matters Submitted to Vote of
Security Holders--Not applicable.
(23) Consents of Experts and Counsel--Not applicable.
(24) Power of Attorney--Not applicable.
(28) Information from Reports Furnished to State Insurance
Regulatory Authorities--Not applicable.
SIGNATURES
Pursuant to the requirement of Section 13 of the Securities Exchange Act
of 1934, the Registrant had duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOUTHERN FINANCIAL BANCORP, INC.
By /s/Georgia S. Derrico
Georgia S. Derrico
Chairman and Chief Executive Officer
Dated: 3/27/97
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on the dates indicated.
Name Title Date
/s/Georgia S. Derrico Director and Chairman of 3/27/97
Georgia S. Derrico the Board and
Chief Executive Officer
/s/David de Give Director and Senior Vice 3/27/97
David de Give President
/s/William H. Lagos Controller 3/27/97
William H. Lagos (Principal Accounting Officer)
/s/Virginia Jenkins Director 3/27/97
Virginia Jenkins
/s/R. Roderick Porter Director 3/27/97
R. Roderick Porter
/s/Neil J. Call Director 3/27/97
Neil J. Call
/s/John L. Marcellus, Jr. Director 3/27/97
John L. Marcellus, Jr.
/s/Michael P. Rucker Director 3/27/97
Michael P. Rucker
Exhibit 13
Southern Financial Bancorp, Inc.
December 31, 1996 Annual Report to Stockholders
Page 11 of Annual Report
Southern Financial Bancorp. Inc.
Financial statements As of
December 31, 1996 and 1995
Together with Auditors' Report
Report of Independent Public Accountants
To the Board of Directors of
Southern Financial Bancorp, Inc.:
We have audited the accompanying consolidated statements of condition of
Southern Financial Bancorp, Inc. (a Virginia corporation) as of December 31,
1996 and 1995, and the related consolidated statements of income, changes
in stockholders' equity and
cash flows for the year ended December 31, 1996, for the six months ended
December 31, 1995, and for the year ended June 30, 1995. These financial
statements are the responsibility of the Bancorp's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an 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 financial statements referred to above present fairly,
in all material respects, the financial position of Southern Financial
Bancorp, Inc. as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the year ended December 31, 1996, for the
six months ended December 31, 1995, and for the year ended June 30, 1995,
in conformity with generally accepted
accounting principles.
Washington, D.C.,
February 4, 1997
Page 12 of Annual Report
Consolidated Statements of Condition
As of December 31, 1996 and 1995
Assets Dec. 31, 1996 Dec. 31,1995
Cash and due from banks $4,004,149 $3,894,884
Overnight earning deposits 2,395,574 1,795,902
Investment securities, available-for-sale 4,205,287 2,827,625
Investment securities, held-to-maturity
(estimated market value of $2,001,875
and $0, respectively) 2,000,000 -
Mortgage-backed securities, available-for-sale 894,332 1,045,098
Mortgage-backed securities, held-to-maturity
(estimated market value of $62,972,202 and
$45,674,350, respectively) 63,217,243 45,997,777
Loans held for sale 444,500 170,000
Loans receivable, net 108,286,903 104,251,481
Federal Home Loan Bank stock, at cost 867,600 950,000
Bank premises and equipment, net 1,487,446 1,146,553
Interest receivable 1,328,551 1,167,022
Real estate owned 340,023 357,023
Other assets 1,337,114 1,197,385
Total assets $190,808,722 $164,800,750
Liabilities and Stockholders' Equity Dec. 31, 1996 Dec. 31, 1995
Liabilities:
Deposits $164,279,105 $143,813,686
Advances from Federal Home Loan Bank 8,500,000 4,000,000
Advances from borrowers for taxes and insurance 105,292 113,631
Other liabilities 1,523,373 1,098,362
Total liabilities 174,407,770 149,025,679
Commitments
Stockholders' equity:
6% Cumulative convertible preferred stock,
$.01 par value, 500,000 shares authorized,
15,634 shares issued and outstanding,
$241,193 aggregate liquidation preference,
respectively 156 166
Common stock, $.01 par value,
5,000,000 shares authorized,
1,594,122 and 1,564,248 shares issued
and outstanding, respectively, as
of December 31, 1996 15,941 13,912
Capital in excess of par value 15,276,373 12,796,014
Retained earnings 1,655,575 3,050,284
Net unrealized gain on securities available-for-sale (76,006) 14,685
Treasury stock, at cost (471,087) (99,990)
Total stockholders' equity 16,400,952 15,775,071
Total liabilities and stockholders' equity $190,808,722 $164,800,750
The accompanying notes are an integral part of these financial statements.
