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, 1997 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 27, 1998 was $21,022,988 (747,484 shares @ $28.125 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 27, 1998, there were 1,592,781 shares
of the registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
I. Portions of Annual Report to Stockholders for the Year Ended
December 31, 1997 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 23, 1998 incorporated by reference into certain
items of Part III.
<PAGE>
Part I.
Special Note Regarding Forward-looking Information
Certain statements under the caption Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
Annual Report and the documents incorporated herein by reference constitute
"forward-looking statements" within the meaning of the United States Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Bancorp, or industry
results, to be materially different from any future results, performance, or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the following: general economic and business
conditions in the Bancorp's market area, inflation, fluctuations in interest
rates, changes in government regulations and competition, which will, among
other things, impact demand for loans and banking services; the ability of the
Bancorp to implement its business strategy; and changes in, or the failure to
comply with, government regulations.
Forward-looking statements are intended to apply only at the time they
are made. Moreover, whether or not stated in connection with a forward-looking
statement, the Bancorp undertakes no obligation to correct or update a
forward-looking statement should the Bancorp later become aware that it is not
likely to be achieved. If the Bancorp were to update or correct a
forward-looking statement, investors and others should not conclude that the
Bancorp will make additional updates or corrections thereafter.
Item 1. Business
General
Southern Financial Bancorp, Inc. ("Southern Financial" or "the
Bancorp") was incorporated in Virginia 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. The only activity of the Bancorp is to own and control all of
the capital stock of Southern Financial Bank. Hereafter, references to Southern
Financial and the Bancorp include the activities of Southern Financial Bank.
Headquartered in Warrenton, Virginia, the Bancorp serves the retail and
commercial financial market as a deposit and 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
the Bancorp currently operates branches include: Loudoun (Middleburg and
Leesburg branches), Fauquier (Warrenton branches), Fairfax (Herndon and Fairfax
branches), Frederick (Winchester branches) and Prince William (Woodbridge
branch). Other counties in the defined market area include: Spotsylvania,
Culpeper, Rappahanock, Clarke and the three counties in the West Virginia
panhandle.
The inner ring of the semi-circle that comprises the Bancorp's market
area is the bedroom community for the close-in greater Metropolitan Washington
commercial centers that 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. The branch
locations in these areas situate Southern Financial to take advantage of the
rapid economic growth of these communities.
The principal business of the Bancorp is the acquisition of deposits
from the general public through its home and branch offices and use of these
deposits to fund its loan and investment portfolios. The Bancorp seeks to be a
full service community bank which provides a wide variety of financial services
to its middle market corporate clients as well as to its retail clients. The
Bancorp is an active commercial lender that often lends in conjunction with the
Small Business Administration ("SBA") 504 and 7(a) loan programs. In addition,
the Bancorp is an active residential construction lender and offers its retail
clients a full menu of permanent residential mortgage loan alternatives. The
Bancorp also invests funds in mortgage-backed securities, securities issued by
Agencies of the Federal Government and preferred stock of the Federal Home Loan
Mortgage Corporation.
The principal sources of funds for the Bancorp's lending and investment
activities are deposits, amortization and repayment of loans, proceeds from the
sales of loans, prepayments from mortgage-backed securities, repayments of
maturing agency securities, FHLB advances and other borrowed money.
Principal sources of revenue are interest and fees on loans and
investment securities and gains from the sale of loans, as well as fee income
derived from the maintenance of deposit accounts. The Bancorp's principal
expenses include interest paid on deposits and advances from the FHLB and other
borrowings, and operating expenses.
Lending Activities
The principal lending activity of the Bancorp is the origination of
loans on commercial real estate primarily through various lending programs of
the U.S. Small Business Administration program. The Bancorp is a certified SBA
lender. In addition, the Bancorp makes conventional and government fixed and
adjustable rate real estate loans to enable borrowers to purchase or refinance
one-to-four-family, owner-occupied residential properties. The Bancorp also
makes owner-occupied residential construction loans secured by first liens on
the properties to which they relate. At December 31, 1997, approximately 82% of
the Bancorp's total loan portfolio, or $107.3 million, consisted of loans
secured by real estate. To a lesser extent, the Bancorp also makes commercial
business and secured and unsecured consumer loans.
Commercial Real Estate Lending.
Commercial Construction Lending. Southern Financial is involved in
financing the construction phase of small business projects prior to the
project being approved by the U. S. Small Business Association ("SBA"). To a
lesser extent, the Bancorp also provides commercial construction financing
for projects outside of the SBA programs. At December 31, 1997, approximately
10% of the Bancorp's loan portfolio consisted of nonresidential construction
loans.
U. S. Small Business Administration ("SBA") Lending. A large majority
of Southern Financial's commercial real estate lending is done in conjunction
with the SBA 7(a) and 504 loan programs. The SBA 7(a) and 504 Loan Programs are
economic development programs 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. Southern Financial is
a certified SBA lender.
Section 7(a) loans may be used for the purchase of real estate,
construction, renovation or leasehold improvements, as well as machinery,
equipment, furniture, fixtures, inventory, and in some instances, working
capital and debt refinance. Start-up businesses are eligible. The SBA guarantees
up to 90% of the loan balance under the 7(a) Program. The 504 Program is used to
finance long-term fixed assets, primarily real estate and large/heavy equipment.
The 504 Program is an economic development program designed to create new jobs
or retain existing jobs. The credit structure of the 504 Program gives borrowers
access to 90% financing of the project. 50% is provided by the financial
institution (in the form of a first trust) and 40% is provided by the certified
development company (the 504 representative) with a second trust. The borrower
provides the remaining 10% of the funds required for the project. As of December
31, 1997, Southern Financial had approximately $7.3 million of loans originated
under the 7(a) Program and $52 million of loans originated under the 504
Program.
Residential Lending
The Bancorp makes fixed and adjustable rate, first mortgage loans with
terms from 3 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 5 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. 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. The Bancorp requires private
mortgage insurance for loans exceeding 80% of the appraised value.
Residential mortgage loans are secured by single-family homes. At
December 31, 1997, loans secured by residential property, both permanent and
construction, totaled $37 million, which represented approximately 29% of total
loans receivable. Approximately 24% of the total loans receivable consisted of
loans secured by permanent mortgages on one-to-four family residential property.
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. The increased credit risk for
consumer and commercial loans is 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. At December 31, 1997, Southern Financial had
$24.3 million of consumer and commercial business loans which represent 18% of
the Bancorp's total loans receivable.
Income from Lending Activities.
Interest on loans, gains on sale of loans, and loan fees and service
charges amounted to approximately 64% of Southern Financial's total revenue for
the year ended December 31, 1997. Income from loan origination fees and other
fees are sources of income which vary with the volume and type of loans and
commitments made and with competitive and economic conditions.
<PAGE>
Loan Portfolio Composition
The following table sets forth the composition of the Bancorp's loan
portfolio during the periods indicated:
<TABLE>
<CAPTION>
At December 31, At June 30,
1997 1996 1995 1995 1994
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(amounts in thousands)
<S> <C>
Mortgage:
Residential $ 30,421 24% $ 35,033 32% $ 37,583 35% $ 40,123 43% $ 38,211 55%
Nonresidential 57,160 43% 46,549 42% 36,742 35% 29,216 31% 14,037 21%
Construction:
Residential 6,534 5% 5,616 5% 8,516 8% 8,460 9% 7,906 12%
Nonresidential 13,161 10% 7,510 7% 11,029 10% 5,941 6% 3,742 5%
-------- ----- ------ ---- ------- ---- ------ ---- ------ ----
Total Mortgage 107,276 82% 94,708 86% 93,870 88% 83,740 89% 63,896 93%
-------- ----- ------ ---- ------- ---- ------ ---- ------ ----
Nonmortgage:
Business 21,253 16% 12,198 11% 9,265 9% 7,601 9% 2,614 4%
Consumer 3,093 2% 3,294 3% 2,761 3% 2,238 2% 1,944 3%
-------- ----- ------ ---- ------- ---- ------
Total Nonmortgage 24,346 18% 15,492 14% 12,026 12% 9,839 11% 4,558 7%
-------- ----- ------ ---- ------- ---- ------ ---- ------ ----
Gross Loans 131,622 100% 110,200 100% 105,896 100% 93,579 100% 68,454 100%
Less:
Deferred Fees 627 412 455 442 489
Allowance for Loan
Losses 2,037 1,501 1,190 1,057 1,008
------- ------ ------- ------ ------
Total Loans
Receivable, Net $ 128,958 $ 108,287 $ 104,251 $ 92,080 $ 66,957
=========== =========== =========== ========== =========
</TABLE>
The following table sets forth the scheduled maturity of selected loans
as of December 31, 1997:
<TABLE>
<CAPTION>
Over 1 Year
Through 5 Years Over 5 years
One Year Fixed Floating Fixed Floating
or Less Rate Rate Rate Rate Total
----------- --------- ---------- --------- ---------- ---------
(amounts in thousands)
<S> <C>
Construction:
Residential $ 6,534 $ - $ $ - $ - $ 6,534
Nonresidential 12,696 - 465 - - 13,161
Business 10,472 1,490 2,572 689 6,030 21,253
------------ ------------ ------------ ------------ ------------ ------------
Total $ 29,702 $ 1,490 $ 3,037 $ 689 $ 6,030 $ 40,948
============== ============= ============== ============= ============= ==========
</TABLE>
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 credit 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 the Bancorp.
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 the Bancorp'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 is hazard insurance,
and flood insurance is required if 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 the Bancorp's unimpaired capital and
surplus. The maximum amount of loans that Southern Financial could have made to
one borrower as of December 31, 1997 was approximately $2.8 million based on 15%
of its unimpaired capital and surplus. As of December 31, 1997, the largest
aggregate amount of such loans by Southern Financial to any one borrower was
$2.6 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. Supporting financial data must
be verified by bank references, trade credit checks and similar procedures. In
addition, commercial loan files are generally 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.
<PAGE>
Past Due Loans and Nonperforming Assets
The following table sets forth information regarding past due loans and
nonperforming assets as of the periods indicated:
<TABLE>
<CAPTION>
At December 31, At June 30,
1997 1996 1995 1995 1994
------- ------- ------- ------- -------
(amounts in thousands)
<S> <C>
Accruing Loans 90 Days
or More Delinquent
Residential $ - $ - $ 878 $ 607 $ 420
Nonresidential - 28 - 196 290
Business 1 - - - -
Consumer - - 3 2 -
------- ------- ------- ------- -------
Total 1 28 881 805 710
======= ======= ======= ======= =======
Nonperforming Loans
Residential 443 321 541 - 84
Nonresidential 1,002 1,257 - - 356
Business - 49 - 39 5
Consumer - 7 50 15 39
------- ------- ------- ------- -------
Subtotal 1,445 1,634 591 54 484
------- ------- ------- ------- -------
Real Estate Owned
Residential 176 340 357 387 -
------- ------- ------- ------- -------
Total Nonperforming Assets $ 1,621 $ 1,974 $ 948 $ 441 $ 484
======= ======= ======= ======= =======
Nonperforming Assets
to Total Assets 0.72% 1.03% 0.58% 0.28% 0.39%
======= ======= ======= ======= =======
</TABLE>
The Bancorp's loss and delinquency experience on its residential real
estate loan portfolio has been limited by a number of factors, including the
Bancorp'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, the Bancorp'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
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, conducts an 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
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 Bancorp has also contracted with an
outside, independent company to perform a detailed loan review, including an
assessment of the adequacy of the allowance for loan losses. 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.
<PAGE>
The following table summarizes activity in the Bancorp's allowance for
loan losses during the periods indicated.
<TABLE>
<CAPTION>
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
1997 1996 1995 1995 1994
------ ------ ------ ------ ------
(amounts in thousands)
<S> <C>
Allowance at Beginning of Period $ 1,501 $ 1,190 $ 1,057 $ 1,008 $ 1,008
Provision for Losses 880 695 150 60 5
Chargeoffs:
Residential (65) (8) - - -
Nonresidential (200) (300) - - -
Business (77) (38) (16) - -
Consumer (27) (43) (1) (11) (6)
-------- -------- -------- -------- --------
Total Chargeoffs (369) (389) (17) (11) (6)
-------- -------- -------- -------- --------
Recoveries:
Residential 12 - - - -
Business 6 3 - - -
Consumer 7 2 - - 1
-------- -------- -------- -------- --------
Total Recoveries 25 5 - - 1
-------- -------- -------- -------- --------
Net Chargeoffs (344) (384) (17) (11) (5)
-------- -------- -------- -------- --------
Allowance at End of Period $ 2,037 $ 1,501 $ 1,190 $ 1,057 $ 1,008
======== ======== ======== ======== ========
Loans at End of Period $ 130,995 $ 109,788 $ 105,441 $ 93,137 $ 67,965
Ratio of Allowance to Loans 1.56% 1.37% 1.13% 1.13% 1.48%
</TABLE>
The following table summarizes the composition of the Allowance for
Loan Losses.
<TABLE>
<CAPTION
At December 31, At June 30,
1997 1996 1995 1995 1994
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------------- ----------------- ----------------- ----------------- -----------------
(amounts in thousands)
<S> <C>
Mortgage:
Residential $ 140 7% $ 152 10% $ 413 35% $ 79 7% $ 419 42%
Nonresidential 1,162 57% 708 47% 249 21% 188 18% 168 17%
Construction:
Residential 27 1% 23 2% 123 10% 254 24% 186 18%
Nonresidential 43 2% 131 9% 133 11% 227 21% 102 10%
Nonmortgage:
Business 438 22% 382 25% 219 18% 262 25% 96 10%
Consumer 41 2% 105 7% 53 4% 47 4% 37 4%
Unallocated 186 9% - 0% - 0% - 0% - 0%
--------- --------- -------- ------- ------- ------- ------- ------- ------- -------
Allowance for Loan Losses $ 2,037 100% $ 1,501 100% $ 1,190 100% $ 1,057 100% $ 1,008 100%
========= ========= ========= ======= ======== ======= ======== ======= ======== =======
</TABLE>
The Bancorp 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.
<PAGE>
Investment Activities
The following table sets forth the Bancorp's investment portfolio as of
the periods indicated:
<TABLE>
<CAPTION>
December 31, December 31, December 31,
1997 1996 1995
---------------- --------------- ---------------
(amounts in thousands)
<S> <C>
Available-for-sale securities:
FHLMC preferred stock $ 3,866 $ 4,310 $ 2,810
FNMA MBS 782 903 1,039
------------------ ----------------- -----------------
$ 4,648 $ 5,213 $ 3,849
================== ================= =================
Heldtomaturity securities:
GNMA MBS $ 42,471 $ 27,388 $ 17,612
FNMA MBS 27,075 21,982 12,066
FHLMC MBS 6,078 7,300 9,397
Collateralized mortgage obligations 4,203 6,547 6,923
FHLB intermediate notes - 2,000 -
FHLB zero-coupon notes 642 - -
----------------- ------------------ -----------------
$ 80,469 $ 65,217 $ 45,998
================== ================= =================
</TABLE>
The following table sets forth information regarding maturity and
average yields of the investment portfolio:
<TABLE>
<CAPTION>
December 31, 1997
Available-for-sale Held-to-maturity
(amounts in thousands) Amortized Weighted Amortized Weighted
Cost Average Yield Cost Average Yield
--------------------------------------------------------------
<S> <C>
FHLMC preferred stock $ 3,866 7.62% - -%
Mortgage-backed securities:
Maturing after 10 years 782 7.07% 79,827 6.71%
FHLB zero-coupon notes:
Maturing after 10 years - -% 642 7.87%
-------------------------------------------------------------
$ 4,648 7.53% $ 80,469 6.72%
=============================================================
</TABLE>
Source of Funds
Deposits
Deposit accounts have been the primary source of the Bancorp's funds
for use in lending, making other investments, and for other general business
purposes. In addition to deposits, Southern Financial obtains funds from loan
repayments, maturing investments, 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.
<PAGE>
The following table shows the average balances and rates
(presented on a monthly average basis) for the Bancorp's deposits for the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31, Six Months Ended June 30,
(amounts in thousands) 1997 1996 1995
------------------------ ------------------------ -------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------- ------- ------- ------- ------- --------
<S> <C>
Demand $ 9,878 0.00% $ 6,658 0.00% $ 5,159 0.00%
Interest checking 15,720 1.18% 14,755 1.44% 11,509 2.36%
Money market and savings 22,834 3.33% 21,066 3.37% 18,607 3.39%
Certificates of deposit 135,863 5.71% 115,672 5.63% 103,047 5.80%
---------- ---------- ----------
$ 184,296 $ 158,151 $ 138,322
========== ========== ==========
Weighted average rate 4.73% 4.70% 4.97%
======== ======= =======
</TABLE>
The following table sets forth by time remaining until
maturity Southern Financial's certificates of deposit of $100,000 or more at
December 31, 1997:
Time Deposits of
Maturity Period $100,000 or More
- ---------------- ------------------
(amounts in thousands)
Three months or less $ 19,291
Over three months through twelve months 20,091
Over twelve months 5,081
-----------------------
Total $ 44,463
=======================
Borrowings
Borrowings consist of short-term advances from the Federal Home Loan
Bank of Atlanta ("FHLB"). The following table sets forth information regarding
the Bancorp's borrowings for the periods indicated:
Six Months
Year Ended Ended
December 31, December 31,
1997 1996 1995
---------------------- --------------
(amounts in thousands)
Ending Balance $ 4,000 $ 8,500 $ 4,000
Average Balance for the Period 5,979 6,077 5,667
Maximum Month-end Balance
During the Period 8,500 12,000 19,000
Average Interest Rate for the Period 5.59% 5.63% 6.69%
Weighted Average Interest Rate at
the End of the Period 5.95% 6.57% 5.85%
<PAGE>
Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. The Bancorp's market risk arises primarily from interest rate risk
inherent in its lending and deposit taking activities. To that end, management
actively monitors and manages its interest rate risk exposure.
The Bancorp's profitability is affected by fluctuations in interest
rates. A sudden and substantial increase in interest rates may adversely impact
the Bancorp's earnings to the extent that the interest rates borne by assets and
liabilities do not change at the same speed, to the same extent, or on the same
basis.
The Bancorp's primary objective in managing interest rate risk is to
minimize the adverse impact of changes in interest rates on the Bancorp's net
interest income and capital while structuring the Bancorp's asset-liability mix
to obtain the maximum yield-cost spread on that mix. Southern Financial relies
primarily on its asset-liability management system to control interest rate
risk.
Market Value of Portfolio Equity
The Bancorp's interest rate sensitivity is primarily monitored by
management through the use of a model which generates estimates of the change in
the Bancorp's market value of portfolio equity ("MVPE") over a range of interest
rate scenarios. Such analysis was prepared by a third party for Southern
Financial. MVPE is the present value of expected cash flows from assets,
liabilities, and off-balance sheet contracts using standard industry assumptions
about estimated loan prepayment rates, reinvestment rates, and deposit decay
rates. The following table sets forth an analysis of the Bancorp's interest rate
risk as measured by the estimated change in MVPE resulting from instantaneous
and sustained parallel shifts in the yield curve (plus or minus 400 basis
points, measured in 100 basis point increments) as of December 31, 1997.