Page 13 of Annual Report
Consolidated Statements of Income
For the Year Ended December 31, 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
Six Months
Year Ended Ended Year Ended
Dec. 31, Dec. 31, June 30,
1996 1995 1995
Interest income:
Loans $10,308,273 $4,967,233 $7,523,092
Mortgage-backed securities and
other investments 4,306,296 1,763,665 3,503,555
Total interest income 14,614,569 6,730,898 11,026,647
Interest expense:
Deposits 7,433,334 3,439,788 5,232,831
Borrowings 342,078 189,675 698,457
Total interest expense 7,775,412 3,629,463 5,931,288
Net interest income 6,839,157 3,101,435 5,095,359
Provision for loan losses 695,000 150,000 60,000
Net interest income after provision
for loan losses 6,144,157 2,951,435 5,035,359
Other income:
Gain on sale of loans 209,962 108,846 267,728
Fee income 886,747 302,992 503,693
Gain on sale of mortgage-backed
securities, net - - 63,208 -
Other 89,553 39,301 43,063
Total other income 1,186,262 514,347 814,484
Other expense:
Employee compensation and benefits 2,147,974 907,371 1,579,581
Premises and equipment 1,591,235 637,105 1,012,374
Deposit insurance assessments 1,085,536 174,145 276,816
Professional fees 93,223 84,209 100,294
Other 989,139 513,233 746,991
Total other expense 5,907,107 2,316,063 3,716,056
Income before income taxes 1,423,312 1,149,719 2,133,787
Provision for income taxes 469,600 414,400 833,070
Net income $ 953,712 $ 735,319 $1,300,717
Earnings per common share:
Primary earnings per share $ 0.59 $ 0.46 $ 0.82
Fully diluted earnings per share $ 0.59 $ 0.46 $ 0.81
Weighted average shares outstanding 1,546,179 1,508,370 1,505,016
The accompanying notes are an integral part of these financial statements.
Page 14 of Annual Report
<TABLE>
Consolidated Statements of Changes in Stockholders' Equity
For the Year Ended December 31, 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
<CAPTION>
Net Unrealized
Capital in Gain (Loss) Total
Preferred Common Excess of Retained Treasury on Securities Stockholders'
Stock Stock Par Value Earnings Stock Available for-sale Equity
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1994 $174 $7,454,696 $3,364,588 $3,242,751 $- $(43,601) $14,018,608
Dividends on preferred
and common stock - - - (258,477) - - (258,477)
Conversion of preferred
shares to common stock (8) 6,032 (6,024) - - - -
Options exercised - 8,000 4,080 - - - 12,080
Four-for-three stock split
effected in the form of a dividend - 2,488,720 (2,488,720) - - - -
Stock dividend of 10% - 995,744 809,041 (1,804,785) - - -
Net unrealized gain on
securities available-for-sale - - - - - 99,895 99,895
Net income - - - 1,300,717 - - 1,300,717
Balance, June 30, 1995 166 10,953,192 1,682,965 2,480,206 - 56,294 15,172,823
Dividends on preferred
and common stock - - - (165,241) - - (165,241)
Options exercised - 58,811 114,958 - - - 173,769
Treasury stock - - - - (99,990) - (99,990)
Net unrealized loss on
securities available-for-sale - - - - - (41,609) (41,609)
Change in par value to 0.01 per share - (10,998,091) 10,998,091 - - - -
Net income - - - 735,319 - - 735,319
Balance, December 31, 1995 166 13,912 12,796,014 3,050,284 (99,990) 14,685 15,775,071
Dividends on preferred
and common stock - - - (360,971) - - (360,971)
Conversion of preferred
shares to common stock (10) 16 (6) - - - -
Options exercised - 594 494,778 - - - 495,372
Stock dividend of 10% - 1,419 1,985,587 (1,987,006) - - -
Treasury stock - - - (444) (371,097) - (371,541)
Net unrealized gain on
securities available-for-sale - - - - - (90,691) (90,691)
Net income - - - 953,712 - - 953,712
Balance, December 31, 1996 $156 $15,941 $15,276,373 $1,655,575 $(471,087) $(76,006) $16,400,952
</TABLE>
The accompanying notes are an integral part of these financial statements.
Page 15 of annual Report
Southern Financial Bancorp, Inc.
Consolidated Statements of Cash Flows
For the Year Ended December 31, 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
Six Months
Year Ended Ended Year Ended
Dec. 31, Dec. 31, June 30,
1996 1995 1995
Cash flows from operating activities:
Net income $ 953,712 $ 735,319 $ 1,300,717
Adjustments to reconcile net income to
net cash provided by operating activities-
Depreciation and amortization 251,249 141,577 451,660
Provision for loan losses 695,000 150,000 60,000
(Benefit) provision for
deferred income taxes (13,849) 61,488 53,590
Gain on sale of loans (209,962) (108,846) (267,728)
Loss on real estate owned 17,000 30,000 -
Gain on sale of securities, net - (63,208) -
Amortization of deferred loan fees (431,247) (290,978) (652,294)
Originations of loans held for sale (10,676,888) (4,328,475) (11,613,600)
Proceeds from sales of loans 10,612,350 4,422,321 12,324,528
Increase in interest receivable (161,529) (112,442) (381,240)
Increase in other assets (94,036) (562,596) (144,454)
Increase (decrease) in other
liabilities 438,861 (46,886) 343,113
Net cash provided by
operating activities 1,380,661 27,274 1,474,292
Cash flows from investing activities:
Net fundings of loans receivable (4,299,175) (12,030,737) (24,530,444)
Purchases of investment securities (3,499,810) (1,807,000) (381,630)
Purchases of mortgage-backed securitie (28,927,466) (3,151,005) (10,271,977)
Sales of mortgage-backed securities
available-for-sale - 4,848,694 -
Paydowns of mortgage-backed securities 11,844,529 4,439,860 6,373,360
(Increase) decrease in overnight
earning deposits, net (599,672) 1,104,111 (404,563)
Investment in real estate owned - - (387,023)
Increase in bank premises
and equipment, net (592,142) (41,942) (433,014)
Decrease (increase) in Federal
Home Loan Bank stock 82,400 (82,400) (136,100)
Net cash used in investing
activities (25,991,336) (6,720,419) (30,171,391)
Cash flows from financing activities:
Increase in deposits, net 20,465,419 6,134,062 37,117,664
Increase (decrease) in advances from
Federal Home Loan Bank 4,500,000 1,000,000 (5,500,000)
Decrease in advances from borrowers
for taxes and insurance (8,339) (89,780) (21,674)
Net proceeds from stock options exercised 495,372 173,768 12,080
Repurchase of common stock (371,541) (99,990) -
Dividends on preferred and common stock (360,971) (165,240) (258,477)
Net cash provided by financing
activities 24,719,940 6,952,820 31,349,593
Net increase in cash and due from banks 109,265 259,675 2,652,494
Cash and due from banks,
beginning of period 3,894,884 3,635,209 982,715
Cash and due from banks, end of period $ 4,004,149 $ 3,894,884 $ 3,635,209
Page 16 of annual Report
Notes to Consolidated Financial Statements
As of December 31, 1996 and 1995
1. Organization and Significant Accounting Policies:
Southern Financial Bancorp, Inc. (the "Bancorp"), 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. The amounts presented as of June 30, 1995, and
for the year ended June 30, 1995 represent the financial position and
results of operations of Southern Financial Federal Savings Bank.
The principal activities of the Bank are to attract deposits, originate
loans and conduct mortgage banking activities as permitted for state
chartered banks by applicable regulations. The Bank conducts full-service
banking operations in Fairfax, Herndon, Leesburg, Middleburg, Warrenton,
Winchester and Woodbridge, Virginia.
The accounting and reporting policies of the Bancorp are in accordance with
generally accepted accounting principles and conform to general practices
within the banking industry. The more significant of these policies are
discussed below. The preparation of financial statements in conformity with
generally accepted accounting principles 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.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Bancorp and the Bank as of December 31, 1996 and 1995, and for the year
ended December 31, 1996, and for the six months ended December 31, 1995.
All significant intercompany accounts and transactions have been
eliminated.
Cash and Due From Banks and Overnight Earning Deposits
Amounts represent actual cash balances held by or due to the Bank.
Investment and Mortgage-Backed Securities
The Bancorp accounts for its investment and mortgage-backed securities in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
Investments in debt securities are classified as held-to-maturity when the
Bancorp has the positive intent and ability to hold those securities to
maturity. Held-to-maturity investments 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 and
mortgage-backed securities classified as available-for-sale are reported at
fair value, with unrealized gains and losses excluded from earnings and
reported as a separate component of 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 and
mortgage-backed securities.
Loans Held for Sale
Mortgage loans originated which are intended for sale in the secondary
market are carried at the lower of cost or estimated market value in the
aggregate.
Impaired Loans
Effective July 1, 1995, the Bancorp implemented SFAS No. 114, "Accounting
by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures."
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
Page 17 of Annual Report
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.
At December 31, 1996, the Bancorp had identified impaired loans with a
carrying value of $1,676,064. At December 31, 1996, estimated collateral
proceeds were in excess of the carrying value of the loans and related
allowance for losses of $333,834. The Bancorp calculates the need for an
allowance for impaired loans based upon historical charge-offs, repayment
experience and specific factors concerning the impaired loans. The average
recorded investment in impaired loans for the year ended December 31, 1996
was $1,322,450. The Bancorp recognized interest income of $44,700 on its
impaired loans for the year ended December 31, 1996.
Loan Origination Fees
Nonrefundable loan fees and direct origination costs are deferred and
recognized over the lives of the related loans as adjustments of yield.
Allowance for Loan Losses
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.
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 that collection of interest is
doubtful.
Premises and Equipment
The Bancorp's premises and equipment are stated at cost less accumulated
depreciation and amortization. Expenditures for maintenance and repairs
which do not materially prolong the useful lives of the assets are charged
to expense.
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 Owned
The Bancorp 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. Costs relating to holding the assets are expensed.