<TABLE>
<CAPTION>
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- --------------------------------------------------------------------------------------------
<S> <C>
Up 400 $20,933 ($3,799) -15.36% 9.24% 113.28%
Up 300 22,476 (2,256) -9.12% 9.92% 121.63%
Up 200 24,019 (713) -2.88% 10.60% 129.97%
Up 100 24,375 (357) -1.44% 10.76% 131.90%
Base 24,732 - 0.00% 10.91% 133.83%
Down 100 24,376 (356) -1.44% 10.76% 131.90%
Down 200 24,020 (712) -2.88% 10.60% 129.98%
Down 300 24,649 (83) -0.33% 10.88% 133.38%
Down 400 25,279 547 2.21% 11.16% 136.79%
</TABLE>
Sensitivity of Net Interest Income
Southern Financial's interest rate sensitivity is also monitored by
management through the use of a model that generates estimates of the change in
the adjusted net interest income over a range of interest rate scenarios. Such
analysis was also prepared by a third party for the Bancorp. Net interest income
represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities. Net interest income also depends upon the
relative amounts of interest-earning assets and interest-bearing liabilities and
the interest rate earned or paid on them. In this regard, the model assumes that
the composition of the Bancorp's interest sensitive assets and liabilities
existing at the beginning of a period remains constant over the period being
measured and also assumes that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities.
<PAGE>
<TABLE>
<CAPTION>
Sensitivity of Net Interest Income
(amounts in thousands)
Change in Adjusted Net
Interest Rates Interest Income Net Interest Margin
In Basis Points % Change Change
(Rate Shock) Amount From Base Percent From Base
- ----------------------------------------------- -----------------------------
<S> <C>
Up 400 $7,732 0.49% 3.41% 0.02%
Up 300 7,871 2.30% 3.47% 0.08%
Up 200 8,010 4.11% 3.54% 0.14%
Up 100 7,852 2.06% 3.47% 0.07%
Base 7,694 0.00% 3.40% 0.00%
Down 100 7,493 -2.61% 3.31% -0.09%
Down 200 7,292 -5.23% 3.22% -0.18%
Down 300 7,325 -4.79% 3.23% -0.16%
Down 400 7,359 -4.35% 3.25% -0.15%
</TABLE>
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in MVPE and in Sensitivity of
Net Interest Income require the making of certain assumptions which may or may
not reflect the manner in which actual yields and costs respond to changes in
market interest rates. Accordingly, although the MVPE table and Sensitivity of
Net Interest Income table provide an indication of the Bancorp's interest rate
risk exposure at a particular point in time, such measurements are not intended
to and do not provide a precise forecast of the effect of changes in market
interest rates on the Bancorp's worth and net interest income.
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, 1997, Southern Financial employed 68 full-time
equivalent persons. Management considers its relations with its employees to be
good. The employees are not covered by a collective bargaining agreement.
The Year 2000
Southern Financial has identified the business impact of preparation
for the Year 2000 as critical to the ongoing ability to serve its customers.
Management clearly understands the necessity to ensure that the client service
bureau which provides data processing services identifies and modifies all
computer applications to ensure that there are no operational issues in the Year
2000 and beyond. In addition, Southern Financial has established a Year 2000
Committee to ensure that Branch Operations, Accounting/General Ledger Systems,
and vendors are Year 2000 compliant. Southern Financial has adopted the Federal
Reserve Bank Board's definition of Year 2000 compliance. These strategies are
being applied against all systems, and the project is to be completed by
September 1999. To further support Year 2000, the Southern Financial Board of
Directors maintains a full awareness of the impact Year 2000 poses on customer
records and bank operations.
<PAGE>
Executive Officers of the Registrant
At December 31, 1997, the executive officers of the Bank who were not
also directors were:
William H. Lagos, 47, joined the Bank in 1986 as Vice President. In
1993, he was promoted to Senior Vice President of Operations; in 1996, he became
Senior Vice President/Controller.
Linda W. Sandridge, 45, joined the Bank in 1987. In 1995, she was
promoted to Vice President/Commercial Lending; in 1997, she was promoted to
Senior Vice President/Commercial Lending.
Laura L. Vergot, 40, joined the Bank in 1989. In 1995, she was promoted
to Vice President/Branch Development; in 1997, she was promoted to Senior Vice
President/Branch Development.
Regulation
Set forth below is a brief description of certain laws and regulations
that 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 the
Bancorp'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 certain loan-to-value restrictions
are imposed on a bank's real estate lending activities. The Bancorp's 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.
<PAGE>
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, 1997, the minimum total
capital ratio (Tier 1 plus Tier 2) required was 8 percent. Southern Financial's
Tier 1 ratio of 13.9% and its total capital ratio of 15.3% 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 4 percent. At December 31, 1997, the Bancorp's leverage ratio
was 8.1%.
Deposit Insurance
The deposits of the Bancorp are currently insured to a maximum of
$100,000 per depositor, subject to certain aggregation rules. The FDIC has
implemented a risk-related assessment system for deposit insurance premiums. All
depository institutions have been assigned to one of nine risk assessment
classifications based on certain capital and supervisory measures. The Bancorp's
deposits are subject to the rates of the Savings Associations Insurance Fund
("SAIF") since Southern Financial converted to a commercial bank from a federal
savings bank on December 1, 1995. Based on the Bancorp's current risk
classification, the Bancorp is required to pay the minimum SAIF assessment.
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. The Bancorp, 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, 1997, Southern Financial had an investment of $931 thousand 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, 1997, Southern Financial had $4 million outstanding in borrowings
from the FHLB of Atlanta.
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.
<PAGE>
Item 2. Properties
Offices and Other Material Properties
At December 31, 1997, the Bancorp 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 the Bancorp as of
December 31, 1997:
<TABLE>
<CAPTION>
=====================================================================================
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
=====================================================================================
<S> <C>
Home Office:
37 E. Main Street Leased September February
Warrenton, VA 1998 1989
Branch Offices:
362 Elden Street Leased June April
Herndon, VA 2000 1986
101 W. Washington Street Leased June November
Middleburg, VA 2002 1987
33 W. Piccadilly Street Owned N/A November
Winchester, VA 1990
526 E. Market Street Leased June March
Leesburg, VA 2002 1992
4021 University Drive Owned N/A July
Fairfax, VA 1997
322 Lee Highway Leased August August
Warrenton, VA 2001 1994
2545 Q-18 Centreville Road Leased September April
Herndon, VA 2001 1995
13542 Minnieville Road Leased December April
Woodbridge, VA 1998 1995
1095 Millwood Pike Owned N/A July
Winchester, VA 1996
=====================================================================================
</TABLE>
<PAGE>
Item 3. Legal Proceedings
Neither the Bancorp nor the Bank is a party to, nor is any of their
property the subject of, any material pending legal proceedings incidental to
the business of the Bancorp and its subsidiary other than those arising in the
ordinary course of business. Although the amount of any ultimate liability with
respect to such matters cannot be determined, in the opinion of management, any
such liability will not have a material adverse effect on the consolidated
financial position or results of operations of the Bancorp.
Item 4. Submission of Matters to Vote of Security Holders
None.
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 1997 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
3 to 12 of the Annual Report.
Item 8. Financial Statements.
The information required herein is incorporated by reference from pages
13 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 20, 1998 ("Definitive Proxy Statement"). For
additional information concerning executive officers of the Registrant who were
not also directors, see "Item I - 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
9 to 10 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.
<PAGE>
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, 1997, 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. 13
Balance Sheets:
December 31, 1997 and December 31, 1996. 14
Statements of Income:
Years Ended December 31, 1997 and 1996,
Six Months Ended December 31, 1995 and
Year Ended June 30, 1995 . 15
Statements of Changes in Stockholders' Equity:
Years Ended December 31, 1997 and 1996,
Six Months Ended December 31, 1995 and
Year Ended June 30, 1995. 16
Statements of Cash Flows:
Years Ended December 31, 1997 and 1996,
Six Months Ended December 31, 1995 and
Year ended June 30, 1995 . 17
Notes to Consolidated Financial Statements. 18-29
(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) (a) Employment contract between Southern Financial Bancorp
and Georgia S. Derrico
(10) (b) Employment contract between Southern Financial Bancorp
and William H. Lagos
(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 13-29 of Annual Report to Stockholders for the
Year Ended December 31, 1997.
(18) Letter re Change in Accounting Principles--Not
applicable.
<PAGE>
(21) Subsidiaries of the registrant:
<TABLE>
<CAPTION>
Percentage of Voting
Jurisdiction of Securities Owned by
Name Incorporation the Parent
------ --------------- ---------------------
<S> <C>
Southern Financial Bank Virginia 100%
(22) Published Report Regarding Matters Submitted to Vote of Security Holders--Not applicable.
(23) (a) Consent of KPMG Peat Marwick LLP
(23) (b) Consent of Arthur Andersen LLP
(24) Power of Attorney - Not applicable
(27) Financial Data Schedule
(28) Information from Reports Furnished to State Insurance Regulatory Authorities - Not applicable
(b) No reports on Form 8-K were filed during the quarter ended December 31, 1997.
</TABLE>
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
<TABLE>
<CAPTION>
SOUTHERN FINANCIAL BANCORP, INC.
<S> <C>
By: /s/Georgia S. Derrico
-------------------------
Georgia S. Derrico
Chairman of the Board
and Chief Executive Officer
Dated: March 30, 1998
- ------------------------
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 March 30, 1998
- ---------------------- the Board, and --------------
Georgia S. Derrico Chief Executive Officer
/s/David de Give Director and Senior Vice March 30, 1998
- ---------------------- President/Treasurer --------------
David de Give
s/sWilliam H. Lagos Senior Vice President/Controller March 30, 1998
- ---------------------- (Principal Accounting Officer) --------------
William H. Lagos
/s/Virginia Jenkins Director March 30, 1998
- ---------------------- --------------
Virginia Jenkins
/s/R. Roderick Porter Director March 30, 1998
- ---------------------- --------------
R. Roderick Porter
/s/Neil J. Call Director March 30, 1998
- ---------------------- --------------
Neil J. Call
/s/John L. Marcellus, Jr. Director March 30, 1998
- ------------------------ ---------------
John L. Marcellus, Jr.
/s/Michael P. Rucker Director March 30, 1998
- ------------------------ ---------------
Michael P. Rucker
</TABLE>
<PAGE>
INDEX TO EXHIBITS
Number and Description
10(a) Employment Contract between Southern Financial Bancorp and Georgia S.
Derrico
10(b) Employment Contract between Southern Financial Bancorp and William H.
Lagos
13 Southern financial Bancorp, Inc. December 31, 1997 Annual Report to
Stockholders
23(a) Consent of KPMG Peat Marwick LLP
23(b) Consent of Arthur Andersen LLP
27 Financial Data Schedule
Exhibit (10 (a)
EMPLOYMENT AGREEMENT
---------------------
This Employment Agreement (this "Agreement") is made as of the 18th day of
April, 1996, between Southern Financial Bank, with its principal offices in
Warrenton, Virginia (hereinafter called the "Bank") and Georgia S. Derrico
(hereinafter called "Executive").
WITNESSETH THAT:
WHEREAS, the parties desire to enter into this Agreement setting forth
the terms and conditions of the employment relationship between the Bank and the
Executive;
WHEREAS, the Board of Directors of the Bank (the "Board") believes it
is in the best interest of the Bank to enter into this Agreement with the
Executive in order to attempt to assure management continuity of the Bank; and
WHEREAS, the Board of Directors of the Bank has approved and authorized
the execution of this Agreement with the Executive.
NOW, THEREFORE, to assure the Bank that it will have the continued
dedication of Executive and the availability of her advice and counsel and to
induce Executive to remain in the employ of the Bank, and for other good and
valuable consideration, the Bank and Executive hereby agree as follows:
1. Definitions.
(i) "Cause," when used in connection with the termination of
Executive's employment by the Bank, shall mean (a) the willful and continued
failure by Executive substantially to perform her duties and obligations to the
Bank (other than any such failure resulting from physical or mental condition,
whether or not such condition constitutes a Disability) which failure continues
after the Bank has given written notice thereof to Executive which notice
specifies the aspects in which the Executive has failed to perform her duties or
obligations to the Bank or (b) the willful engaging by Executive in misconduct
which is materially injurious to the Bank, monetarily or otherwise. For purposes
of this definition, no act, or failure to act, on Executive's part shall be
considered "willful" unless done, or omitted to be done, by Executive in bad
faith and without reasonable belief that his or her action or omission was in
the best interests of the Bank.
(ii) "Change in Control" shall mean the occurrence of any of the
following:
(a) any "person" (as such term is used in Sections 13 (d) and 14 (d) of the
Exchange Act, an "Acquiring Person") becomes the "beneficial owner" (as such
term is defined in Rule 13d - 3 promulgated under the Exchange Act, a
"Beneficial Owner"), directly or indirectly, of securities of the Bank
representing 25% or more of the combined voting power of the Bank's then
outstanding securities;
(b) an Acquiring Person becomes the Beneficial Owner, directly or
indirectly, of securities of the Bank representing 10% or more of the combined
voting power of the Bank's then outstanding securities and either the Board or
the U.S. Office of Thrift Supervision makes a determination that such
acquisition constitutes or will constitute the acquisition of control of the
Bank for purposes of this Agreement:
(c) the Bank's stockholders approve an agreement to merge or consolidate
the Bank with another corporation (other than a corporation 50% or more of which
is controlled by, or is under common control with, the Bank) and, during the
period commencing six months before such approval and ending two years after
such approval, individuals who at the beginning of such period constitute the
Board cease for any reason to constitute at least a majority thereof; or
(d) the Bank sells 80% or more of its assets to an Acquiring Person.
However, a Change in Control shall not occur by reason of any transaction in
which Executive, or a group of individuals or entities including Executive,
participates as an Acquiring Person in the events described in clauses (a), (b),
or (d) of this Section 1(ii) or owns, directly or indirectly, a majority of a
corporation described in clause (c) of this Section 1 (ii).
(iii) "Committee" shall mean the Compensation Committee of the Board.
(iv) "Compensation" shall mean the sum of (a) Executive's annual base
salary at the highest rate earned by her at any time during the twelve months
immediately preceding a Termination Date plus (b) the highest annual bonus
earned by Executive with respect to any of the three calendar years preceding
the Termination Date.
(v) "Contract Period" shall mean the period commencing on the date
hereof and terminating on the third anniversary of the date hereof; provided,
that on each anniversary of the date hereof the Contract Period shall be
automatically extended unless either party has prior to such anniversary date
given written notice to the other that it does not desire the Contract Period to
be so extended.
(iv) "Disability" shall mean a physical or mental condition which in
the judgement of the Executive renders the Executive unable to substantially
perform the requirements of the positions of Chief Executive Officer and
Chairman of the Board of Directors of the Bank.
(vii) "Effective Period" shall mean the period commencing on the date
of a Change in Control and terminating on the first anniversary of such Change
in Control.
(viii) "Good Reason" when used with reference to a termination by
Executive of her employment with the Bank shall mean:
(a) the assignment to Executive of any duties inconsistent with, or the
reduction of powers or functions associated with, her positions, duties,
responsibilities and status with the Bank immediately prior to a Change in
Control, or any removal of Executive from, or any failure to reelect Executive
to, any positions or offices Executive held immediately prior to a Change in
Control;
(b) a reduction by the Bank of Executive's base salary as in effect
immediately prior to a Change in Control;
(c) a change in Executive's principal work location;
(d) (i) the failure by the Bank to continue in effect any employee benefit
plan, program or arrangement in which Executive was participating immediately
prior to a Change in Control (or, for each such plan, a substitute plan, program
or arrangement providing Executive with substantially similar benefits) or (ii)
the taking of any action, or the failure to take any action, by the Bank which
could adversely affect Executive's benefits under, any such plan, program or
arrangement;
(e)the failure by the Bank to pay Executive any portion of Executive's
current compensation, or any portion of Executive's compensation deferred under
any plan, agreement or arrangement of or with the Bank, within seven (7) days of
the date such compensation is due;
(f) the failure by the Bank to obtain an assumption of the obligations of the
Bank under this Agreement by any successor to the Bank; or
(g) any termination of Executive's employment by the Bank during the Contract
Period which is not effected pursuant to the requirements of this Agreement.
(ix) "Termination Date" shall mean the effective date as provided
hereunder of the termination of Executive's employment.
(x) "Without Cause" when used in conjunction with the termination of
Executive's employment by the Bank, shall mean any termination of employment of
Executive by the Bank which is not a termination of employment for Cause.
2. Employment. The Bank agrees to employ the Executive as its Chief
Executive Officer during the Contract Period and the Executive accepts such
position. As Chief Executive Officer, the Executive shall render administrative
and management services to the Bank as are customarily performed by persons
situated in a similar executive capacity. The Executive shall perform her duties
under this Agreement in accordance with such reasonable standards established
from time to time by the Board. [During the Contract Period, the Bank agrees to
use its best efforts to cause the Executive to be nominated for and appointed to
the position of Chairman of the Board of the Bank.]
3. Compensation.
(a) The Bank agrees to pay the Executive during the Contract Period base
salary at a rate of not less than $165,000 per annum (the "Base Salary"). The
Base Salary shall be payable not less frequently than monthly in accordance with
the practices of the Bank as in effect from time to time. The amount of Base
Salary shall be reviewed by the Board not less often than annually and may be
increased (but not decreased) from time to time by such amounts as the Board in
its discretion may decide.
(b) During the Contract Period, the Executive shall be entitled to
participate in an equitable manner with all other officers of the Bank in
discretionary bonuses as authorized and declared by the Board to its executive
employees. No other compensation provided for in this Agreement shall be deemed
a substitute for the Executive's right to participate in such bonuses when and
as declared by the Board.
(c) During the Contract Period, the Executive shall be entitled to
participate in any stock option, stock purchase, pension, thrift, deferred
profit-sharing, group life insurance, medical coverage, education or other
retirement or employee benefit plan that the Bank may adopt for the benefit of
its executive employees.
(d) During the Contract Period, the Executive shall be eligible to
participate in any fringe benefit plan or program which may be or become
applicable to the Bank's executive employees, which shall include use of an
automobile, a reasonable expense account, the payment of reasonable expenses for
attending annual and periodic meetings of trade associations and any other
benefits which are commensurate with the responsibilities and functions to be
performed by the Executive under this Agreement.
(e) In addition to the benefits provided to the Executive pursuant to
Sections 3 (c) and (d) above, the Executive shall also be entitled to any
benefits provided for in the Bank's employee or personnel manual.