Core Deposit Intangibles
The Bancorp amortizes its core deposit intangibles over five years, which
represents the estimated lives of the depository accounts acquired.
Income Taxes
The Bancorp accounts for certain income and expense items differently for
financial reporting purposes than for income tax reporting purposes,
principally the provision for loan losses and loan related fees. Deferred
income taxes are provided in recognition of these temporary differences.
Page 18 of annual Report
Earnings Per Share
Primary earnings per common share were computed by dividing income, less
dividends on preferred stock, by the average weighted number of shares of
common stock and common stock equivalents outstanding during the periods.
Common stock equivalents included 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. Fully diluted earnings
per common share were determined in the same manner except that common
stock equivalents also included the number of shares issuable on conversion
of the convertible preferred shares to common shares.
Financial Instruments with Off-Balance Sheet Risk
The Bancorp, in the normal course of business, is a party to financial
instruments with off-balance sheet risk 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.
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. The Bancorp 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.
Issued But Not Yet Adopted Statements of Financial Accounting Standards
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" was issued in June 1996 and is
effective for transactions on a prospective basis beginning January 1,
1997. Earlier or retroactive application is not permitted. This statement
provides accounting and reporting standards for transfers and servicing of
financial assets extinguishments of liabilities. Those standards are based
on consistent application of a financial-components approach that focuses
on control. Adoption of this Statement is not expected to have a material
impact on the Bancorp.
Reclassifications
Certain reclassifications were made to the prior year financial statements
to conform to the current year presentation.
2. Investment Securities:
The portfolio consists of the following securities:
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale:
FHLMC preferred stock $4,310,235 $11,355 $116,303 $4,205,287
December 31, 1995
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale:
FHLMC preferred stock $2,810,425 $31,200 $14,000 $2,827,625
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Held-to-Maturity:
FHLB Agency Callables $2,000,000 $ 1,875 $ - $2,001,875
The portfolio balance of FHLB Agency Callable Securities was $0 as of
December 31, 1995.
Page 19 of Annual Report
3. Mortgage-Backed Securities:
The portfolio consists of the following securities:
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale:
FNMA participation
certificates $902,824 $ - $8,492 $894,332
December 31, 1995
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale:
FNMA participation
certificates $1,039,353 $5,745 $ - $1,045,098
December 31, 1996
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Held-to-maturity:
FHLMC participation
certificates $ 7,300,246 $ 20,736 $ 52,650 $ 7,268,332
FNMA participation
certificates 21,981,743 42,607 183,797 21,840,553
GNMA participation
certificates 27,387,797 95,893 46,549 27,437,141
Collateralized mortgage
obligations 6,547,457 8,215 129,496 6,426,176
Total $63,217,243 $167,451 $412,492 $62,972,202
December 31, 1995
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Held-to-maturity:
FHLMC participation
certificates $ 9,397,071 $22,335 $ 72,688 $ 9,346,718
FNMA participation
certificates 12,065,698 - 185,819 11,879,879
GNMA participation
certificates 17,612,474 25,094 82,645 17,554,923
Collateralized mortgage
obligations 6,922,534 34,380 64,084 6,892,830
Total $45,997,777 $81,809 $405,236 $45,674,350
Held-to-maturity securities are carried at cost adjusted for amortization
of premiums and accretion of discounts. All of the held-to-maturity
securities other than $8.5 million of 15-year fixed rate securities have
adjustable rates of interest. The rates on approximately 17 percent of the
portfolio are tied to the 11th District and national cost of funds indices
and adjust monthly. The remaining rates are tied to the one year constant
maturity treasury index.
Available-for-sale securities are carried at fair value with unrealized
losses reported as a separate
component of stockholders' equity, net of the tax effect. All of the
available-for-sale securities have fixed interest rates.
There were no sales of mortgage-backed securities during the year ended
December 31, 1996.
During the six months ended December 31, 1995, net proceeds from sales of
available-for-sale
mortgage-backed securities were $4,848,694. Gross gains of $63,208 were
realized on the sale of
mortgage-backed securities during the six months ended December 31, 1995.
Page 20 of Annual Report
As of December 31, 1996 and December 31, 1995, mortgage-backed securities
having a book value of $49,743,572 and $30,124,830, respectively, were
pledged as collateral for advances from the Federal Home Loan Bank of
Atlanta ("FHLB") and as collateral for escrow deposits in accordance with
Federal and state requirements.
A comparison of amortized cost and market value for securities, along with
the contractual dates of maturity, by category of security as of December
31, 1996 is as follows:
Aggregate
Amortized Market
Cost Value
Available-for-sale securities:
Investment securities- $ - $ -
Mortgage-backed securities-
Maturing after ten years 902,824 894,332
Total available-for-sale securities $902,824 $894,332
Held-to-maturity securities:
Investment securities-
Maturing after one year, but within five years $2,000,000 $2,001,875
Mortgage-backed securities-
Maturing after ten years 63,217,243 62,972,202
Total held-to-maturity securities $65,217,243 $64,974,077
As of December 31, 1995, all investment and mortgage-backed securities had
maturity dates of after ten years.
4.Loans Receivable:
Loans receivable consist of the following:
December 31, December 31,
1996 1995
Mortgages:
Residential $ 35,032,684 $ 37,583,119
Nonresidential 46,548,847 36,742,339
Construction:
Residential 5,616,121 8,515,853
Nonresidential 7,510,374 11,028,772
Nonmortgages:
Business 12,197,921 9,265,345
Consumer 3,294,171 2,760,636
Total loans receivable 110,200,11 8 105,896,064
Less:
Deferred loan fees, net (412,274) (454,334)
Allowance for loan losses (1,500,941) (1,190,249)
Loans receivable, net $108,286,903 $104,251,481
Page 21 of annual Report
The following sets forth information regarding the allowance for loan losses:
December 31, December 31,
1996 1995
Balance, beginning of period $1,190,249 $1,057,445
Charge-offs, net (384,308) (17,196)
Provision charged to income 695,000 150,000
Balance, end of period $1,500,941 $1,190,249
The Bancorp's loan portfolio is concentrated in the Northern Virginia area.
At December 31, 1996 and 1995, the average yield on loans receivable was
9.18 percent and 9.32 percent, respectively. The amount
of loans being serviced for others was $4,121,734 and $3,384,496 at
December 31, 1996 and 1995, respectively. At December 31, 1996, there were
no loans on which the Bancorp was still accruing interest which had
payments ninety days or more past due. At December 31, 1995, there were
seven loans on which the Bancorp was still accruing interest with a total
balance of approximately $881,028 which had payments ninety days or more
past due.
The loan portfolio includes loans on which the Bancorp is not currently
accruing any interest income. The total outstanding principal and
uncollected interest on these loans consists of the following:
December 31, December 31,
1996 1995
Principal outstanding $1,676,064 $591,049
Uncollected interest 220,461 27,675
There were no sales of real estate owned during the year ended December
31, 1996, the six months ended December 31, 1995, or the year ended June
30, 1995.
5.Bancorp Premises and Equipment:
The Bancorp's premises and equipment consists of the following:
December 31, December 31,
1996 1995
Land $ 125,647 $ 50,000
Building and improvements 587,980 350,424
Furniture and equipment 1,335,548 1,105,650
Leasehold improvements 996,885 947,843
3,046,060 2,453,917
Less- Accumulated depreciation and amortization (1,558,614) (1,307,364)
Bancorp premises and equipment, net $1,487,446 $1,146,553
Depreciation and amortization expense aggregated $251,249 and $111,303 for
the year ended December 31, 1996, and for the six months ended December 31,
1995, respectively.
6. Interest Receivable:
Accrued interest receivable consists of the following:
December 31, December 31,
1996 1995
Interest on loans $ 890,133 $ 840,385
Interest on mortgage-backed securities
and other investments 438,418 326,637
Total $1,328,551 $1,167,022
Page 22 of annual Report
7. Real Estate Owned:
The following activity occurred during the year ended December 31, 1996 and
the six months ended December 31, 1995:
December 31, December 31,
1996 1995
Beginning balance $357,023 $387,023
Additions - -
Holding period write-down (17,000) (30,000)
Ending balance $340,023 $357,023
Balance represents one property in Loudoun County, Virginia.
8. Deposits:
Deposits consist of the following:
1996 1995
Weighted Weighted
Average Average
Interest Interest
Rate Amount Rate Amount
Checking accounts 0.65% $23,424,025 1.74% $18,881,792
Money market and savings accounts 3.23 21,502,863 3.37 19,302,329
Certificates of deposit 5.59 119,352,217 5.73 105,629,565
4.57% $164,279,105 4.89% $143,813,686
As of December 31, 1996, certificates of deposit have scheduled fiscal year
maturity dates as follows:
1997 $101,212,198
1998 10,791,485
1999 4,336,878
2000 3,011,656
$119,352,217
Deposits totaling approximately $24,135,017 and $19,611,149 had balances
greater than $100,000 at December 31, 1996 and 1995, respectively, of which
$13,861,572 and $11,595,231 represented certificates of deposit at December
31, 1996 and 1995, respectively.
Interest expense by deposit category follows:
1996 1995
Checking accounts $ 238,279 $ 135,574
Money market and savings accounts 683,839 314,728
Certificates of deposit 6,511,216 2,989,486
$7,433,334 $3,439,788
Total cash paid for interest aggregated approximately $2,628,853 and
$1,292,324 for the year ended December 31, 1996, and the six months ended
December 31, 1995, respectively.
Page 23 of Annual Report
9. Advances from Federal Home Loan Bank:
The Bancorp has a credit availability agreement with FHLB totaling
$25,000,000. The agreement does not have a maturity date and advances are
made at FHLB's discretion. At December 31, 1996 and 1995, advances from
FHLB totaled $8,500,000 and $4,000,000, respectively. Advances are made at
variable interest rates. The weighted average rates of interest were 6.57
percent and 5.85 percent at December 31, 1996 and 1995, respectively.