4. Vacations; Leaves of Absence. At such reasonable times as the Board shall
in its discretion permit, the Executive shall be entitled, without loss of pay,
to absent herself voluntarily from the performance of her employment under this
Agreement, all such voluntary absences to count as vacation, provided that,
(a) The Executive shall be entitled to an annual vacation in accordance
with policies established in the Bank's employee or personnel manual;
(b) The timing of vacation shall be scheduled in a reasonable manner by the
Executive; and
(c) In addition to the aforesaid paid vacations, the Executive shall be
entitled, without loss of pay, to absent herself voluntarily from the
performance of her employment with the Bank for such additional periods of time
and for such valid and legitimate reasons as the Board in its discretion may
determine. Further, the Board shall be entitled to grant to the Executive a
leave or leaves of absence with or without pay at such time or times and upon
such terms and conditions as the Board, in its discretion, may determine.
5. Termination of Employment During the Contract Period. During the
Contract Period and prior to a Change in Control, the Executive's employment
with the Bank may be terminated at any time by the Board or by the Executive for
any reason or without reason; provided, that the Executive shall provide the
Bank with at least 90 days prior written notice (or such shorter period as the
Board and the Executive may agree) of her termination of her employment with the
Bank. The Executive shall be entitled to the following benefits and payments
upon a termination of her employment with the Bank during the Contract Period
and prior to a Change in Control.
(a) In the event of the termination of the employment of the Executive with
the Bank by the Bank for Cause or by the Executive (whether or not for Good
Reason), the Executive shall be entitled to all compensation and benefits earned
by her and unpaid at the time of such termination, and shall not be entitled to
any further compensation or benefits hereunder.
(b) In the event of the termination of the employment of the Executive with
the Bank Without Cause, the Executive shall be entitled to:
(i) the continuation of the Base Salary for the remainder of the
Contract Period; and
(ii) until the earlier of; (a) the expiration of the Contract Period or
(b) Executive's commencement of full time employment with a new employer,
Executive's continued participation in all life, medical, dental, prescription
drug and long and short-term disability insurance plans, programs or
arrangements in which the Executive was entitled to participate at any time
during the twelve month period prior to the Termination Date, provided that
Executive's continued participation is possible under the general terms and
provisions of such plans, programs, or arrangements. In the event that
Executive's participation in any such plan, program or arrangement is
prohibited, the Bank shall arrange to provide Executive with benefits
substantially similar to those which Executive is entitled to receive under such
plans, programs or arrangements for such period.
[Executive shall not be required to mitigate the amount of the payment and
benefits provided for in this Section 5(b) by seeking other employment or
otherwise. Except as provided for in this Section 5(b) shall not be reduced by
any compensation or other amounts paid to or earned by Executive as the result
of employment with another employer after the Termination Date or otherwise.]
(c) In the event of the termination of the employment of the Executive as a
result of the death or Disability of the Executive during the Contract Period,
she shall be entitled to benefits under the life insurance and disability plans,
programs and arrangements in which she is entitled to participate pursuant to
the terms of this Agreement, and she shall not be entitled to any further
compensation or benefits hereunder.
6. Termination of Employment of Executive By the Bank During the Effective
Period.
(i) During the Effective Period, the Bank shall have the right to terminate
Executive's employment hereunder for Cause or Without Cause by following the
procedures hereinafter specified.
(ii) During the Effective Period, Executive Period, Executive's employment
may not be terminated for Cause unless and until a notice of intent to terminate
Executive's employment for Cause, specifying the particulars or conduct of
Executive forming the basis for such termination, is given to Executive by the
Committee and, subsequently, a majority of the Board finds, after reasonable
notice to Executive (but in no event less than fifteen (15) days' notice) and an
opportunity for Executive and her counsel to be heard by the Board, that
termination of Executive's employment for Cause is justified. Termination of
Executive's employment for cause shall become effective after such finding has
been made by the Board and five (5) business days after the Board gives to
Executive notice thereof, specifying in detail the particulars of the conduct of
Executive found by the Board to justify such termination for Cause.
(iii) During the Effective Period, the Bank shall have the absolute right to
terminate Executive's employment Without Cause at anytime by vote of a majority
of the Board. Termination of Executive's employment Without Cause shall be
effective five (5) business days after the Board gives to Executive notice
thereof, specifying that such termination is Without Cause.
(iv) Upon a termination of Executive's employment for Cause during the
Effective Period, Executive shall have no right to receive any compensation or
benefits hereunder. Upon a termination of Executive's employment for Cause
during the Effective Period, Executive shall be entitled to receive the benefits
provided in Section 8 hereof.
7. Termination of Employment by Executive During Effective Period.
During the Effective Period, Executive shall be entitled to terminate her
employment with the Bank and , if such termination is for Good Reason or on
account of Disability, to receive the benefits provided in Section 8 hereof.
Executive shall give the Bank notice of voluntary termination of employment,
which notice need specify only Executive's desire to terminate her employment
and, if such termination is for Good Reason or Disability, set forth in
reasonable detail the facts and circumstances claimed by Executive to constitute
Good Reason or Disability. Termination of Executive's employment by Executive
pursuant to this Section 7 shall be effective five (5) business days after
Executive gives notice thereof to the Bank. The Executive shall not be entitled
to the benefits provided in Section 8 upon her death during the Effective
Period.
8. Benefits Upon Termination in Certain Circumstances. Upon the termination
of the employment of Executive by the Bank pursuant to Section 6 (iii) hereof or
by Executive for Good Reason or Disability pursuant to Section 7 hereof,
Executive shall be entitles to receive the following payments and benefits:
(i) The Bank shall pay to Executive, not later than the Termination
Date, a lump sum cash amount equal to the sum of (a) the full base salary earned
by Executive through the Termination Date and unpaid at the Termination Date,
calculated at the highest rate of base salary in effect at any time during the
twelve months immediately preceding the Termination Date, (b) any bonus earned
by Executive but not paid at the Termination Date, (c) the amount of any base
salary attributable to vacation earned by Executive but not taken before the
Termination Date, (d) 1/12 of the amount of the bonus earned by Executive with
respect to the calendar year ending immediately prior to the Termination Date
times the number of months, including the Termination Date times the number of
months, including partial months, from the beginning of the calendar year
including the Termination Date through the Termination Date, and (e) all other
amounts earned by Executive and unpaid at the Termination Date.
(ii) The Bank shall pay to Executive, not later than the Termination
Date, a lump sum cash amount equal to the product of three (3) times Executive's
Compensation.
(iii) The Bank shall maintain in full force and effect for Executive's
continued benefit until the earlier of (a) the expiration of three years after
the Termination Date or (b) Executive's commencement of full time employment
with a new employer, all life, medical, dental, prescription drug and long- and
short-term disability insurance plans, programs or arrangements in which
Executive was entitled to participate at any time during the twelve month period
prior to the Termination Date, provided that Executive's continued participation
is possible under the general terms and provisions of such plans, programs or
arrangements. In the event that Executive's participation in any such plan,
program, or arrangement is prohibited, the Bank shall arrange to provide
Executive with benefits substantially similar to those which Executive is
entitled to receive under such plans, programs or arrangements for such period.
(iv) The Bank shall pay to Executive the cost, in an amount not to
exceed 20% of Executive's annual base salary as in effect immediately prior to
the Change in Control, of professional out-placement services rendered to
Executive within 6 months following termination of the employment of Executive
as and when such costs are incurred.
(v) Executive shall not be required to mitigate the amount of any
payment provided for in this Section 8 by seeking other employment or
otherwise. Except as provided in Section 8 (iii), the amount of any payment
provided for in this Section 8 shall not be reduced by any compensation or other
amounts paid to or earned by Executive as the result of employment with another
employer after the Termination Date or otherwise.
(vi) Any payment made pursuant to the Section 8 must be in compliance
with 12 U.S.C. 1828(k) and any regulations promulgated thereunder. If any
payment is in violation of such Section or regulations, the Executive shall
waive her right to such payments.
9. Legal Fees and Expenses. The Bank shall pay to the Executive all
reasonable legal fees and expenses incurred by the Executive in enforcing this
Agreement if it is determined that the executive's employment with the Bank was
terminated by the Bank Without Cause or, during the Effective Period, by the
Executive for Good Reason (including all such fees and expenses, if any,
incurred in contesting or disputing any such termination or in seeking to obtain
or enforce any right or benefit provided to the Executive by this Agreement or
under any other plan, program or arrangement of the Bank or agreement with the
Bank). The Executive shall be entitles to interest, computed at the "applicable
Federal rate" (within the meaning of Section 7872 (f) (2) (A) of the Internal
Revenue Code of 1986) for term loans, with respect to any amount for which she
is entitled to reimbursement hereunder, from the date on which the Executive
paid such amount until the reimbursement date.
10. Payment Obligations Absolute. The Bank's obligation to pay Executive
the amounts provided for hereunder shall be absolute and unconditional and shall
not be affected by any circumstances, including, without limitation, any
set-off, counterclaim, recoupment, defense or other right which the Bank may
have against her or anyone else. All amounts payable by the Bank hereunder shall
be paid without notice or demand.
11. Tax Adjustment.
(a) The amount of payments provided for herein shall be increased to the
extent necessary to pay (i) any excise tax imposed by Section 4999 of the
Internal Revenue Code of 1986, as it may from time to time be amended (the
"Code"), on the payments and benefits provided for herein, and (ii) any such
excise tax and any other taxes (including, without limitation, federal and state
income and employment taxes) on the payments provided for in this Section 11.
The Bank shall pay to Executive the payments provided for in this Section 11 as
soon as practical following the determination of the tax counsel referred to
below. If any such excise tax is imposed as a result of the combination of
payments or benefits provided hereunder and payments or benefits not provided
hereunder, then in calculating the amount of payments required pursuant to this
Section 11, the excise tax shall be treated as first being imposed as a result
of payments and benefits provided hereunder, including the payments provided
pursuant to this Section 11. Tax counsel selected by Executive and reasonable
acceptable to the Bank shall determine whether the increase provided for by this
Section 11(a) shall be required. All determinations of tax counsel shall be
binding on the Bank and Executive. Tax counsel shall determine that payments
shall be increased only if, and to the extent that, it is more likely than not
that the payments or benefits provided for herein, including in this Section 11,
are subject to a tax imposed by the Code. In making the determinations required
by this Section 11m, tax counsel may rely on t benefit consultants accountants
or other experts, The Bank hereby agrees to pay for all reasonable fees and
expenses of such tax counsel and other experts pursuant to this Section 11. (b)
If, subsequent to the payment to Executive of payments pursuant to this Section
11, the tax counsel referred to in this Section 11 reasonable determines that
the amount of the payments paid pursuant to this Section 11 are greater than, or
less than, the amount required to have been paid, Executive shall reimburse the
Bank an amount, or the Bank shall pay to Executive an additional amount,
respectively, based upon such determination.
12. Required Provisions.
(a) The Bank may terminated the Executive's employment at any time, but any
termination by the Bank, other than termination For Cause, shall not prejudice
Executive's right to compensation or other benefits to which she thereby becomes
entitled under this Agreement. Executive shall not have the right to receive
compensation or other benefits pursuant to this Agreement as a result of, or
for any period after, termination For Cause.
(b) If the Executive is suspended and/or temporarily prohibited from
participating in the conduct of the Bank's affairs by a notice served under
Section 8 (e) (3) or (g)(1), of the Federal Deposit Insurance Act (12 U.S.C.
1818 (e)(3) and (g)(1)), the Bank's obligations under this Agreement shall be
suspended as of the date of service unless stayed by appropriate proceedings. If
the charges in the notice are dismissed, the Bank may, in its discretion, (i)
pay the Executive all or part of the compensation withheld while its obligations
hereunder were suspended and (ii) reinstate (in whole or in part) any of its
obligations which were suspended
(c) If the Executive is removed and/or permanently prohibited from
participating in the conduct of the Bank's affairs by an order issued under
Section 8 (e)(4) or (g)(1) of the Federal Deposit Insurance Act (12 U.S.C. 1818
(e)(4) or (g)(1)), all obligations of the Bank under this Agreement shall
terminate as of the effective date of the order, but vested rights of the
Executive shall not be affected.
(d) If the Bank is in default (as defined in Section 3 (x)(1) of the
Federal Insurance Deposit Act), all obligations under this Agreement shall
terminate as of the date of default, but vested rights of the Executive shall
not be affected. Furthermore, this Section 12(d) shall not apply to the extent
that this Agreement was subject to the prior written approval of the Director or
his or her designee.
(e) All obligations of the Bank under this Agreement shall be terminated,
except to the extent determined that continuation of the contract is necessary
for the continued operation of the Bank, (i) by the Director or his or her
designee, at the time the Federal Deposit Insurance Corporation or the
Resolution Trust Corporation enters into an agreement to provide assistance to
or on behalf of the Bank under the authority contained in Section 13(c) of the
Federal Deposit Insurance Act; or (ii) by the Director or his or her designee,
at the time the Director or his or her designee approves a supervisory merger to
resolve problems related to operation of the Bank or when the Bank is determined
by the Director to be in an unsafe or unsound condition. Any rights of the
Executive that have already vested, however, shall not be affected by such
action.
13. Successor; Binding Agreement
(i) The Bank shall require any successor (whether direct or indirect, by
purchase, merger, consolidation, liquidation or otherwise) to all or
substantially all of the business and/or assets of the Bank to agree to assume
and to assume all of the obligations of the Bank under this Agreement upon or
prior to such succession taking place. A copy of such assumption and agreement
shall be delivered to Executive promptly after its execution by the successor.
Failure of the Bank to obtain such agreement upon or prior to any such
successions shall be a breach of this Agreement and shall constitute Good Reason
for Executive to terminate her employment with the Bank under this Agreement.
For purposes of implementing the foregoing, the date on which any such
successions becomes effective shall be deemed the Termination Date. As used in
this Agreement, "Bank" shall mean the Bank as hereinbefore defined and any
successor to its business and/or assets as aforesaid which executes and delivers
the agreement provided for in this Section 13 (i) or which otherwise becomes
bound by all the terms and provisions of this Agreement by operation of law.
(ii) This Agreement is personal to Executive and Executive may not assign
or transfer any part of her rights or duties hereunder, or any compensation due
to her hereunder, to any other person, except that this Agreement shall inure to
the benefit of and be enforceable be Executive's personal or legal
representatives, executors, administrators, heirs, distributes, devisees or
beneficiaries.
14. Modification; Waiver. No provision of this Agreement may be modified,
waived or discharged unless such waiver, modification or discharge is agreed to
in a writing signed by Executive and by such director of the Bank as may be
specifically designated by the Board. Waiver by any party of any breach of or
failure to comply with any provision of this Agreement by the other party shall
not be construed as, or constitute waiver of such provision, or a waiver of any
other breach or, or failure to comply with, any other provision of this
Agreement.
15. Notice. All notices, requests, demands and other communications
required or permitted to be given by either party to the other party to this
Agreement shall be in writing and shall be deemed to have been duly given when
delivered personally or received by certified or registered mail, return receipt
requested, postage prepaid, at the address of the other party as follows:
If to the Bank to:
Southern Financial Bank
Attention: Board of Directors or Secretary
37 E. Main Street
Warrenton, VA 20186
If to Executive to:
Georgia S. Derrico
2954 Burrland
The Plains, VA 22171
Either party hereto may change its address for purposes of this
Section 15 by giving fifteen (15) days' prior notice to the other party hereto.
16. Headings. The headings in this Agreement are inserted for convenience
and reference only and shall not be a part of or control or affect the meaning
of this Agreement.
17. Counterparts. This Agreement may be executed in several counterparts,
each of which shall be deemed an original.
18. Governing Law. This Agreement has been executed and delivered in the
State of Virginia, and its validity, interpretation, performance, and
enforcement shall be governed by laws of said State but only to the extent not
superseded by federal law. The required provisions in this Agreement were
inserted pursuant to existing applicable federal regulations. Any future
regulatory changes which amend or repeal the required provision in a manner
favorable to the Executive shall be automatically incorporated into this
Agreement upon the effective date of such regulatory change.
19. Payroll and Withholding Taxes. The Bank may withhold from any amounts
payable to Executive hereunder all federal, state, city or other taxes that the
Bank may reasonably determine are required to be withheld pursuant to any
applicable law or regulation.
20. Entire Agreement. Except as explicitly provided for herein, this
Agreement supersedes any and all other oral or written agreements heretofore
made relating to the subject matter hereof and constitutes the entire agreement
of the parties relating to the subject matter hereof. In particular, this
Agreement supersedes and replaces in its entirety the Employment Agreement dated
as of August 1985, between the Executive and the Bank.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first written above.
SOUTHERN FINANCIAL BANK
By: /s/Joyce V. Clatterbuck
---------------------------
Corporate Secretary
/s/ Georgia S. Derrico
---------------------------
Exhibit (10) (b)
EMPLOYMENT AGREEMENT
THIS AGREEMENT, entered into as of the 1st day of January, 1997, by and
between SOUTHERN FINANCIAL BANK, a Virginia chartered bank, (the "Corporation"),
and WILLIAM H. LAGOS (the "Executive").
WITNESSETH:
WHEREAS, the Corporation desires to retain the services of the
Executive on the terms and conditions set forth herein and, for purpose of
effecting the same, the Board of Directors of the Corporation has approved this
Employment Agreement and authorized its execution and delivery on the
Corporation's behalf to the Executive; and
WHEREAS, the Executive is presently the duly elected and acting Senior
Vice President of the corporation and, as such, is a key executive officer of
the Corporation whose continued dedication, availability, advice and counsel to
the Corporation is deemed important to the Board of Directors of the
Corporation, the Corporation and its stockholders;
WHEREAS, the services of the Executive, his experience and knowledge of
the affairs of the Corporation, and his reputation and contacts in the industry
are valuable to the Corporation; and
WHEREAS, the Corporation wishes to attract and retain such
well-qualified executives and it is in the best interests of the Corporation and
of the Executive to secure the continued services of the Executive;
WHEREAS, the Corporation considers the establishment and maintenance of
a sound management to be part of its overall corporate strategy and to be
essential to protecting and enhancing the best interests of the Corporation and
its stockholders; and
WHEREAS, the Corporation is a wholly-owned subsidiary of Southern
Financial Bancorp, Inc., a Virginia corporation (the "Holding Company");
NOW THEREFORE, to assure the Corporation of the Executive's continued
dedication, the availability of his advice and counsel to the Board of Directors
of the Corporation, and to induce the Executive to remain and continue in the
employ of the Corporation and for other good and valuable consideration, the
receipt and adequacy whereof each party hereby acknowledges, the Corporation and
the Executive hereby agree as follows:
1. EMPLOYMENT: The Corporation agrees to, and does hereby, employ the Executive,
and the Executive agrees to, and does hereby, accept such employment, for the
period beginning as of the date hereof and ending on June 30, 1998. This
Agreement shall automatically renew for successive periods of twelve (12) months
each unless one party notifies the other of its intent to terminate within
thirty (30) days of the end of the then current term.
2. EXECUTIVE DUTIES: The Executive agrees that, during the term of his
employment under this Agreement and in his capacity as Senior Vice President, he
will devote his full business time and energy to the business, affairs and
interests of the Corporation and serve it diligently and to the best of his
ability. The services and duties to be performed by the Executive shall be those
appropriate to his office and title as currently and from time to time hereafter
specified in the Corporation's By-Laws or otherwise specified by its Board of
Directors.