Advances outstanding at December 31, 1996, mature on February 14, 1997,
October 15, 1997, and January 30, 1998, and are secured by mortgage-backed
securities having a book value of $49,732,572.
The Bancorp has entered into interest rate cap agreements whereby the
counterparty institution agreed to cap the cost of a component of the FHLB
advances outstanding floating-rate debt for an agreed upon period of time.
The cap agreement was accounted for as a hedge. The cost of the interest
rate caps were amortized into interest expense on a straight-line basis
over the terms of the agreements. At December 31, 1996 and 1995,
respectively, the Bancorp had outstanding interest rate caps with a total
notional amount of $0 and $1,000,000.
10. Stockholders' Equity:
Each share of the Bancorp's preferred stock is convertible to 1.61 shares
of common stock. The preferred stock has an annual dividend rate of 6
percent. Dividends are payable quarterly and are cumulative.
The Bancorp's Board of Directors declared a 10 percent stock dividend in
July 1996 and 1995 and a four-for-three stock split in February 1995, which
was effected in the form of a dividend. All earnings per share amounts
have been calculated as if these distributions occurred on July 1, 1992,
the beginning of fiscal year 1993.
In December 1995, the Bancorp changed the par value of its common stock
from $8.00 per common share to $0.01 per common share. This resulted in a
decrease in common stock of $10,998,091.
In fiscal year 1987, the Bancorp'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 fiscal year 1994, this plan was amended to
allow an additional 100,000 shares 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.
The Bancorp 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 Statement of Financial
Accounting Standards("SFAS") No. 123, "Accounting for Stock-Based
Compensation", the Bancorp's net income and earnings per share in the
Consolidated Statements of Income, would have been reduced to the following
pro forma amounts:
December 31,
1996 1995
Net income:
As reported $953,712 $735,319
Pro forma 603,344 522,390
Earnings per share:
As reported 0.62 0.49
Pro forma 0.39 0.35
Weighted-average assumptions:
Expected lives (years) 10.00 10.00
Risk-free interest rate (%) 6.06% 6.22%
Expected volatility (%) 45.00% 45.00%
Expected dividends (annual per share) - -
Page 24 of annual Report
The Bancorp did not record any compensation costs in 1996 or 1995 related
to its stock option plan. In addition, no significant modifications to the
plan were made during the periods. The fair values of the stock options
outstanding used to determine the pro forma impact of the options to
compensation expense, and thus, net income and earnings per share, were
based on the Noreen-Wolfson option pricing model for each grant made in
1996 and 1995, using the key assumptions detailed above.
Compensation cost charged against historical net income in the above table
was increased by the fair value of stock-based compensation grants. The
compensation cost amounted to $350,368 and $212,929 for the year ended
December 31, 1996 and the six months ended December 31, 1995, respectively.
During the initial phase-in period, the effects of applying SFAS No. 123
to historical net income to provide pro forma disclosures are not likely to
be representative of the effects on reported net income for future years
because the SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995.
A summary of the status of the Bancorp's stock option plan as of December
31, 1996 and 1995, and changes during the year ended December 31, 1996, and
the six months ended December 31, 1995, is presented below. Average prices
and shares subject to options have been adjusted to reflect stock
dividends.
1996 1995
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding at beginning of year 188,792 $9.94 171,871 $9.82
Granted 66,029 13.43 45,980 13.18
Exercised 65,373 8.18 24,219 7.92
Forfeited - -
Expired 12,121 13.04 4,840 12.08
Outstanding at December 31, 177,327 11.02 188,792 9.94
Options exercisable at December 31, 112,127 125,891
Weighted average fair value
of options granted during the period $5.92 $6.01
The following table summarizes information about fixed stock options
outstanding at December 31, 1996.
Options Outstanding Options Exercisable
Weighted
Remaining Average
Exercise Number Contractual Number Exercise
Price Outstanding Life Exercisable Price
months
$7.49 8,874 42 8,874 $7.49
7.75 12,907 6 12,907 7.75
8.83 30,653 90 30,653 8.83
8.99 4,840 18 4,840 8.99
9.30 7,260 30 7,260 9.30
9.61 16,940 78 16,940 9.61
11.98 30,653 103 30,653 11.98
12.73 15,403 115 - -
13.64 43,195 109 - -
13.64 6,602 112 - -
177,327 112,127
Page 25 of Annual Report
There were 10 option holders at December 31, 1996. Options exercised
during 1996 had exercise prices ranging from $6.81 to $10.57. Options
exercised during 1995 had exercise prices ranging from $6.81 to $10.57.
The closing price of the Bancorp's stock at December 31, 1996 was $13.50
per share.
On May 28, 1996, the Bancorp acquired 9,374 shares of its own stock at a
market price of $16.00 in a stock swap transaction with the Chief Executive
Officer. The shares acquired were accepted as payment to redeem 22,026
options to purchase common stock. This purchase was accounted for as
treasury stock by the Bancorp.
On July 30, 1996, the Bancorp acquired 14,771 shares of its own stock at a
market price of $15.31 in a stock swap transaction with the Controller. The
shares acquired were accepted as payment to redeem 22,000 options to
purchase common stock. The purchase was accounted for as treasury stock by
the Bancorp.
11. Regulatory Matters:
The Bancorp's primary supervisory agent is the Federal Reserve Bank. The
Federal Reserve Bank has mandated certain 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.
Effective January 1, 1994, the Bancorp implemented SFAS No. 115. This
pronouncement requires, among other items, the reporting of unrealized
gains and losses in available-for-sale securities in stockholders' equity.
At December 31, 1996, the Bank reported net unrealized losses of $76,006,
net of tax, in stockholder's equity. These net unrealized losses were
excluded from Tier I and Tier II capital for regulatory reporting in
accordance with current regulatory agency guidance.
The Bancorp is subject to various regulatory capital requirements
administered by the federal banking agencies. 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 the Bancorp's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bancorp must meet specific capital guidelines that
involve quantitative measures of the Bancorp's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Bancorp's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitaive measures established by regulation to ensure capital adequacy
require the Bancorp 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). Management believes, as of
December, 31, 1996, that the Bancorp meets all capital adequacy
requirements to which it is subject.
As of December 31, 1996, the most recent notification from the Federal
Reserve Bank categorized the Bancorp as adequately capitalized under the
regulatory framework for prompt corrective action. To be categorized as
adequately capitalized the Bancorp 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.
The Bancorp's actual capital amounts and ratios are also presented in the
tables below. (All dollar amounts are in 000s).
Page 26 of Annual Report
To be Well
For Capital Capitalized Under
Adequacy Prompt Corrective
Actual Puproses Action Provisions
Amount Ratio Amount Ratio Amount Ratio
As of December 31, 1996:
Total Capital:
(to risk weighted assets) $17,554 16.6% =>$8,431 =>8.0% =>$10,539 =>10.0%
Tier I Capital
(to risk weighted assets) $16,234 15.4% =>$4,216 =>4.0% =>$6,323 =>6.0%
Tier I Capital
(to average assets) $16,234 8.7% =>$7,477 =>4.0% =>$9,346 =>5.0%
As of December 31, 1995:
Total Capital:
(to risk weighted assets) $16,628 15.9% =>$8,355 =>8.0 =>$10,443 =>10.0%
Tier I Capital
(to risk weighted assets) $15,438 14.8% =>$4,177 =>4.0% =>$6,266 =>6.0%
Tier I Capital
(to average assets) $15,438 9.6% =>$6,424 =>4.0% =>$8,030 =>5.0%
Legislation was enacted on September 30, 1996 that imposed on thrift
institutions a one-time assessment of 65.7 basis points on their
SAIF-insured deposits to capitalize the SAIF. The Bancorp was required to
pay the assessment since it was considered a thrift institution at the time
the SAIF legislation was initiated. During 1996, the Bank paid
approximately $830,270 for the SAIF assessment which is included in deposit
insurance assessments on the accompanying Consolidated Statements of
Income.
12. Parent Company Activity:
The Bancorp owns all of the outstanding shares of the Bank. The statement
of condition and statement of income are as follows:
Statement of Condition
As of December 31, 1996
Assets:
Investment in bank $16,443,483
Other assets 36,925
Total assets $16,480,408
Liabilities:
Other liabilities $ 3,450
Total liabilities $ 3,450
Stockholders' equity:
Preferred stock $ 156
Common stock 15,941
Capital in excess of par 15,276,373
Retained earnings 1,655,575
Treasury stock (471,087)
Total stockholders' equity 16,476,958
Total liabilities and stockholders' equity $16,480,408
Page 27 of Annual Report
Statement of Income
For the Year Ended December 31, 1996
Equity in earnings of Bank $ 953,712
13. Estimated Fair Value of Financial Instruments:
Effective December 31, 1995, the Bancorp implemented SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments." SFAS No. 107
requires all entities to disclose the fair value of financial instruments,
both assets and liabilities recognized and not recognized in the statement
of financial position, for which it is practicable to estimate fair value.
If estimating fair value is not practicable, the statement requires
disclosure of descriptive information pertinent to estimating the value of
a financial instrument.