3. COMPENSATION: The Corporation agrees to pay the Executive, and the Executive
agrees to accept, as compensation for all services rendered by him to the
Corporation during the period of his employment under this Agreement, base
salary at the annual rate of Eighty-Five Thousand Dollars ($85,000.00), which
shall be payable in monthly, semi-monthly or bi-weekly installments in
conformity with the Corporation's policy relating to salaried employees. Such
salary may be increased in the sole and absolute discretion of the Corporation's
Board of Directors or Committee thereof duly authorized by the Board of
Directors to so act. The Board of Directors, in its discretion, may cause the
Corporation to pay bonuses to the Executive from time to time.
4. PARTICIPATION IN BENEFIT PLANS, REIMBURSEMENT OF BUSINESS EXPENSES AND OTHER
BENEFITS: (i) During the term of employment under this Agreement, the Executive
shall be eligible to participate in any pension, group insurance,
hospitalization, deferred compensation or other benefit, bonus or incentive
plans of the Corporation presently in effect (including, without limitation, the
Corporation's stock option plans) or hereafter adopted by the Corporation and
generally available to any employees of senior executive status, and,
additionally, the Executive shall have the use of the Corporation's facilities
and executive benefits as are customarily made available by the Corporation to
its executive officers.
(ii) During the term of this Agreement, to the extent that such
expenditures are substantiated by the Executive as required by the Internal
Revenue Service and policies of the Corporation, the Corporation shall reimburse
the Executive promptly for all expenditures (including travel, entertainment,
parking and business meetings) made in accordance with rules and policies
established from time to time by the Board of Directors of the Corporation in
pursuance and furtherance of the Corporation's business and good will.
5. ILLNESS: In the event the Executive is unable to perform his duties under
this Agreement on a full-time basis for a period of six (6) consecutive months
by reason of illness or other physical or mental disability, and at or before
the end of such period he does not return to work on a full-time basis, the
Corporation may terminate this Agreement without further or additional
compensation payment being due the Executive from the Corporation pursuant to
this Agreement, except benefits accrued through the date of such termination
under employee benefit plans of the Corporation. These benefits shall include
long-term disability and other insurance or other benefits then regularly
provided by the Corporation to disabled employees, as well as any other
insurance benefits so provided.
6. DEATH: In the event of the Executive's death during the term of this
Agreement, this Agreement shall terminate as of the end of the month in which
the Executive dies. This Section 6 shall not affect the rights of any person
under other contract between the Executive and the Corporation or under any life
insurance policy.
7. TERMINATION WITHOUT CAUSE/RESIGNATION FOR GOOD REASON: Notwithstanding the
provisions of Section 1 hereof, the Board of Directors of the Corporation may,
without Cause (as hereafter defined), terminate the Executive's employment under
this Agreement at any time in any lawful manner by giving not less than thirty
(30) days written notice to the Executive. The Executive may resign for Good
Reason (as hereafter defined) at any time by giving not less than thirty (30)
days written notice to the Corporation. If the Corporation terminates the
Executive's employment without Cause or the Executive resigns for Good Reason,
then in either event the Executive shall be paid a gross sum equivalent to one
and one half (1.5) times the annual salary required under Section 3 of the then
current term of this Agreement. This sum shall be paid to Employee, at such
times as payment was theretofore made, over the eighteen-month period following
the date of such termination or resignation.
b) For purposes of this Agreement, "Good Reason" shall mean breach by
the Corporation of a material obligation hereunder that is not
cured within ten (10) days after written notice thereof.
(c) Resignation by the Executive for Good Reason shall be communicated
by a written Notice of Resignation to the Corporation. A "Notice
of Resignation" shall mean a notice which shall indicate the
specific provision(s) in this Agreement relied upon and shall set
forth in reasonable detail the facts and circumstances claimed to
provide a basis for a resignation for Good Reason.
(d) If within thirty (30) days after any Notice of Resignation is
given the corporation notifies the Executive that a dispute exists
concerning the resignation for Good Reason and that it is
requesting arbitration pursuant to Section 17, the Corporation
shall continue to pay the Executive his full salary and benefits
as described in Sections 3 and 4, as and when due and payable, at
least until such time as a final decision is reached by the panel
of arbitrators. If Good Reason for resignation by the Executive
is ultimately determined not to exist, then all sums paid by the
Corporation to the Executive, including but not limited to the
cost to the Corporation of providing the Executive such fringe
benefits, from the date of such resignation to the date of the
resolution of such dispute shall be promptly repaid by the
Executive to the Corporation with interest at the rate charged
from time to time by the Corporation to its most substantial
customers for unsecured extensions of credit.
A failure by the Corporation to notify the Executive that a
dispute exists concerning the resignation for Good Reason within
thirty (30) days after any Notice of Resignation is given shall
constitute a final waiver by the Corporation of its right to
contest either that such resignation was for Good Reason or its
obligations to the Executive under Section 7(a) hereof.
e) If the Executive's employment terminates after a Change of
Control (as defined in Section 9 hereof), the payments to
which he is entitled pursuant to Section 9 shall be in lieu of
any payment to which he might otherwise be entitled under the
terms of this Section 7.
8. RESIGNATION - TERMINATION FOR CAUSE - BRANCH OFFICE DISAPPROVAL - REGULATORY
TERMINATION: (a) Notwithstanding the provisions of Section 1 of this Agreement,
the Board of Directors of the Corporation may, in its sole discretion, terminate
the Executive's employment for Cause. For the purposes of this Agreement,
"Cause" shall mean personal dishonesty, incompetence, willful misconduct, breach
of fiduciary duty involving personal profit, intentional failure to perform
stated duties, willful violation of any law, rule, or regulation (other than
traffic violations or similar offenses) or final cease-and-desist order, or
material breach of any provision of this Agreement.
(b) Termination of the Executive's employment by the Corporation for Cause
pursuant to Section 8(a) shall be communicated by written Notice of Termination
to the Executive. A "Notice of Termination" shall mean a notice which shall
indicate the specific termination provision(s) in this Agreement relied upon and
shall set forth with particularity the facts and circumstances claimed to
provide a basis for termination of employment for Cause under the provision so
indicated.
If within thirty (30) days after any Notice of Termination is given the
Executive notifies the Corporation that a dispute exists concerning the
termination for Cause and that he is requesting arbitration pursuant to Section
17, the Corporation shall continue to pay the Executive his full salary and
benefits as described in Sections 3 and 4, as and when due and payable, at least
until such time as a final decision is reached by the panel of arbitrators. If a
termination for Cause by the Corporation is challenged by the Executive and the
termination is ultimately determined to be justified, then all sums paid by the
Corporation to the Executive pursuant to this Section 8(b), plus the cost to the
Corporation of providing the Executive such fringe benefits from the date of
such termination to the date of the resolution of such dispute, shall be
promptly repaid by the Executive to the Corporation with interest at the rate
charged from time to time by the corporation, to its most substantial customers
for unsecured lines of credit. Should it ultimately be determined that a
termination by the Corporation pursuant to Section 8(a) was not justified, then
the Executive shall be entitled to retain all sums paid to him pending the
resolution of such dispute and he shall entitled to receive, in addition, the
payments and other benefits provided for in Section 7(a).
A failure by the Executive to notify the Corporation that a dispute
exists concerning the termination for Cause within ninety (90) days after the
Notice of Termination is given shall constitute a final waiver by the Executive
of his right to contest that such termination was for Cause.
(c) In the event that the Executive resigns from or otherwise voluntarily
terminates his employment by the Corporation at any time (except a termination
for Good Reason pursuant to Section 7 hereof), or if the Corporation rightfully
terminates the Executive's employment for Cause, this Agreement shall terminate
upon the date of such resignation or termination of employment for Cause, and
(subject to Section 8(b) the Corporation thereafter shall have no obligation to
make any further payments under this Agreement, provided that the Executive
shall be entitled to receive any benefits, insured or otherwise, that he would
otherwise be eligible to receive under any benefit plans of the Corporation or
any affiliate of the Corporation.
(d) If the Executive is suspended and/or temporarily prohibited from
participating in the conduct of the Corporation's affairs by a notice served
under Sections 8(e) (3) or 8 (g) (1) [12 U.S.C. ss.ss.1818 (e) (3) and 1818 (g)
(1)] of the Federal Deposit Insurance Act, 12 U.S.C. ss.1811 et seq. (the
"Federal Deposit Insurance Act"), the Corporation's obligations under this
Agreement shall be suspended as of the date of service unless stayed by
appropriate proceedings. If the charges in the notice are dismissed, the
Corporation may in its discretion, (i) pay the Executive all or part of the
compensation withhheld while its contract obligations were suspended, and (ii)
reinstate (in whole or in part) any of its obligations which were suspended.
If the Executive is removed and/or permanently prohibited from
participating in the conduct of the Corporation's affairs by an order issued
under Sections 8(e) (4) or 8 (g) (1) of the Federal Deposit Insurance Act [12
U.S.C. ss.ss.1818 (e) (4) OR 1818 (g) (1)], all obligations of the Corporation
under this Agreement shall terminate as of the effective date of the order, but
vested rights of the contracting parties shall not be affected.
If the Corporation is in default [as default is defined in Section 3(x)
(1) of the Federal Deposit Insurance Act], all obligations under this Agreement
shall terminate as of the date of default, but this paragraph shall not affect
any vested rights of the contracting parties.
Except to the extent it is determined that continuation of this
Agreement is necessary for the continued operation of the Corporation, all
obligations under this Agreement shall be terminated:
(i) by the Director (as Director is defined in the Federal Deposit Insurance
Act) or his or her designee, at the time the Federal Deposit Insurance enters
into an agreement to provide assistance to or on behalf of the Corporation under
the authority contained in Section 13(c) of the Federal Deposit Insurance Act;
or
(ii) by the Director or his or her designee, at the time the Director
or his or her designee approves a supervisory merger to resolve problems related
to operation of the Corporation or when the Corporation is determined by the
Director to be in an unsafe or unsound condition.
Any rights of the parties that have already vested, however, shall not
be affected by such action.
9. CHANGE OF CONTROL: If the Executive's employment by the Corporation shall be
terminated in connection with or subsequent to a Change of Control of the
Holding Company by (i) the Corporation other than for Cause or as a result of
the Executive's death, disability or retirement or (ii) the Executive for Good
Reason, then the Corporation shall:
(a) Pay to the Executive, in one lump sum payment on the date of termination or
the date on which the Change in Control of the Holding Company occurs, whichever
first occurs, a cash severance amount equal to 1.5 times the total cash
compensation paid to the Executive during the previous twelve (12) months; and
(b) For purposes of this Agreement, a Change in Control of the Holding Company
occurs in any of the following events: (i) The acquisition by any "person" or
"group" (as defined in Sections 13(d) and 14(d) of the Securities and Exchange
Act of 1934 ("Exchange Act")), other than the Holding Company, any subsidiary of
the Holding Company or any Holding Company or subsidiary's employee benefit
plan, directly or indirectly, as "beneficial owner" (as defined in Rule 13d-3
under the Exchange Act) of securities of the Holding Company representing forty
percent (40%) or more of either the then outstanding shares or the combined
voting power of the then outstanding securities of the Holding Company; (ii)
Either a majority of the directors of the Holding Company elected at the Holding
Company's annual stockholders meeting shall have been nominated for election
other than by or at the direction of the "incumbent directors" of the Holding
Company, or the "incumbent directors" shall cease to constitute a majority of
the directors of the Holding Company. The term "incumbent director" shall mean
any director who was a director of the Holding Company on January 1, 1997 and
any individual who becomes a director of the Holding Company subsequent to
January 1, 1997 and who is elected or nominated by or at the direction of at
least two-thirds of the then incumbent directors; (iii) The shareholders of the
Holding Company approve (x) a merger, consolidation or other business
combination of the Holding Company with any other "person" or "group" (as
defined in Sections 13(d) and 14(d) of the Exchange Act) or affiliate thereof,
other than a merger or consolidation that would result in the outstanding common
stock of the Holding Company immediately prior thereto continuing to represent
either by remaining outstanding or by being converted into common stock of the
surviving entity or a parent or affiliate thereof) at least fifty percent (50%)
of the outstanding common stock of the Holding Company or such surviving entity
or a parent or affiliate thereof outstanding immediately after such merger,
consolidation or other business combination, or (y) a plan complete liquidation
of the Holding Company or an agreement for the sale or disposition by the
Holding Company of all or substantially all of the Holding Company's assets; or
(iv) Any other event or circumstance which is not covered by the foregoing
subsections but which the Board of Directors of the Holding Company determines
to affect control of the Holding Company and with respect to which the Board of
Directors adopts a resolution that the event or circumstance constitutes a
Change of Control for the purposes of the Agreement.
The Control Change Date is the date on which an event described in (i),
(ii), (iii) or (iv) occurs.
10. SUCCESSORS: The Corporation will require any successor (whether direct or
indirect, by purchase, merger, consolidation or otherwise) to all or
substantially all of the business and/or assets of the Corporation, or either
one of them, by agreement in form and substance satisfactory to the Executive,
to expressly assume and agree to perform this Agreement in its entirety. Failure
of the Corporation to obtain such agreement prior to the effectiveness of any
such succession shall be a breach of this Agreement and shall entitle the
Executive to the compensation described in Section 7(a) or Section 9, as
appropriate. As used in this Agreement, "Corporation" shall mean Southern
Financial Bancorp, Inc. and any successor to its business and/or assets as
aforesaid which executes and delivers the agreement provided for in this Section
10(c) or which otherwise becomes bound by all the terms and provisions of this
Agreement by operation of law.
11. LIMITATION OF BENEFITS: It is the intention of the parties that no payment
be made or benefit provided to the Executive that would constitute an "excess
parachute payment" within the meaning of Section 280G of the Internal Revenue
Code of 1986, as amended (the Code) and any regulations thereunder, thereby
resulting in a loss of an income tax deduction by the Corporation or the
imposition of an excise tax on the Executive under Section 4999 of the Code. If
the independent accountants serving as auditors for the Corporation immediately
prior to the date of a Change of Control determine that some or all of the
payments or benefits scheduled under this Agreement, when combined with any
other payments or benefits provided to the Executive on a Change of Control by
the Corporation, and any affiliate of the Corporation required to be aggregated
with the Corporation under Section 280G of the Code, would constitute
nondeductible excess parachute payments by the Corporation under Section 280G of
the Code, then the payments or benefits scheduled under this Agreement will be
reduced to one dollar less than the maximum amount which may be paid or provided
without causing any such payments or benefits scheduled under this Agreement or
otherwise provided on a Change of Control to be nondeductible. The determination
made as to the reduction of benefits or payments required hereunder by the
independent accountants shall be binding on the parties. The Executive shall
have the right to designate within a reasonable period which payments or
benefits scheduled under this Agreement will be reduced; provided, however, that
if no direction is received from the Executive, the Corporation shall implement
the reductions under this Agreement in its discretion.
12. NOTICES: For the purposes of this Agreement, notices and all other
communications provided for in the Agreement shall be in writing and shall be
deemed to have been duly given when delivered or mailed by United States
registered or certified mail, return receipt requested, postage prepaid,
addressed as follows:
If to the Executive: William H. Lagos
------------------------------------
------------------------------------
If to the Corporation: Southern Financial Bancorp, Inc.
37 East Main Street, Warrenton, VA 20186
or at such other address as any party may have furnished to the other in writing
in accordance herewith, except that notices of change of address shall be
effective only upon receipt.
13. MODIFICATION - WAIVERS - APPLICABLE LAW: No provisions of this Agreement may
be modified, waived or discharged unless such waiver, modification or discharge
is agreed to in writing, signed by the Executive and on behalf of the
Corporation by such officer as may be specifically designated by the Board of
Directors of the Corporation. No waiver by either party hereto at any time of
any breach by the other party hereto of, or compliance with, any condition or
provision of this Agreement to be performed by such other party shall be deemed
a waiver of similar or dissimilar provision or conditions at the same or at any
prior or subsequent time. No agreements or representations, oral or otherwise,
express or implied, with respect to the subject matter hereof have been made by
either party which are not set forth expressly in this Agreement. The validity,
interpretation, construction and performance of this Agreement shall be governed
by the laws of the State of Virginia.
14. INVALIDITY - ENFORCEABILITY: The invalidity or unenforceability of any
provisions of this Agreement shall not affect the validity or enforceability of
any other provision of this Agreement, which shall remain in full force and
effect. Any provision in this Agreement which is prohibited or unenforceable in
any jurisdiction shall, as to such jurisdiction, be ineffective only to the
extent of such prohibition or unenforceability without invalidating or affecting
the remaining provisions hereof, and any such prohibition or unenforceability in
any jurisdiction shall not invalidate or render unenforceable such provision in
any other jurisdiction.
15. SUCCESSOR RIGHTS: This Agreement shall inure to the benefit of and be
enforceable by the Executive's personal or legal representatives, executors,
administrators, successors, heirs, distributees, devisees and legatees. If the
Executive should die while any amounts would still be payable to him hereunder,
all such amounts, unless otherwise provided herein, shall be paid in accordance
with the terms of this Agreement to his executor or, if there is no such
executor, to his estate.
16. HEADINGS: Descriptive headings contained in this Agreement are for
convenience only and shall not control or affect the meaning or construction of
any provision hereof.
17. ARBITRATION: Any dispute, controversy or claim arising under or in
connection with this Agreement shall be settled exclusively by arbitration,
conducted before a panel of three arbitrators, in ________________, Virginia, in
accordance with the Commercial Arbitration Rules of the American Arbitration
Association then in effect. The Corporation shall pay all administrative fees
associated with such arbitration. Judgment may be entered on the arbitrator's
award in any court having jurisdiction. Subject to Section 10(a), unless
otherwise provided in the rules of the American Arbitration Association, the
arbitrators shall, in their award, allocate between the parties the costs of
arbitration, which shall include reasonable attorneys' fees and expenses of the
parties, as well as the arbitrator's fees and expenses, in such proportions as
the arbitrators deem just.
18. CONFIDENTIALITY - NONSOLICITATION: (a) The Executive acknowledges that the
Corporation may disclose certain confidential information to the Executive
during the term of this Agreement to enable him to perform his duties hereunder.
The Executive hereby covenants and agrees that he will not, without prior
written consent of the Corporation, during the term of this Agreement or at any
time thereafter, disclose or permit to be disclosed to any third party by any
method whatsoever any of the confidential information of the Corporation. For
purposes of this Agreement, "confidential information" shall include, but not be
limited to, any and all records, notes, memoranda, data, ideas, processes,
methods, techniques, systems, formulas, patents, models, devices, programs,
computer software, writings, research, personnel information, customer
information, the Corporation's financial information, plans, or any other
information of whatever nature in the possession or control of the Corporation
which has not been published or disclosed to the general public, or which gives
to the Corporation an opportunity to obtain an advantage over competitors who do
not know of or use it. The Executive further agrees that if his employment
hereunder is terminated for any reason, he will leave with the Corporation and
will not take originals or copies of any and all records, papers, programs,
computer software and documents and all matter of whatever nature which bears
secret or confidential information of the Corporation.
The foregoing paragraph shall not be applicable if and to the extent
the Executive is required to testify in a judicial or regulatory proceeding
pursuant to an order of a judge or administrative law judge issued after the
Executive and his legal counsel urge that the aforementioned confidentiality be
preserved.
The foregoing covenants will not prohibit the Executive from disclosing
confidential or other information to other employees of the Corporation or any
third parties to the extent that such disclosure is necessary to the performance
of his duties under this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement effective
as of the date first above written.
"EXECUTIVE"
ATTEST: /s/ Lynette D. Ridgley /s/ William H. Lagos
----------------------- --------------------
Lynette D. Ridgley William H. Lagos
SOUTHERN FINANCIAL BANK
ATTEST: /s/ Lynette D. Ridgley BY: /s/ Georgia S. Derrico
---------------------- ------------------------
Lynette D. Ridgley Georgia S. Derrico
Exhibit 13
Southern Financial Bancorp, Inc.
December 31, 1997 Annual Report to Stockholders
Banking has changed since the days when you could walk into a bank lobby and be
greeted by name. Your bankers used to know who you were and they knew your
family. They were interested in the success of your business because your
success was the community's success. It was not uncommon for bank employees to
visit your business either to buy your goods or services, or simply to stop by
and say hello.
In today's world of big bank conglomerations and daily mergers, you
have become just an account number. Loan approvals and customer service are
found only after telephoning faceless employees in distant cities. Major
decisions impacting your life are made by people who don't know you and don't
know your community. They may have never set foot in your state!
Community banking is still alive and well at Southern Financial Bank,
where you get old fashioned treatment. The employees and decision-makers of
Southern Financial are your neighbors and friends. Whether you are buying or
building your first home, starting or expanding your business, or investing in
your future, Southern Financial is committed to the success of your dreams.
For the second consecutive year, Southern Financial Bank has won awards
for being a top small business lender. Southern Financial Bank has enabled
businesses to realize their goals through a wide spectrum of lending programs.
These programs are individually designed because Southern Financial knows that
each business is unique and each loan must be tailored to fit the specific needs
of those businesses. A sampling of some of the opportunities we have funded this
year include a dinner theater, riding stables, batting cages, a hair salon, a
women's clinic, and an assisted care living facility. In doing so, Southern
Financial has helped our communities grow and has enriched the lives of those
who live within those communities.
As a top priority, each of our branches has a commitment to be involved in the
community. Each branch manager is involved with his or her local Chamber of
Commerce and hosts various seminars designed to educate our neighbors on such
diverse topics as credit management, building your own home, the Small Business
Administration, and estate planning. One manager has helped a local nonprofit
daycare center by making a donation for each new account opened. Other employees
volunteer their time and talents in community services such as: a local rescue
squad member, a neighborhood church deacon, and a Little League coach. You might
even see our employees marching in your local parade!
While Southern Financial Bank offers the convenience of technologically
advanced banking services including automated telephone access to deposit and
loan information, teller satellite systems, and 24 hour fund access through
automated teller machines, we pride ourselves on knowing your name when you
visit us. When you call us, you are greeted by a person, not an automated menu.
Finally, the person making decisions about you and your future will be someone
who knows you and knows your community.
Our commitment to helping our neighbors is strong. We are
proud to remain a small community bank dedicated to supporting the growth of
our neighborhoods and communities, and to providing you with the means to
realize your opportunities.
<PAGE>
FINANCIAL HIGHLIGHTS
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
at December 31, at June 30,
---------------------------------------------- ------------------------------
Financial Condition 1997 1996 1995 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C>
Total Assets $ 226,598 $ 190,809 $164,801 $157,201 $124,108
Net Loans 128,958 108,287 104,251 92,080 66,957
Total Deposits 202,200 164,279 143,814 137,680 100,562
Stockholders' Equity 18,543 16,401 15,775 15,173 14,019
</TABLE>
<TABLE>
<CAPTION>
Six Months
Year Ended Ended
December 31, December 31, Year Ended June 30,
Results of Operations 1997 1996 1995 1995 1994
<S> <C>
- -----------------------------------------------------------------------------------------------------------------------------------
Interest Income $ 17,005 $ 14,615 $6,731 $11,027 $7,615
Interest Expense 9,043 7,776 3,629 5,931 3,650
- -----------------------------------------------------------------------------------------------------------------------------------
Net Interest Income 7,962 6,839 3,101 5,095 3,966
Provision for Loan Losses 880 695 150 60 5
- -----------------------------------------------------------------------------------------------------------------------------------
Net Interest Income After
Provision for Loan Losses 7,082 6,144 2,951 5,035 3,961
Other Income 1,728 1,186 514 814 1,128
Special SAIF Assessment 0 830 0 0 0
Other Expense 5,582 5,077 2,316 3,716 3,147
- -----------------------------------------------------------------------------------------------------------------------------------
Income before Taxes 3,228 1,423 1,150 2,134 1,942
Provision for Income Taxes 1,022 469 414 833 757
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME 2,206 954 735 1,301 1,184
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Per Common Share Data:
Net Income Diluted * $ 1.33 $ 0.59 $ 0.46 $ 0.85 $ 0.93
Dividends Paid $ 0.28 $ 0.24 $ 0.12 $ 0.20 $ 0.20
Book Value $ 11.47 $ 10.32 $ 10.05 $ 9.82 $ 9.06
Weighted Average Diluted Shares
Outstanding 1,657,706 1,621,958 1,608,231 1,530,255 1,273,451
Actual Shares Outstanding 1,591,679 1,564,248 1,385,092 1,369,149 1,366,694
Cumulative Convertible Preferred Stock
Actual Shares Outstanding 15,634 15,634 16,634 16,634 17,388
</TABLE>
* Prior period numbers have been restated to conform with SFAS 128 "Earnings Per
Share."
<TABLE>
<CAPTION>
at or for the
at or for the Six Months
Year Ended Ended at or for the Year Ended
December 31, December 31, June 30,
------------------------------ ---------------- -----------------------------
Growth & Financial Ratios 1997 1996 1995 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C>
% Change in Equity 13.06% 3.97% 3.97% 8.23% 62.82%
% Change in Assets 18.76% 15.78% 4.83% 26.66% 20.44%
% Change in Loans 19.09% 3.87% 13.22% 37.52% 14.88%
Equity/Assets Ratio 8.18% 8.60% 9.57% 9.65% 11.30%
Return on Average Assets 1.05% 0.52% 0.91% 0.90% 1.06%
Operating Expense to
Average Assets 2.66% 3.25% 2.88% 2.56% 2.81%
Return on Average Equity 12.70% 5.91% 9.50% 8.95% 10.06%
Net Interest Margin 3.92% 3.93% 3.98% 3.60% 3.61%
Efficiency Ratio 57.61% 73.61% 64.05% 62.88% 61.78%
Other Data:
Number of Full Service Branches 10 10 9 9 6
Number of ATMs 9 8 7 7 4
</TABLE>
<PAGE>
Dear Shareholder:
Having managed your Bank through the S&L and real estate crisis of the late
1980's, I can attest to the fact that the life of a banker is much more fun when
the financial crisis is on the other side of the world. With stability in our
markets, 1997 was a year in which your Bank saw the efforts of the past decade
come to fruition. Moreover, it laid the foundation for future solid growth.
Net income for 1997 was a record $2.2 million - more than double the earnings in
1996. Even more impressive, net income was up 46% in 1997 from what it would
have been in 1996 in the absence of any SAIF assessment. Earnings per share on a
fully diluted basis rose to $1.33 in 1997, the highest level ever. Your Bank's
Return on Average Assets was a solid 1.05% and Return on Average Equity rose to
12.70%. The Efficiency Ratio for the year was 57.6% - one of the best ever.
Your Bank also set new records in all of the key balance sheet categories.
Deposits rose to $202.2 million up 23.1% from the prior year, and more than
double their level at year-end three and a half years ago. Net loans rose to a
new high of $129.0 million - up 19.1% from the level at year-end 1996.
To ensure that we start 1998 in a position of strength, we increased Southern
Financial's loan loss reserve to $2.0 million, or 1.6% of total loans. This is
the Bank's highest percentage ever and is reflective of the growth in the
commercial loan component of the Bank's portfolio.
In last year's Annual Report, I wrote about your Bank's long standing use of the
Small Business Administration's lending programs. In 1997, we moved aggressively
ahead in this area in the communities we serve. We believe that our commercial
lending staff is second to none in SBA expertise.
Data from the Washington, DC District Office of the SBA for the year ending
September 1997, shows Southern Financial, in terms of volume, ahead of
NationsBank, Franklin National Bank, First Union, and Crestar while behind the
specialized lenders such as the Money Store, Virginia Asset Financing
Corporation, and ATT Capital. Moreover, unlike most of our competitors in this
field, your Bank never sold any of the SBA loans it had originated. Now that we
have a solid and profitable portfolio of SBA loans as an earning asset, we plan
to begin selling part of our new production during the first quarter of 1998. We
expect that these sales will enhance your Bank's 1998 earnings.
We dedicate ourselves to the continued growth of our business in the communities
we serve in the expectation that your Bank will build on its strong base, going
from strength to strength.
I look forward to seeing you at our Annual Meeting on April 23rd.
Very truly yours,
Georgia S. Derrico
Chairman & CEO
<PAGE>
CHART
BOOK VALUE PER SHARE
6/30/94 $ 9.06
12/31/95 $10.05
12/31/96 $10.32
12/31/97 $11.47
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview. Net income for the year ended December 31, 1997, was a record
at $2.2 million ($1.33 diluted earnings per share), an increase of 46% over
earnings of $1.5 million ($0.93 diluted earnings per share) for the year ended
December 31, 1996, before a charge to replenish the Savings Association
Insurance Fund, and an increase of 131% over reported earnings of $954 thousand
($0.59 per diluted share) for the year ended December 31, 1996. Total assets
increased 19% to $226.6 million at December 31, 1997, from $190.8 million at
December 31, 1996. Total loans outstanding and loans held for sale increased to
$130.4 million, up 20% from $108.7 million at December 31, 1996. Investment
securities also rose from $70.3 million to $85.2 million, an increase of 21% for
the period. Deposits increased 23%, rising to $202.2 million at December 31,
1997, from $164.3 million at December 31, 1996. Since December 31, 1996, the
number of deposit accounts has increased from 19,924 to 22,319, or 12%.
Balance sheet. The total assets of Southern Financial were $226.6
million at December 31, 1997, an increase of $35.8 million, or 18.8%, from
$190.8 million at December 31, 1996. This growth was due to an increase in loans
receivable of $20.7 million, or 19.1%, to $129.0 million at December 31, 1997
from $108.3 million at December 31, 1996, and to an increase in investment
securities of $14.9 million, or 21.1%, to $85.2 million at December 31, 1997
from $70.3 million at December 31, 1996. Total liabilities increased $33.7
million, or 19.3%, to $208.1 million at December 31, 1997 from $174.4 million at
December 31, 1996.
CHART
TOTAL ASSETS
12/31/94* $144,573,000
12/31/95 $164,801,000
12/31/96 $190,809,000
12/31/97 $226,598,000
* Restated to calendar year to conform with 1995, 1996, and 1997
Loans. Loans receivable, net of deferred fees and allowances for
losses, were $129.0 million at December 31, 1997, an increase of $20.7 million,
or 19.1%, over $108.3 million at December 31, 1996. During the twelve months
ended December 31, 1997, Southern Financial continued to emphasize loan
originations connected with various lending programs of the U.S. Small Business
Administration Program. As a result, the growth in the loan portfolio occurred
in non-mortgage business loans, which increased by $9.1 million, and in loans
secured by nonresidential property, which increased by $16.3 million. The
weighted average interest rate on total loans receivable increased to 9.37% at
December 31, 1997 from 9.18% at December 31, 1996.
<PAGE>
Investment securities. The portfolio of investment securities at
December 31, 1997 consisted of $80.5 million in securities classified as
held-to-maturity and $4.7 million classified as available-for-sale. The
portfolio of securities held-to-maturity consisted of FNMA, GNMA and FHLMC
mortgage-backed participation certificates, collateralized mortgage obligations,
and FHLB Zero-coupon Notes. $17.5 million of the mortgage securities had fixed
rates of interest and original maturities of 15 years and $5.0 million had fixed
interest rates with original maturities of 30 years. The remainder of $57.3
million had adjustable rates of interest, all of which adjust in one year or
less. The FHLB Zero-coupon Notes have a fixed rate of interest and are callable
starting in June 1998. The mortgage securities classified as available-for-sale
had fixed rates of interest and original maturities of 15 years. The FHLMC
Preferred Stock, classified as available for sale, carries a fixed dividend rate
and is callable starting in September 1998.
Liabilities. The increase in assets was funded primarily by an increase
in customer deposits. Deposits at December 31, 1997 were $202.2 million, an
increase of $37.9 million, or 23.1%, over deposits of $164.3 million at December
31, 1996. All deposit categories increased with the largest growth occurring in
certificates of deposit which increased by $29.8 million, or 25.0%, to $149.2
million at December 31, 1997 from $119.4 million at December 31, 1996. The
weighted average interest rate for all accounts increased to 4.79% at December
31, 1997 from 4.57% at December 31, 1996. The increase in deposits reflects the
opening in July of 1996 of a new branch in Winchester, as well as growth in the
Bank's customer base at all branches, augmented by an increased advertising
campaign.
CHART
TOTAL DEPOSITS
12/31/94 $130,191,000
12/31/95 $143,814,000
12/31/96 $164,279,000
12/31/97 $202,200,000
Totals as of 12/31
Advances from the Federal Home Loan Bank of Atlanta ("FHLB") totaled
$4.0 million at December 31, 1997, a decrease of $4.5 million from $8.5 million
at December 31, 1996.
<PAGE>
Results of Operation
The operating results of the Bank depend primarily on its net interest
income, which is the difference between interest and dividend income on
interest-earning assets, such as loans and investments, and interest expense on
interest-bearing liabilities such as deposits and borrowings. Operating results
are also affected by the level of its noninterest income, including income or
loss from the sale of loans and fees and service charges on deposit accounts,
and by the level of its operating expenses, including compensation, premises and
equipment, deposit insurance assessments and income taxes. The following tables
provide information regarding changes in interest income and interest expense,
as well as the underlying components of interest-earning assets and
interest-bearing liabilities.
The following table presents, for the periods indicated, average
monthly balances of and weighted average yields on interest-earning assets and
average balances and weighted average effective interest paid on interest
bearing liabilities.
The subsequent table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning asset and interest-bearing liability, information is provided
on changes attributable to changes in volume (changes in volume multiplied by
old rate) and changes in rates (changes in rates multiplied by old volume). The
dollar amount changes in interest income and interest expense attributable to
changes in rate/volume (change in rate multiplied by change in volume) has been
allocated between rate and volume variances based on the percentage relationship
of such variances to each other.
<PAGE>
<TABLE>
<CAPTION>
Rate Sensitivity Analysis
(in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Year ended December 31, Year ended December 31, Six months ended
1997 1996 December 31,1995
<S> <C>
- ----------------------------------------------------------------------------------------------------------------------
Average Average Average Average Average Average
balance yield/rate balance yield/rate balance yield/rate
Interest-earning assets:
Loans receivable $ 118,809 9.74% $ 106,254 9.70% $100,777 9.86%
Investments 83,900 6.48 67,910 6.35 55,005 6.41
-------------------------------------------------------------------------------------
Total interest-earning assets 202,709 8.39 174,164 8.39 155,782 8.64
--------------------------------------------------------------------------------------
Interest-bearing liabilities:
Deposits 184,296 4.73 158,151 4.70 138,322 4.97
Borrowings 5,979 5.59 6,077 5.63 5,667 6.69
--------------------------------------------------------------------------------------
Total interest-bearing 190,275 4.76 164,228 4.73 143,989 5.04
liabilities:
--------------------------------------------------------------------------------------
Average dollar difference
between interest-bearing assets
and interest-bearing liabilities 12,434 9,936 11,793
--------------------------------------------------------------------------------------
Interest rate spread 3.63 3.66 3.60
--------------------------------------------------------------------------------------
Interest margin 3.92 3.93 3.98
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Rate/Volume Analysis
(in thousands)
- ----------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1997 Year ended December 31, 1996
compared to year ended December 31, compared to six months ended
1996 December 31, 1995
<S> <C>
- -------------------------------------------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
Interest income
Loans receivable $ 1,218 $ 42 $ 1,260 $ 535 ($160) $ 375
Investments 1,035 95 1,130 815 (36) 779
----------------------------------------------------------------------------------
Total interest income 2,253 137 2,390 1,350 (196) 1,154
----------------------------------------------------------------------------------
Interest expense
Deposits 1,229 47 1,276 890 (337) 553
Borrowings (6) (2) (8) 30 (67) (37)
----------------------------------------------------------------------------------
Total interest expense 1,223 45 1,268 920 (404) 516
----------------------------------------------------------------------------------
Net interest income 1,030 92 1,122 430 208 638
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
CHART
NET INCOME
6/30/94 $1,184,000
6/30/95 $1,301,000
12/31/95** $1,470,000
12/31/96* $1,800,000
12/31/97 $2,206,000
*Adjusted to exclude SAIF special assessment.
**Net Income has been annualized for comparison purposes.
Comparison of the year ended December 31, 1997 with the year ended December 31,
1996
Southern Financial's net income for the year ended December 31, 1997
was $2.2 million, an increase of 131.2% over net income of $954 thousand for the
year ended December 31, 1996. The increase in net income was primarily due to an
increase in net interest income of 16.4%, a decline of 90.0% in deposit
insurance assessments, and an increase of 45.7% in other income. Diluted
earnings per share for the year ended December 31, 1997 were $1.33 as compared
to $0.59 for the year ended December 31, 1996. The weighted average number of
diluted shares of common stock outstanding were 1,657,706 for the year ended
December 31, 1997 and 1,621,958 for the year ended December 31, 1996. 1996
earnings per share data have been restated to conform with SFAS 128, "Earnings
per Share."
Net interest income. Net interest income before provision for loan
losses was $8.0 million for the year ended December 31, 1997, an increase of
16.4% over $6.8 million for the year ended December 31, 1996. This increase was
due to the growth in the average level of earning assets from $174.2 million to
$202.7 million. The interest rate spread decreased slightly from 3.66% to 3.63%
during the year ended December 31, 1997, and the interest margin went from 3.93%
to 3.92% during the same period.
Total interest income. Total interest income was $17.0 million for the
year ended December 31, 1997, an increase of 16.4% over $14.6 million for the
year ended December 31, 1996. This increase resulted from growth in
interest-earning assets, as well as a marginal improvement in mix. Average loans
receivable increased by $12.6 million and average investment securities
increased by $16.0 million over 1996.