Some of the Bancorp's assets and liabilities are financial instruments;
however, certain of these financial instruments lack an available trading
market. Significant estimates, assumptions and present value calculations
were therefore used for the purposes of the following disclosure, resulting
in a great degree of subjectivity inherent in the indicated fair value
amounts. Comparability among financial institutions may be difficult due
to the wide range of permitted valuation techniques and the numerous
estimates and assumptions which must be made. The estimated fair values of
the Bancorp's financial instruments at December 31, 1996 are as follows:
December 31, 1996
Carrying Fair
Amount Value
Financial assets:
Cash and amounts due from banks $ 4,004,149 $ 4,004,149
Available-for-sale securities 5,099,619 5,099,619
Held-to-maturity securities 65,217,243 64,974,077
Loans receivable, net of reserve 108,286,903 108,336,794
Loans held for sale 444,500 444,500
Financial liabilities:
Deposits-
Checking accounts 23,424,025 23,424,025
Money market and savings accounts 21,502,863 21,502,863
Certificates of deposit 119,352,217 119,442,477
The following methods and assumptions were used to estimate the fair value
amounts at December 31, 1996:
Cash and Due From Banks
Carrying amount approximates fair value.
Available-for-Sale Securities
Fair value is based on quoted market prices.
Held-to-Maturity Securities
Fair value is based on quoted market prices, dealer quotes or estimates
using dealer quoted market prices for similar securities.
Loans Receivable, Net of Reserve
Fair value of certain homogeneous groups of loans (e.g., single-family
residential, automobile loans, home improvement loans and fixed-rate
commercial and multifamily 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 the
Bancorp for loans with similar terms to borrowers of similar credit
quality. For loans which reprice frequently at market rates (e.g., home
equity, variable-rate commercial and multifamily, real estate construction
and ground loans), the carrying amount approximates fair value.
Page 28 of annual Report
Loans Held for Sale
Fair Value is determined using quoted market prices for loans or outstanding
commitment prices from investors.
Deposits
Deposit liabilities payable on demand, consisting of NOW accounts, money
market deposits, statement savings and other deposit accounts, are assumed
to have an estimated fair value equal to carrying value. The indicated
fair value does not consider the value of the Bancorp's estimated deposit
customer relationships.
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 maturities.
Off-Balance Sheet Instruments
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.
14. Savings Plan:
In fiscal year 1993, the Bancorp began 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 U.S. employees may defer a portion of their pretax earnings,
up to the Internal Revenue Service annual contribution limit. The Bancorp
matches each employee's contributions on a discretionary basis, based on
Bancorp profits up to a maximum of 6 percent of the employee's earnings.
The Bancorp expects to make a cash contribution by March 15, 1997, covering
the year ended December 31, 1996. The Bancorp's cash contributions to the
Savings Plan were $22,943 and $28,385 for the years ended December 31, 1996
and 1995, respectively.
15. Provision for Income Taxes:
The provision for income taxes consists of the following:
Year Ended Six Months Ended Year Ended
December 31, December 31, June 30,
1996 1995 1995
Current provision:
Federal $483,449 $320,154 $760,309
State - 32,758 90,771
483,449 352,912 851,080
Deferred (benefit) provision:
Federal (13,849) 58,072 (16,929)
State - 3,416 (1,081)
(13,849) 61,488 (18,010)
$469,600 $414,400 $833,070
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. 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. The amount of the deferred tax asset
considered realizable, however, could be reduced in the near term if
estimates of future taxable income are reduced. Total cash paid for taxes
aggregated $916,000 and $550,350 for the year ended December 31, 1996,
and for the six months ended December 31, 1995, respectively.
Page 29 of Annual Report
Deferred tax assets and liabilities were comprised of the following
significant components as of December 31, 1996 and 1995:
1996 1995
Assets:
Provision for losses on loans and real estate owned $198,125 $ 53,526
Deferred loan fees 161,820 219,676
Depreciation 83,923 67,308
Gross deferred tax assets 443,868 340,510
Liabilities:
FHLB dividend 35,771 35,771
Valuation of Loans and Securities 39,074 -
Other 64,577 14,142
Gross deferred tax liabilities 139,422 49,913
Net deferred tax assets $304,446 $290,597
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 Six Months Ended Year Ended
December 31, 1996 December 31, 1995 June 31, 1995
Pretax income 34% 34% 34%
State taxes - 2% 5%
Dividends received
deduction (1%) - -
Effective tax rate 33% 36% 39%
16. Commitments:
The Bank leases its corporate headquarters and branch facilities under
operating lease agreements expiring through 2001. As of December 31, 1996,
future minimum lease payments required under these arrangements, assuming
no extension options are exercised, are as follows:
Years Ending
December 31, Minimum Lease Payments
1997 $440,549
1998 377,892
1999 244,041
2000 218,487
2001 168,148
Thereafter
Rent expense aggregated $504,647 and $240,976 for the year ended December
31, 1996, and for the six months ended December 31, 1995, respectively.
Outstanding loan commitments amounted to $9,119,150 and $6,402,500 at
December 31, 1996 and 1995, respectively. The Bank had commitments from
investors of $2,769,800 and $4,525,600 to purchase loans from the Bank at
December 31, 1996 and 1995, respectively.
At December 31, 1996, the Bank had commercial letters of credit outstanding
in the amount of approximately $251,907.
At December 31, 1996, the Bank had unfunded lines of credit of $10,724,839.
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