The yield on total interest-earning assets was 8.39% for the year ended
December 31, 1997, which reflected no change compared to 1996. For the year
ended December 31, 1997, the yield on average loans receivable was 9.74%, up
from 9.70% for the year ended December 31, 1996, while the yield on average
investment securities increased from 6.35% during 1996 to 6.48% for the year
ended December 31, 1997. The greater increase in lower yielding investment
securities than in loans caused the overall average yield to remain flat as
compared to 1996.
Total interest expense. Total interest expense for the year ended
December 31, 1997 was $9.0 million, an increase of 16.3% over $7.8 million for
the year ended December 31, 1996. This increase was due primarily to growth in
the average balance of deposits, which were $184.3 million for the year ended
December 31, 1997 compared to $158.2 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.76% for the year ended
December 31, 1997, an increase of only 3 basis points from 4.73% for the year
ended December 31, 1996.
<PAGE>
Provision for loan losses. The provision for loan losses amounted to
$880 thousand for the year ended December 31, 1997, an increase over the
provision of $695 thousand for the year ended December 31, 1996. The provision
for loan losses is a current charge to earnings to increase the allowance for
loan losses. The Bancorp has established the allowance for loan losses to absorb
the inherent risk in lending after considering an evaluation of the loan
portfolio, current economic conditions, changes in the nature and volume of
lending and past loan experience. During the year ended December 31, 1997, the
Bank's volume of nonresidential mortgages and commercial loans increased. These
loans tend to carry a higher risk classification. The increase in the provision
for loan losses reflects the growth in the portfolio as well as the change in
the type of loans. The Bank's opinion is that the allowance for loan losses at
December 31, 1997 remains adequate. Although the Bank believes that the
allowance is adequate, there can be no assurances that additions to such
allowance will not be necessary in future periods, which would adversely affect
the Bank's results of operations. The allowance for loan losses at December 31,
1997 was $2.0 million, or 1.55% of total loans receivable compared to $1.5
million, or 1.37% at December 31, 1996.
Other income. Other income totaled $1.7 million for the year ended
December 31, 1997, an increase of 45.7%, from $1.2 million for the year ended
December 31, 1996. The increase was attributable primarily to fee income, which
increased by 52.3% to $1.4 million for the year ended December 31, 1997 from
$950 thousand for the prior year. Fee income, consisting primarily of
transaction fees on NOW accounts, increased due to increased volume in these
types of deposit accounts. Gain on sale of loans decreased 8.7% to $192 thousand
for the year ended December 31, 1997 from $210 thousand for the year ended
December 31, 1996, reflecting lower originations of residential loans held for
sale which decreased 20.0% to $8.4 million for the year ended December 31, 1997
from $10.5 million for the year ended December 31, 1996.
Other expenses. Other expenses for the year ended December 31, 1997
were $5.6 million, a decrease of 5.5% from $5.9 million for the year ended
December 31, 1996. There were increases in most expense categories, such as
employee compensation and benefits, premises and equipment, and advertising
during 1997, but they were more than offset by the significant decrease in
deposit insurance assessments.
Employee compensation and benefits increased 17.9% to $2.5 million for
the year ended December 31, 1997 from $2.1 million for the prior year. The
increase reflects the cost of staffing the new branch opened in July 1996 for a
full year, as well as increased staffing levels to accommodate growth in the
Bank's customer base and normal wage increases for existing personnel.
Expenses for premises and equipment increased 15.6% to $1.8 million for
the year ended December 31, 1997 from $1.6 million for the year ended December
31, 1996. This increase is primarily the result of operating the Millwood branch
opened in June 1996 for a full year and the cost associated with relocating the
Fairfax branch during 1997. Data processing costs also increased $92 thousand
because of growth in the number of accounts and transaction volumes related to
customer deposits.
Deposit insurance assessments decreased from $1.1 million for the year
ended December 31, 1996 to $109 thousand for the year ended December 31, 1997.
The 1996 expense reflected a one-time assessment on thrifts and banks with
thrift deposits to recapitalize the Savings Association Insurance Fund. The
Bank's one-time assessment was $830 thousand.
<PAGE>
Advertising expense increased 49.9% to $214 thousand for the year ended
December 31, 1997 from $143 thousand for the prior year because of an increased
reliance on advertising to expand the Bank's customer base.
Other expenses remained relatively constant during the year ended
December 31, 1997 compared to the prior year.
Comparison of the year ended December 31, 1996 with the six months
ended December 31, 1995
Southern Financial's net income for the year ended December 31, 1996
totaled $954 thousand, a decrease on an annualized basis of 35.1%, from $735
thousand for the six months ended December 31, 1995. The decrease in net income
was primarily due to an increase on an annualized basis of 212% in deposit
insurance assessments and of 132% in provision for loan losses; these were
partially offset by an increase on an annualized basis of 10.3% in net interest
income and 15.3% in other income. Diluted earnings per share for the year ended
December 31, 1996 were $0.59 as compared to $0.46 for the six months ended
December 31, 1995. The weighted average number of diluted shares of common stock
outstanding were 1,621,958 for the year ended December 31, 1996 and 1,608,231
for the six months ended December 31, 1995. Earnings per share data have been
restated to conform to SFAS 128, "Earnings per Share."
Net interest income. Net interest income before provision for loan
losses was $6.8 million for the year ended December 31, 1996 and $3.1 million
for the six months ended December 31, 1995. On an annualized basis, this
represents an increase of 10.3%. This increase was due to an increase in the
average level of earning assets from $155.8 million to $174.2 million. The
interest rate spread increased from 3.60% for the six months ended December 31,
1995 to 3.66% for the year ended December 31, 1996, but the interest margin
decreased from 3.98% to 3.93% over the same periods. The decrease in the
interest rate margin was due to the fact that interest -bearing liabilities
increased by a greater percentage than interest earning assets.
Total interest income. Total interest income was $14.6 million for the
year ended December 31, 1996, an increase on an annualized basis of 8.6%, from
$6.7 million for the six months ended December 31, 1995. This increase resulted
from a growth in interest-earning assets which more than offset the decline in
related yields. Interest-earning assets averaged $174.2 million for the year
ended December 31, 1996, up from $155.8 million for the six months ended
December 31, 1995. This increase was due partially to the increase in average
loans receivable from $100.8 million for the six months ended December 31, 1995
to $106.3 million for the year ended December 31, 1996.
The yield on total interest-earning assets decreased 25 basis points to
8.39% for the year ended December 31, 1996 from 8.64% for the six months ended
December 31, 1995. For the year ended December 31, 1996, the yield on loans
receivable was 9.70%, down from 9.86% for the six months ended December 31,
1995. This decrease reflects the fact that lending rates were lower in the
latter period than in the former, as evidenced by successive declines in the
Prime Rate from 9% to 8.25% from July 8, 1995 to February 1, 1996. The average
yield on investments decreased from 6.41% for the six months ended December 31,
1995 to 6.35% for the year ended December 31, 1996.
Total interest expense. Total interest expense for the year ended
December 31, 1996 was $7.8 million, which represents on an annualized basis an
increase of 7.1%, from $3.6 million for the six months ended December 31, 1995.
This increase was due to an increase in the average balance of interest-bearing
liabilities, which was more than offset by decreases in the weighted effective
rates paid thereon. For the year ended December 31, 1996 average
interest-bearing liabilities were $164.2 million, up $20.2 million from $144.0
million for the six months ended December 31, 1995. The average effective rate
paid on interest bearing liabilities was 4.73% for the year ended December 31,
1996, a decrease of 31 basis points from 5.04% for the six months ended December
31, 1995.
CHART
RETURN ON AVERAGE EQUITY
12/31/94** 8.68%
12/31/95** 9.27%
12/31/96* 9.36%
12/31/97 12.70%
*Adjusted to exclude SAIF special assessment.
**Restated to calendar years to conform with 1996 and 1997.
<PAGE>
Provision for loan losses. The provision for loan losses amounted to
$695 thousand for the year ended December 31, 1996, an increase of 132% on an
annualized basis over the provision of $150 thousand for the six months ended
December 31, 1995, reflecting an increase in the Bank's volume of nonresidential
mortgages and commercial loans. The allowance for loan losses at December 31,
1996 was $1.5 million, or 1.37% of total loans receivable versus 1.13% at
December 31, 1995.
Other income. Other income totaled $1.2 million for the year ended
December 31, 1996, an increase on an annualized basis of 15.3%, from $514
thousand for the six months ended December 31, 1995. The increase was
attributable primarily to fee income, which increased on an annualized basis by
42.3% to $950 thousand for the year ended December 31, 1996 from $334 thousand
for the six months ended December 31, 1995. Fee income consisting primarily of
transaction fees on NOW accounts, increased due to increased volume in these
types of deposit accounts. Gain on sale of loans decreased 3.6% on an annualized
basis to $210 thousand for the year ended December 31, 1996 from the six months
ended December 31, 1995, in spite of the fact that originations of loans held
for sale increased 22.1% on an annualized basis to $10.5 million for the year
ended December 31, 1996 from $4.3 million for the six months ended December 31,
1995.
Other expenses. Other expenses for the year ended December 31, 1996
were $5.9 million, an increase on an annualized basis of 27.5% from $2.3 million
for the six months ended December 31, 1995. Increases on an annualized basis
occurred in most categories of expenses. The most significant factor
contributing to the increase was the growth in deposit insurance assessments and
the opening of a new branch in June 1996.
Employee compensation and benefits increased on an annualized basis
18.4% to $2.1 million for the year ended December 31, 1996 from $907 thousand
for the six months ended December 31, 1995. The increase reflects the additional
personnel needed to staff one new branch and normal wage increases for existing
personnel.
Expenses for premises and equipment increased on an annualized basis
24.9% to $1.6 million for the year ended December 31, 1996 from $637 thousand
for the six months ended December 31, 1995. This increase reflects the costs
associated with opening one new branch and supporting the Bank's growth. Data
processing costs are included and increased due to the increase in the number
and activity of customer deposit accounts.
Deposit insurance assessments increased on an annualized basis 212% to
$1.1 million for the year ended December 31, 1996 from $174 thousand for the six
months ended December 31, 1995. The increased deposit insurance assessment
reflects the Bancorp's one-time SAIF assessment of $830 thousand.
Advertising expense increased on an annualized basis 74.7% to $143
thousand for the year ended December 31, 1996 from $41 thousand for the six
months ended December 31, 1995. This increase was the result of an increased
reliance on advertising to expand the Bank's customer base.
<PAGE>
Other expenses decreased on an annualized basis 15.6% to $940 thousand
for the year ended December 31, 1996 from $557 thousand for the six months ended
December 31, 1995. This decrease was partly
due to the fact that there were non-recurring costs in the six months ended
December 31, 1995 of approximately $60 thousand relating to the Bank's
conversion to a Virginia commercial bank charter.
Comparison of the six months ended December 31, 1995 with the year ended June
30, 1995
Southern Financial's net income for the six months ended December 31,
1995 totaled $735 thousand, an increase on an annualized basis of 13.0%, from
$1.3 million for the year ended June 30, 1995. The increase in net income was
primarily due to an increase on an annualized basis of 21.7% in net interest
income which was partially offset by an increase on an annualized basis of 24.7%
in other expenses. Diluted earnings per share for the six months ended December
31, 1995 were $0.46 as compared to $0.85 for the year ended June 30, 1995. The
weighted average number of diluted shares of common stock outstanding were
1,608,231 for the six months ended December 31, 1995 and 1,530,255 for the year
ended June 30, 1995.
Net interest income. Net interest income before provision for loan
losses was $3.1 million for the six months ended December 31, 1995 and $5.1
million for the year ended June 30, 1995. On an annualized basis, this
represents an increase of 21.7%. This increase was due to an increase in the
interest rate spread to 3.60% for the six months ended December 31, 1995 from
3.20% for the year ended June 30, 1995. Also, net loans receivable increased to
$104.3 million at December 31, 1995 an increase of $12.2 million, or 13.2%, from
$92.1 million at June 30, 1995.
Total interest income. Total interest income was $6.7 million for the
six months ended December 31, 1995, an increase on an annualized basis of 22.1%,
from $11.0 million for the year ended June 30, 1995. This increase resulted from
both a growth in interest-earning assets as well as the related yields.
Interest-earning assets averaged $155.8 million for the six months ended
December 31, 1995, up from $141.5 million for the year ended June 30, 1995. This
increase was due to the increase in average loans receivable from $81.2 million
for the year ended June 30, 1995 to $100.8 million for the six months ended
December 31, 1995.
The yield on total interest-earning assets increased 85 basis points to
8.64% for the six months ended December 31, 1995 from 7.79% for the year ended
June 30, 1995. For the six months ended December 31, 1995, the yield on loans
receivable was 9.86% up from 9.26% for the year ended June 30, 1995. This
increase reflects the originations of nonresidential loans which typically carry
higher interest rates. The average yield on investment securities increased from
5.78% for the year ended June 30, 1995 to 6.49% for the six months ended
December 31, 1995.
<PAGE>
Total interest expense. Total interest expense for the six months ended
December 31, 1995 was $3.6 million, which represents on an annualized basis an
increase of 22.4%, from $5.9 million for the year ended June 30, 1995. This
increase was due to increases in both the average balance of interest-bearing
liabilities as well as the weighted effective rate paid thereon. For the six
months ended December 31, 1995 average interest-bearing liabilities were $144.0
million, up $14.7 million from $129.3 million for the year ended June 30, 1995.
The average effective rate paid on interest bearing liabilities was 5.04% for
the six months ended December 31, 1995, an increase of 45 basis points from
4.59% for the year ended June 30, 1995.
Provision for loan losses. The provision for loan losses amounted to
$150 thousand for the six months ended December 31, 1995, an increase over the
provision of $60 thousand for the twelve months ended June 30, 1995, reflecting
an increase in the Bank's volume of nonresidential mortgages and commercial
loans. The allowance for loan losses at December 31, 1995 was $1.2 million, or
1.13% of total loans receivable.
Other income. Other income totaled $514 thousand for the six months
ended December 31, 1995, an increase on an annualized basis of 26.3%, from $814
thousand for the year ended June 30, 1995. The increase was attributable in part
to the gain on sale of investment securities available-for-sale of $63 thousand
for the six months ended December 31, 1995. Fee income increased on an
annualized basis by 23.4% to $334 thousand for the six months ended December 31,
1995 from $541 thousand for the year ended June 30, 1995. Fee income consisting
primarily of transaction fees on NOW accounts, increased due to increased volume
in these types of deposit accounts. Gain on sale of loans decreased to $109
thousand for the six months ended December 31, 1995.
Other expenses. Other expenses for the six months ended December 31,
1995 were $2.3 million, an increase on an annualized basis of 24.7% from $3.7
million for the year ended June 30, 1995. Increases on an annualized basis
occurred in all categories of expenses. The most significant factor contributing
to the increases was the growth of the Bank. In the year ended June 30, 1995,
three new branches were opened. One branch was opened in August 1994 and two
branches in April 1995.
Employee compensation and benefits increased on an annualized basis
14.9% to $907 thousand for the six months ended December 31, 1995 from $1.6
million for the year ended June 30, 1995. The increase reflects the additional
personnel needed to staff three new branches and normal wage increases for
existing personnel.
Expenses for premises and equipment increased on an annualized basis
25.9% to $637 thousand for the six months ended December 31, 1995 from $1.0
million for the year ended June 30, 1995. The increase reflects the cost
associated with opening three new branches and supporting the Bank's growth.
Data processing costs are included and increased due to the increase in the
number and activity of customer deposit accounts.
Deposit insurance assessments increased on an annualized basis 25.6% to
$174 thousand for the six months ended December 31, 1995 from $277 thousand for
the year ended June 30, 1995. The deposit insurance assessment is based on the
dollar volume of deposit accounts and reflects the growth in the customer
deposit base.
<PAGE>
Other expenses increased 44.9% on an annualized basis to $557 thousand
for the six months ended December 31, 1995 from $768 thousand for the year ended
June 30, 1995. This increase was partly due to $26 thousand in repairs and
maintenance costs incurred on real estate owned and an adjustment of $30
thousand on real estate owned to fair value. The increase in other expenses was,
also, partly the result of costs of approximately $60 thousand relating to the
Bank's conversion to a Virginia commercial bank charter, the aforementioned cost
of opening new branches and growth in the customer deposit base.
Asset/Liability Management
Southern Financial, like most other banks and thrift institutions, is
engaged primarily in the business of investing funds obtained from deposits and
borrowings into interest-bearing loans and investments. Consequently, Southern
Financial's earnings depend to a significant extent on its net interest income,
which is the difference between (i) the interest income on loans and investments
and (ii) the interest expense on deposits and borrowing. Southern Financial, to
the extent that its interest-bearing liabilities do not reprice or mature at the
same time as its interest-bearing assets, is subject to interest rate risk and
corresponding fluctuations in its net interest income. Asset/liability
management policies have been employed in an effort to manage Southern
Financial's interest-earning assets and interest-bearing liabilities, thereby
controlling the volatility of net interest income, without having to incur
unacceptable levels of credit risk.
With respect to the Bank's residential mortgage loan portfolio, it is
Southern Financial's policy to keep in portfolio those mortgage loans which have
an adjustable interest rate and to sell most fixed rate mortgage loans
originated into the secondary market. In addition, the Bank's commercial loans
generally have rates that are tied to the prime rate, the one-year CMT rate, or
the three-year CMT rate. Both of these policies help control Southern
Financial's exposure to rising interest rates.
It is the current policy of the Bank that the core securities portfolio
will be invested in adjustable rate mortgage securities with a diversified mix
of repricing periods and indices. The core securities portfolio now consists of
FNMA, GNMA and FHLMC adjustable rate participation certificates and private
label collateral mortgage obligations. All of these securities adjust annually
or more frequently. From time to time, the Asset/Liability Management Committee
may elect to purchase and hold for sale fixed rate mortgage-backed securities as
well as federal agency preferred stock and federal agency bonds 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. In this connection, the Bank currently holds approximately $18.3 million in
15-year fixed rate mortgage-backed securities, $5.0 million in 30-year fixed
rate mortgage-backed securities, $642 thousand in 15-year FHLB Bonds, and $3.9
million in FHLMC preferred stock.
CHART
EFFICIENCY RATIO
12/31/94 62.78%
12/31/95 63.75%
12/31/96 63.26%
12/31/97 57.61%
*Adjusted to exclude SAIF special assessment.
**Restated to calendar years to conform with 1996 and 1997.
<PAGE>
Liquidity and Capital Resources
Southern Financial's principal sources of funds are deposits, loan
repayments, proceeds from the sale of loans, repayments from mortgage-backed
securities, repayments from federal agency bonds, FHLB advances, other
borrowings and retained income.
At December 31, 1997, Southern Financial had $16.4 million of
undisbursed loan funds and $5.4 million of approved loan commitments. The amount
of certificate of deposit accounts maturing in calendar year 1998 is $120.2
million. In addition, the $4.0 million of FHLB advances are scheduled to mature
in calendar year 1998. It is anticipated that funding requirements for these
commitments can be met from the normal sources of funds previously described.
Southern Financial is subject to regulations of the Federal Reserve
Board that impose certain minimum regulatory capital requirements. Under current
Federal Reserve Board regulations, these requirements are (a) leverage capital
of 4.0% of adjusted average total assets; (b) tier I capital of 4% of
risk-weighted assets; (c) tier I and II capital of 8% of risk-weighted assets.
At December 31, 1997, the Bank's capital ratios were 8.1% leverage capital;
13.9% tier I capital; and 15.3% tier I and II capital.
Impact of Inflation and Changing Prices
The financial statements and related notes presented herein have been
prepared in accordance with generally accepted accounting principles. These
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation.
Unlike many industrial companies, substantially all of the assets and
virtually all of the liabilities of Southern Financial are monetary in nature.
As a result, interest rates have a more significant impact on the Bank's
performance than the effects of general levels of inflation. Interest rates may
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services. However, other expenses do reflect general levels
of inflation.
[LOGO] Southern Financial Bancorp, Inc.
Financial Statements
December 31, 1997 and 1996
Together With Independent Auditors' Report
<PAGE>
Independent Auditors' Report
To the Board of Directors and Stockholders of
Southern Financial Bancorp, Inc.:
We have audited the accompanying consolidated balance sheet of Southern
Financial Bancorp, Inc. (Bancorp) as of December 31, 1997, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of Bancorp's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The accompanying consolidated financial
statements of the Bancorp as of December 31, 1996 and 1995, and June 30, 1995,
were audited by other auditors whose report thereon dated February 4, 1997,
expressed an unqualified opinion on those statements.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Southern Financial
Bancorp, Inc. as of December 31, 1997, and the results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Washington, D.C.
February 3, 1998
<PAGE>
Southern Financial Bancorp, Inc.
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Assets
December 31, December 31,
1997 1996
------------- --------------
<S> <C>
Cash and due from banks $ 4,559,266 $ 4,004,149
Overnight earning deposits 545,470 2,395,574
Investment securities, available-for-sale 4,692,758 5,099,619
Investment securities, held-to-maturity (estimated market value
of $80,795,929 and $64,974,077, respectively) 80,468,952 65,217,243
Loans held for sale 1,414,445 444,500
Loans receivable, net 128,958,190 108,286,903
Federal Home Loan Bank stock, at cost 930,500 867,600
Premises and equipment, net 2,398,541 1,487,446
Interest receivable 1,659,886 1,328,551
Real estate owned 176,168 340,023
Other assets 793,759 1,337,114
--------------- ---------------
Total assets $ 226,597,935 $ 190,808,722
=============== ===============
</TABLE>
<PAGE>
Southern Financial Bancorp, Inc.
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Liabilities and Stockholders' Equity
December 31, December 31,
1997 1996
<S> <C>
Liabilities:
Deposits $ 202,200,249 $ 164,279,105
Advances from Federal Home Loan Bank
4,000,000 8,500,000
Other liabilities
1,855,085 1,628,665
Total liabilities 208,055,334 174,407,770
Commitments
Stockholders' equity:
6% Cumulative convertible preferred stock, $.01 par value,
500,000 shares authorized, 15,634 shares issued and
outstanding 156 156
Common stock, $.01 par value, 5,000,000 shares
authorized, 1,621,553 and 1,591,679 shares issued and
outstanding, respectively 16,216 15,941
Capital in excess of par value 15,556,882 15,276,373
Retained earnings 3,406,501 1,655,575
Net unrealized gain (loss) on securities available-for-sale 33,933 (76,006)
Treasury stock, at cost (471,087) (471,087)
-------------- -------------
Total stockholders' equity 18,542,601 16,400,952
-------------- -------------
Total liabilities and stockholders' equity $ 226,597,935 $ 190,808,722
============== =============
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
Southern Financial Bancorp, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 1997 and 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
<TABLE>
<CAPTION>
Six Months
Year Ended Year Ended Ended Year Ended
December 31, December 31, December 31, June 30,
1997 1996 1995 1995
-------------------- ------------------ ------------------ -----------------
<S> <C>
Interest income:
Loans $ 11,567,846 $ 10,308,273 $ 4,967,233 $ 7,523,092
Investment securities 5,436,986 4,306,296 1,763,665 3,503,555
------------ ------------ ------------ ------------
Total interest income 17,004,832 14,614,569 6,730,898 11,026,647
------------ ------------ ------------ ------------
Interest expense:
Deposits 8,709,000 7,433,334 3,439,788 5,232,831
Borrowings 334,346 342,078 189,675 698,457
------------ ------------ ------------ ------------
Total interest expense 9,043,346 7,775,412 3,629,463 5,931,288
------------ ------------ ------------ ------------
Net interest income 7,961,486 6,839,157 3,101,435 5,095,359
Provision for loan losses 880,000 695,000 150,000 60,000
------------ ------------ ------------ ------------
Net interest income after provision for
loan losses 7,081,486 6,144,157 2,951,435 5,035,359
Other income:
Gain on sale of loans 191,773 209,962 108,846 267,728
Fee income 1,447,545 950,376 333,996 541,437
Gain on sale of mortgage-backed
securities, net - - 63,208 -
Other 89,161 25,924 8,297 5,319
------------ ------------ ------------ ------------
Total other income 1,728,479 1,186,262 514,347 814,484
------------ ------------ ------------ ------------
Other expense:
Employee compensation and benefits 2,531,851 2,147,974 907,371 1,579,581
Premises and equipment 1,840,169 1,591,235 637,105 1,012,374
Deposit insurance assessments 109,010 1,085,536 174,145 276,816
Advertising 213,763 142,633 40,814 79,167
Other 887,102 939,729 556,628 768,118
------------ ------------ ------------ ------------
Total other expense 5,581,895 5,907,107 2,316,063 3,716,056
------------ ------------ ------------ ------------
Income before income taxes 3,228,070 1,423,312 1,149,719 2,133,787
Provision for income taxes 1,021,800 469,600 414,400 833,070
------------ ------------ ------------ ------------
Net income $ 2,206,270 $ 953,712 $ 735,319 $ 1,300,717
============ ============ ============= ===============
Earnings per common share:
Basic* $ 1.39 $ 0.61 $ 0.48 $ 0.85
Diluted* $ 1.33 $ 0.59 $ 0.46 $ 0.85
Weighted average shares outstanding:
Basic* 1,577,243 1,544,338 1,508,601 1,505,016
Diluted* 1,657,706 1,621,958 1,608,231 1,530,255
</TABLE>
*Prior period numbers have been restated to conform with SFAS 128, "Earnings Per
Share."
The accompanying notes are an integral part of these financial statements.
<PAGE>
Southern Financial Bancorp, Inc.
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 1997 and 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
- ----------------------------------------------------------------------------------------------------------------------
Preferred Common Stock Capital in Retained
Stock Excess of Par Earnings
Value
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Balance, June 30, 1994 $ 174 $ 7,454,696 $ 3,364,588 $ 3,242,751
Dividends on preferred and common stock -- -- -- (258,477)
Conversion of preferred shares to common stock (8) 6,032 (6,024) --
Options exercised -- 8,000 4,080 --
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 -- -- -- --
Net income -- -- -- 1,300,717
- ----------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1995 166 10,953,192 1,682,965 2,480,206
Dividends on preferred and common stock -- -- -- (165,241)
Options exercised -- 58,811 114,958 --
Treasury stock -- -- -- --
Net unrealized loss on securities available-for-sale -- -- -- --
Change in par value to $0.01 per share -- (10,998,091) 10,998,091 --
Net income -- -- -- 735,319
- ----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 166 13,912 12,796,014 3,050,284
Dividends on preferred and common stock -- -- -- (360,971)
Conversion of preferred shares to common stock (10) 16 (6) --
Options exercised -- 594 494,778 --
Stock dividend of 10% -- 1,419 1,985,587 (1,987,006)
Treasury stock -- -- -- (444)
Net unrealized loss on securities available-for-sale -- -- -- --
Net income -- -- -- 953,712
- ----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 156 15,941 15,276,373 1,655,575
Dividends on preferred and common stock -- -- -- (455,344)
Options exercised -- 275 280,509 --
Net unrealized gain on securities available-for-sale -- -- -- --
Net income -- -- -- 2,206,270
- ----------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $ 156 $ 16,216 $ 15,556,882 $ 3,406,501
=======================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 1997 and 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
- ---------------------------------------------------------------------------------------------------------------------
Treasury Stock Net Unrealized Gain Total
(Loss) on Securities Stockholders'
Available-for-Sale Equity
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Balance, June 30, 1994 $ -- $ (43,601) $ 14,018,608
Dividends on preferred and common stock -- -- (258,477)
Conversion of preferred shares to common stock -- -- --
Options exercised -- -- 12,080
Four-for-three stock split effected in the form of
a dividend -- -- --
Stock dividend of 10% -- -- --
Net unrealized gain on securities available-for-sale -- 99,895 99,895
Net income -- -- 1,300,717
- ---------------------------------------------------------------------------------------------------------------------
Balance, June 30, 1995 -- 56,294 15,172,823
Dividends on preferred and common stock -- -- (165,241)
Options exercised -- -- 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 -- -- --
Net income -- -- 735,319
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 (99,990) 14,685 15,775,071
Dividends on preferred and common stock -- -- (360,971)
Conversion of preferred shares to common stock -- -- --
Options exercised -- -- 495,372
Stock dividend of 10% -- -- --
Treasury stock (371,097) -- (371,541)
Net unrealized loss on securities available-for-sale -- (90,691) (90,691)
Net income -- -- 953,712
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 (471,087) (76,006) 16,400,952
Dividends on preferred and common stock -- -- (455,344)
Options exercised -- -- 280,784
Net unrealized gain on securities available-for-sale -- 109,939 109,939
Net income -- -- 2,206,270
- ---------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 $ (471,087) $ 33,933 $ 18,542,601
=====================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
Southern Financial Bancorp, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1997 and 1996,
For the Six Months Ended December 31, 1995, and
For the Year Ended June 30, 1995
<TABLE>
<CAPTION>
Six Months
Year Ended Year Ended Ended Year Ended
December 31, December 31, December 31, June 30,
1997 1996 1995 1995
------------- ------------- -------------- ---------------
<S> <C>
Cash flows from operating activities:
Net income $ 2,206,270 $ 953,712 $ 735,319 $ 1,300,717
Adjustments to reconcile net income to
net cash provided by operating
activities-
Depreciation and amortization 566,989 251,249 141,577 451,660
Provision for loan losses 880,000 695,000 150,000 60,000
Provision for deferred income taxes 56,088 (13,849) 61,488 53,590
Gain on sale of loans (191,773) (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 (607,286) (431,247) (290,978) (652,294)
Net funding of loans held for sale (778,172) (64,538) 93,846 710,928
Increase in interest receivable (331,335) (161,529) (112,442) (381,240)
Decrease (increase) in other assets 484,071 (94,036) (562,596) (144,454)
Increase (decrease) in other
liabilities 226,420 430,522 (136,666) 321,439
------------- ------------- ------------- -------------
Net cash provided (used) by
operating activities 2,511,272 1,372,322 (62,506) 1,452,618
------------- ------------- ------------- -------------
Cash flows from investing activities:
Net funding of loans receivable (21,421,747) (4,299,175) (12,030,737) (24,917,467)
Purchases of investment securities (35,017,808) (32,427,276) (4,958,005) (10,653,607)
Paydowns of investment securities 20,020,684 11,844,529 4,439,860 6,373,360
Sale of investment securities
available-for-sale - - 4,848,694 -
Decrease (increase) in overnight
earning deposits, net 1,850,104 (599,672) 1,104,111 (404,563)
Increase in premises and equipment, net (911,095) (592,142) (41,942) (433,014)
Sale of real estate owned 340,023 - - -
(Increase) decrease in Federal Home
Loan Bank stock (62,900) 82,400 (82,400) (136,100)
------------- ------------- ------------- --------------
Net cash used in investing
activities (35,202,739) (25,991,336) (6,720,419) (30,171,391)
------------- ------------- ------------- --------------
Cash flows from financing activities:
Increase in deposits, net 37,921,144 20,465,419 6,134,062 37,117,664
Increase (decrease) in advances from
Federal Home Loan Bank (4,500,000) 4,500,000 1,000,000 (5,500,000)
Net proceeds from stock options
exercised 280,784 495,372 173,768 12,080
Repurchase of common stock - (371,541) (99,990) -
Dividends on preferred and common stock (455,344) (360,971) (165,240) (258,477)
------------ ------------- ------------- --------------
Net cash provided by
financing activities 33,246,584 24,728,279 7,042,600 31,371,267
----------- ------------ ------------- --------------
Net increase in cash and due from banks 555,117 109,265 259,675 2,652,494
Cash and due from banks, beginning of period 4,004,149 3,894,884 3,635,209 982,715
------------- ------------- -------------- --------------
Cash and due from banks, end of period $4,559,266 $ 4,004,149 $ 3,894,884 $ 3,635,209
============= ============= ================ ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
Southern Financial Bancorp, Inc.
Consolidated Notes to Financial Statements
December 31, 1997 and 1996
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 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 for the year ended June 30, 1995 represent 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 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. Certain reclassifications were made to the prior year financial
statements to conform to the current year presentation. The preparation of
financial statements in conformity with 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, 1997 and 1996, and for the years
ended December 31, 1997 and 1996, the six months ended December 31, 1995, and
the year ended June 30, 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 Bancorp. For
purposes of the consolidated statements of cash flows, the Bancorp defines cash
and due from banks as cash and cash equivalents.
Investment Securities
The Bancorp accounts for its investment securities in three categories:
held-to-maturity, available-for-sale, and trading. Investments in debt
securities are classified as held-to-maturity when the Bancorp has the positive
intent and ability to hold those securities to maturity. Held-to-maturity
securities are measured at amortized cost. The amortization of premiums and
accretion of discounts are computed using a method that approximates the level
yield method. Investment securities classified as available-for-sale are
reported at fair value, with unrealized gains and losses excluded from earnings
and reported in a separate component of stockholders' equity on an after-tax
basis. Trading securities are reported at fair value with unrealized gains and
losses included in earnings. The specific identification method is used to
determine gains or losses on sales of investment securities.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value.
Loans Receivable
Interest income is accrued on loans as earned on the outstanding principal
balances on the level yield method. Nonrefundable loan fees and direct
origination costs are deferred and recognized over the lives of the related
loans as adjustments of yield. Accrual of interest is discontinued when
management believes, after considering economic and business conditions and
collection efforts, that the borrower's financial condition is such that
collection of interest is doubtful. Any accrued interest considered
uncollectable is charged against current income.
The allowance for loan losses is established through a provision for loan
losses, which is charged to expense. Loans are charged against the allowance for
loan losses when management believes that the collectibility of the principal is
unlikely. The allowance is a current estimate of the losses inherent in the
present portfolio based upon management's evaluation of the loan portfolio.
Estimates of losses inherent in the portfolio involve the exercise of judgment
and the use of assumptions. The evaluations take into consideration such factors
as changes in the nature, volume and quality of the loan portfolio, prior loss
experience, level of nonperforming loans, current and anticipated general
economic conditions and the value and adequacy of collateral. Changes in the
estimate of future losses may occur due to changing economic conditions and the
economic conditions of borrowers.
<PAGE>
A loan is considered impaired when, based on all current information and
events, it is probable that the Bancorp will be unable to collect all amounts
due according to the contractual terms of the agreement, including all scheduled
principal and interest payments. Such impaired loans are measured based on the
present value of expected future cash flows, discounted at the loan's effective
interest rate or, as a practical expedient, impairment may be measured based on
the loan's observable market price, or if, the loan is collateral - dependent,
the fair value of the collateral. When the measure of the impaired loan is less
than the recorded investment in the loan, the impairment is recorded through a
valuation allowance. Loans for which foreclosure is probable continue to be
accounted for as loans.
Each impaired loan is evaluated individually to determine the income
recognition policy. Generally, payments received are applied in accordance with
the contractual terms of the note or as a reduction of principal.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Expenditures for maintenance and repairs that do not materially
prolong the useful lives of the assets are charged to expense as incurred.
Depreciation is computed using the straight-line method over estimated
useful lives of three to ten years for furniture and equipment and 30 years for
buildings. Amortization of leasehold improvements is computed using the
straight-line method over the shorter of ten years or the lease term.
Real Estate 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 as incurred.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted
income tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Earnings Per Share
In 1997 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 128, "Earnings per Share." SFAS No. 128
replaced the calculation of primary and fully-diluted earnings per share with
basic and diluted earnings per share. Basic earnings per common share is
computed by dividing net income, less dividends on preferred stock, by the
weighted average number of shares of common stock outstanding during the
periods. Diluted earnings per common share is computed by dividing net income by
the weighted average number of shares of common stock and common stock
equivalents outstanding during the periods. Common stock equivalents include the
number of shares issuable on exercise of outstanding options less the number of
shares that could have been purchased with the proceeds from the exercise of the
options based on the average price of common stock during the period plus the
number of shares issuable on conversion of the convertible preferred shares to
common shares, if dilutive.
Financial Instruments with Off-Balance Sheet Risk
The Bancorp is a party to financial instruments with off-balance sheet risk
in the normal course of business primarily to meet the financing needs of its
customers. These financial instruments involve, to varying degrees, elements of
credit risk that are not recognized in the balance sheet.
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.
New Accounting Standards
In June 1997 the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." This statement establishes standards for the
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. SFAS No. 130 requires that all items
that are required to be recognized as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. SFAS No. 130 is effective for fiscal years beginning
after December 15, 1997. Management does not believe the implementation of this
statement will have a material impact on the Bancorp.
In June 1997 the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services,
geographical areas, and major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997. Management does not
believe the implementation of this statement will have a material impact on the
Bancorp.
<PAGE>
2. Investment Securities:
The portfolio consists of the following securities:
<TABLE>
<CAPTION
- ----------------------------------------------------------------------------------------------------------
December 31, 1997
- ----------------------------------------------------------------------------------------------------------
Gross
Gross Unrealized Estimated Fair
Amortized Cost Unrealized Gains Losses Value
---------------- ----------------- ---------------- -----------------
<S> <C>
Available-for sale:
FHLMC preferred stock $ 3,865,985 $ 80,630 $ 39,054 $ 3,907,561
FNMA MBS 782,186 3,011 - 785,197
---------------- ----------------- ---------------- -----------------
$ 4,648,171 $ 83,641 $ 39,054 $ 4,692,758
---------------- ----------------- ---------------- -----------------
---------------------------------------------------------------------
December 31, 1996
---------------------------------------------------------------------
Gross
Gross Unrealized Estimated Fair
Amortized Cost Unrealized Gains Losses Value
Available-for sale:
FHLMC preferred stock $ 4,310,235 $ 11,355 $ 116,303 $ 4,205,287
FNMA MBS 902,824 - 8,492 894,332
---------------- ----------------- ---------------- -----------------
$ 5,213,059 $ 11,355 $ 124,795 $ 5,099,619
---------------- ----------------- ---------------- -----------------
---------------------------------------------------------------------
December 31, 1997
---------------------------------------------------------------------
Gross
Gross Unrealized Estimated Fair
Amortized Cost Unrealized Gains Losses Value
---------------- ----------------- ---------------- -----------------
Held-to-maturity:
GNMA MBS $ 42,471,075 $ 226,020 $ 39,186 $ 42,657,909
FNMA MBS 27,075,234 191,349 80,392 27,186,191
FHLMC MBS 6,077,859 69,247 37,836 6,109,270
Collateralized mortgage obligations 4,202,852 32,176 32,469 4,202,559
FHLB zero-coupon notes 641,932 - 1,932 640,000
---------------- ----------------- ---------------- -----------------
$ 80,468,952 $ 518,792 $ 191,815 $ 80,795,929
---------------------------------------------------------------------
December 31, 1996
---------------------------------------------------------------------
Gross
Gross Unrealized Estimated Fair
Amortized Cost Unrealized Gains Losses Value
---------------- ----------------- ---------------- -----------------
Held-to-maturity:
GNMA MBS $ 27,387,797 $ 95,893 $ 46,549 $ 27,437,141
FNMA MBS 21,981,743 42,607 183,797 21,840,553
FHLMC MBS 7,300,246 20,736 52,650 7,268,332
Collateralized mortgage obligations 6,547,457 8,215 129,496 6,426,176
FHLB intermediate notes 2,000,000 1,875 - 2,001,875
---------------- ----------------- ---------------- -----------------
$ 65,217,243 $ 169,326 412,492 $ 64,974,077
---------------------------------------------------------------------
</TABLE>
<PAGE>
Held-to-maturity securities are carried at cost adjusted for amortization
of premiums and accretion of discounts. Held-to-maturity securities totaling
$57,283,372 have adjustable rates of interest while the remaining
held-to-maturity securities totaling $23,185,580 have fixed interest rates.
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 investment securities during the years ended
December 31, 1997 and 1996. Gross gains of $63,208 were realized on the sale of
securities during the six months ended December 31, 1995.
As of December 31, 1997 and December 31, 1996, securities having a book
value of $71,324,504 and $49,743,572, 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 estimated fair value for securities,
along with the contractual dates of maturity, by category of security as of
December 31, 1997 follows:
December 31, 1997
------------------------------------
Estimated
Amortized Fair
Cost Value
--------------- ---------------
Available-for-sale securities:
FHLMC Preferred Stock $ 3,865,985 $ 3,907,561
Mortgage-backed securities-
Maturing after ten years 782,186 785,197
--------------- ---------------
$ 4,648,171 $ 4,692,758
Total available-for-sale securities =============== ===============
Held-to-maturity securities:
FHLB Zero Coupon Notes-
Maturing after ten years $ 641,932 $ 640,000
Mortgage-backed securities-
Maturing after ten years 79,827,020 80,155,929
--------------- ---------------
Total held-to-maturity securities $ 80,468,952 $ 80,795,929
=============== ===============
Contractual maturity of mortgage-backed securities is not a reliable
indicator of their expected life because borrowers have the right to repay their
obligations at any time.
<PAGE>
3. Loans Receivable:
Loans receivable consist of the following:
December 31,
------------------------------------
1997 1996
---------------- ----------------
Mortgage:
Residential $ 30,421,147 $ 35,032,684
Nonresidential 57,160,286 46,548,847
Construction:
Residential 6,534,271 5,616,121
Nonresidential 13,160,542 7,510,374
Nonmortgage:
Business 21,252,681 12,197,921
Consumer 3,092,938 3,294,171
-------------- --------------
Total loans receivable 131,621,865 110,200,118
Less-
Deferred loan fees, net (627,143) (412,274)
Allowance for loan losses (2,036,532) (1,500,941)
-------------- ----------------
Loans receivable, net $ 128,958,190 $ 108,286,903
============== ================
The following sets forth information regarding the allowance for loan
losses during the years ended:
December 31,
-----------------------------------
1997 1996
-------------- -------------
Balance, beginning of period $ 1,500,941 $ 1,190,249
Charge-offs, net (344,409) (384,308)
Provision charged to income 880,000 695,000
-------------- -------------
Balance, end of period $ 2,036,532 $ 1,500,941
============== =============
The Bancorp's loan portfolio is concentrated in the Northern Virginia area.
At December 31, 1997 and 1996, the average yield on loans receivable was 9.37
percent and 9.18 percent, respectively. The amount of loans being serviced for
others was $137,208 and $4,121,734 at December 31, 1997 and 1996, respectively.
At December 31, 1997, there was one loan with a balance of approximately $1,000
that had payments ninety days or more past due on which interest was still
accruing. At December 31, 1996, there were no loans that had payments ninety
days or more past due on which interest was still accruing.
Impaired loans were as follows:
December 31,
---------------------------------
1997 1996
-------------- --------------
Carrying value $ 1,444,861 $ 1,676,064
Allocation of general reserve 204,313 333,834
<PAGE>
The average carrying balances and interest income earned on impaired loans
were as follows:
<TABLE>
<CAPTION>
Year Ended Six Months Ended
December December 31,
1997 1996 1995
------------------------------------------------------------------
<S> <C>
Average carrying value $ 1,373,997 $ 1,322,450 $ 312,836
Income anticipated under
original loan agreements 165,400 220,461 27,675
Income recorded 5,000 44,700 7,790
==================================================================
</TABLE>
4. Premises and Equipment:
Premises and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
-------------- -------------
<S> <C>
Land $ 568,500 $ 125,647
Building and improvements 951,028 587,980
Furniture and equipment 1,748,500 1,335,548
Leasehold improvements 1,008,393 996,885
-------------- --------------
4,276,421 3,046,060
Less- Accumulated depreciation and amortization (1,877,880) (1,558,614)
-------------- --------------
Premises and equipment, net $ 2,398,541 $ 1,487,446
============== ==============
</TABLE>
Depreciation and amortization expense aggregated $327,340 and $251,249 for
the years ended December 31, 1997 and December 31, 1996, respectively.
5. Real Estate Owned:
The following activity occurred during the years ended:
December 31,
--------------------------
1997 1996
------------- ------------
Beginning balance $ 340,023 $ 357,023
Additions 176,168 -
Sales (335,023) -
Holding period write-down (5,000) (17,000)
------------ ------------
Ending balance $ 176,168 $ 340,023
============ ============
The balance at December 31, 1997 represents two properties located in
Virginia.
6. Deposits:
Deposits consist of the following:
<TABLE>
<CAPTION>
December 31,
1997 1996
--------------------------------------------------------------------
<S> <C>
Weighted Average Weighted Average
Interest Rate Amount Interest Rate Amount
---------------- ------------ ---------------- ------------
Demand accounts --% $ 13,001,697 --% $ 7,721,619
Interest checking accounts 1.16 16,570,989 0.97 15,702,406
Money market and savings accounts 3.46 23,443,684 3.23 21,502,863
Certificates of deposit 5.82 149,183,879 5.59 119,352,217
============ ============
4.79% $202,200,249 4.57% $164,279,105
============ ============
</TABLE>
As of December 31, 1997, certificates of deposit mature as follows:
1998 $120,202,436
1999 17,251,775
2000 5,825,994
2001 5,903,674
------------
$149,183,879
============
Deposits totaling approximately $33,541,040 and $24,135,017 had balances
greater than $100,000 at December 31, 1997 and 1996, respectively, of which
$17,962,855 and $13,861,572 represented certificates of deposit at December 31,
1997 and 1996, respectively.
The following sets forth information regarding interest expense by deposit
category for the years ended:
December 31.
----------------------------
1997 1996
------------ ------------
Interest checking accounts $ 185,000 $ 211,746
Money market and savings accounts 761,000 710,372
Certificates of deposit 7,763,000 6,511,216
------------ ------------
$ 8,709,000 $ 7,433,334
============ ============
Total cash paid for interest aggregated approximately $3,017,413 and
$2,628,853 for the years ended December 31, 1997 and December 31, 1996,
respectively.
7. Advances from Federal Home Loan Bank:
The Bancorp has a credit availability agreement with FHLB totaling
$35,000,000. This availability was increased from $25,000,000 on November 21,
1997. The agreement does not have a maturity date and advances are made at
FHLB's discretion. At December 31, 1997 and 1996, advances from FHLB totaled
$4,000,000 and $8,500,000, respectively. $2,000,000 of advances at December 31,
1997 carried a fixed rate of interest. All other advances are made at variable
interest rates. The weighted average rates of interest were 5.95 percent and
6.57 percent at December 31, 1997 and 1996, respectively. Advances outstanding
at December 31, 1997, mature on January 30, 1998 and October 15, 1998, and are
secured by investment securities having a book value of $68,655,295.
8. Stockholders' Equity:
Each share of the Bancorp's preferred stock is convertible to 1.6 shares
of common stock. The preferred stock has an aggregate liquidation preference of
$241,193. The preferred stock has an annual dividend rate of 6 percent.
Dividends are payable quarterly and are cumulative. Dividends paid on the
preferred stock totaled $13,602, $14,254, $7,236, and $14,636 for the years
ended December 31, 1997 and 1996, the six months ended December 31, 1995, and
the year ended June 30, 1995, respectively.
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 at the beginning of fiscal year
1995.
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 and an off-setting increase in capital in excess of par
value 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. During 1997, the 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 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:
<PAGE>
<TABLE>
<CAPTION>
Year Ended Six Months
December 31, Ended
-------------------------- -----------
1997 1996 1995
------------ ------------ -----------
<S> <C>
Net income:
As reported $ 2,206,270 $ 953,712 $ 735,319
Pro forma 2,045,266 603,344 522,390
----------- ---------- ----------
Basic earnings per share
As reported 1.39 0.61 0.48
Pro forma 1.30 0.39 0.35
Diluted earnings per share
As reported 1.33 0.59 0.46
Pro forma 1.23 0.37 0.32
----------- ---------- ----------
Weighted-average assumptions:
Expected lives (years) 10.00 10.00 10.00
Risk-free interest rate (%) 5.76% 6.06% 6.22%
Expected volatility (%) 23.39% 45.00% 45.00%
Expected dividends (annual per share) .13% - -
------------ ---------- ---------
</TABLE>
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 calculated using an acceptable option pricing model for
each grant made in 1997,1996 and 1995, using the key assumptions detailed above.
A summary of the status of the Bancorp's stock option plan as of December
31, 1997, 1996 and 1995, respectively, and changes during the years ended
December 31, 1997 and 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.
<TABLE>
<CAPTION>
1997 1996 1995
------------------------- ---------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------- -------- ------- ------ ------- ------
<S> <C>
Outstanding at beginning of period 177,327 $ 11.02 188,792 $ 9.94 171,871 $ 9.82
Granted 31,500 15.79 66,029 13.43 45,980 13.18
Exercised 27,431 10.24 65,373 8.18 24,219 7.92
Expired 7,082 11.74 12,121 13.04 4,840 12.08
Outstanding at December 31, 174,314 11.97 177,327 11.02 188,792 9.94
-------- -------- ------- ------ ------- ------
Options exercisable at December 31, 142,814 112,127 125,891
======== ======= =======
Weighted average fair value of
options granted during the period $ 7.74 5.92 $ 6.01
</TABLE>
<PAGE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
Remaining
Exercise Options Options Contractual Life
Price Outstanding Exercisable (months)
- -------------- ------------ ----------- -----------------
$ 7.49 7,260 7,260 30
8.83 29,039 29,039 78
8.99 4,840 4,840 6
9.30 6,453 6,453 18
9.61 16,133 16,133 64
11.98 29,846 29,846 91
12.73 9,902 9,902 103
13.64 39,341 39,341 97
13.75 3,000 -- 109
16.00 28,500 -- 115
---------------------------
174,314 142,814
======= =======
There were 11 option holders at December 31, 1997. Options exercised during
1997 had exercise prices ranging from $7.49 to $13.64. 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.
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. The Bancorp accounted for this purchase as treasury
stock.
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 Bancorp accounted for the purchase as treasury stock.
9. Regulatory Matters:
The Bancorp's primary supervisory agent is the Federal Reserve Bank. The
Federal Reserve Bank has mandated certain minimum capital standards for the
industry. In addition, the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") outlines various levels of capital adequacy for the industry.
Failure to meet minimum capital requirements can initiate certain mandatory
- - and possibly additional discretionary - actions by regulation that, if
undertaken, could have a direct material effect on 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
judgements by the regulators about components, risk weightings, and other
factors.
Quantitative 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).
As of December 31, 1997, 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.
<PAGE>
The Bancorp's actual capital amounts and ratios are also presented in the
tables below. (All dollar amounts are in thousands.)
<TABLE>
<CAPTION>
To be Well Capitalize
For Capital Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
---------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------ ------- ----- ------ -----
<S> <C>
As of December 31, 1997
Total Capital: $ 20,161 15.3% $ 10,543 8.0% $ 13,179 10.0%
(to risk-weighted assets)
Tier I Capital: $ 18,343 13.9% $ 5,271 4.0% $ 7,907 6.0%
( to risk-weighted assets)
Tier I Capital: $ 18,343 8.1% $ 9,067 4.0% $ 11,333 5.0%
(to average assets)
As of December 31, 1996
Total Capital: $ 17,554 16.6% $ 8,431 8.0% $ 10,539 10.0%
(to risk-weighted assets)
Tier I Capital: $ 16,234 15.4% $ 4,216 4.0% $ 6,323 6.0%
(to risk-weighted assets)
Tier I Capital: $ 16,234 8.7% $ 7,477 4.0% $ 9,346 5.0%
(to average assets)
</TABLE>
During 1996, the Bancorp paid an additional $830,270 one-time SAIF
assessment required by legislation to recapitalize the SAIF.
10. Parent Company Activity:
The Bancorp owns all of the outstanding shares of the Bank. Accordingly,
the statement of condition and statement of income for the Bancorp only, are as
follows:
Balance Sheet
December 31, 1997
Assets:
Investment in bank $ 18,446,401
Other assets 65,668
--------------
Total assets $ 18,512,069
==============
Liabilities:
Other liabilities $ 3,401
--------------
Stockholders' equity:
Preferred stock 156
Common stock 16,216
Capital in excess of par 15,556,882
Retained earnings 3,406,501
Treasury stock (471,087)
--------------
Total stockholders' equity 18,508,668
--------------
Total liabilities and stockholders'
equity $ 18,512,069
==============
Statement of Income
for the Year Ended December 31, 1997
Equity in earnings of Bank $ 2,206,270
==============
<PAGE>
11. Estimated Fair Value of Financial Instruments:
The assumptions used and the estimates disclosed represent management's
best judgment of appropriate valuation methods. These estimates are based on
pertinent information available to management as of December 31, 1997. In
certain cases, fair values are not subject to precise quantification or
verification and may change as economic and market factors, and management's
evaluation of those factors change.
Although management uses its best judgment in estimating the fair value of
these financial instruments, there are inherent limitations in any estimation
technique. Therefore, these fair value estimates are not necessarily indicative
of the amounts that the Bancorp would realize in a market transaction. Because
of the wide range of valuation techniques and the numerous estimates which must
be made, it may be difficult to make reasonable comparisons of the Bancorp's
fair value information to that of other financial institutions. It is important
that the many uncertainties discussed above be considered when using the
estimated fair value disclosures and to realize that because of these
uncertainties, the aggregate fair value amount should in no way be construed as
representative of the underlying value of the Bancorp. The estimated fair values
of the Bancorp's financial instruments at December 31, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
($ in thousands) December 31, 1997 December 31, 1996
--------------------------- ---------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
<S> <C> ------------- ------------ ------------ ------------
Financial assets:
Cash and amounts
due from banks $ 4,559 $ 4,559 $ 4,004 $ 4,004
Available-for-sale
securities 4,693 4,693 5,100 5,100
Held-to-maturity
securities 80,469 80,796 65,217 64,974
Loans receivable,
net of allowance 128,958 132,597 108,287 108,337
Loans held for sale 1,414 1,441 445 445
Financial liabilities:
Deposits-
Checking accounts 29,573 26,710 23,424 23,424
Money market and
savings accounts 23,444 22,859 21,503 21,503
Certificates of
deposit 149,184 149,563 119,352 119,442
</TABLE>
The following methods and assumptions were used to estimate the fair value
amounts at December 31, 1997 and 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.
Loans Receivable, Net of Allowance
Fair value of loans is estimated using discounted cash flow analyses based
on contractual repayment schedules. The discount rates used in these
analyses are based on either the interest rates paid on U.S. Treasury
securities of comparable maturities adjusted for credit risk and
non-interest operating costs or the interest rates currently offered by the
Bancorp for loans with similar terms to borrowers of similar credit
quality.
Loans Held for Sale
Fair value is based on selling prices arranged by arms-length contracts
with third parties.
Deposits
At December 31, 1997, fair value of deposit liabilities payable on demand,
consisting of NOW accounts, money market deposits, statement savings and
other deposit accounts is estimated using discounted cash flow analyses
based on an assumed decay of core balances over time. The indicated fair
value does not consider the value of the Bancorp's estimated deposit
customer relationships. At December 31, 1996, deposit liabilities payable
on demand, consisting of NOW accounts, money market deposits, statement
savings and other deposit accounts were assumed to have an estimated fair
value equal to carrying value. Fair value of fixed-rate certificates of
deposit is estimated based on discounted cash flow analyses using the
remaining maturity of the underlying accounts and interest rates currently
offered on certificates of deposit with similar original maturities.
<PAGE>
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.
12. 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 one half of each
employee's contributions on a discretionary basis based on Bancorp profit, such
match not to exceed 3 percent of the employee's earnings. The Bancorp's matching
contributions to the Savings Plan were $24,000 and $20,000 for the years ended
December 31, 1997 and 1996, respectively.
13. Provision for Income Taxes:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Year Ended Year Ended Six Months Ended Year Ended
December 31, December 31, December 31, June 30,
1997 1996 1995 1995
----------- ----------- ----------- ------------
<S> <C>
Current provision:
Federal $ 1,231,183 $ 483,449 $ 320,154 $ 760,309
State -- -- 32,758 90,771
----------- ----------- ----------- ------------
1,231,183 483,449 352,912 851,080
----------- ----------- ----------- ------------
Deferred (benefit)
provision:
Federal (209,383) (13,849) 58,072 (16,929)
State -- -- 3,416 (1,081)
----------- ----------- ----------- ------------
(209,383) (13,849) 61,488 (18,010)
----------- ----------- ----------- ------------
$ 1,021,800 $ 469,600 $ 414,400 $ 833,070
============ =========== =========== ============
</TABLE>
Deferred income taxes reflect temporary differences in the recognition of
revenue and expenses for tax reporting and financial statement purposes,
principally because certain items, such as the allowance for loan losses and
loan fees, are recognized in different periods for financial reporting and tax
return purposes. A valuation allowance has not been established for deferred tax
assets. Realization of the deferred tax asset is dependent on generating
sufficient taxable income. Although realization is not assured, management
believes it is more likely than not that all of the deferred tax asset will be
realized.
Deferred tax assets and liabilities were comprised of the following
significant components as of December 31, 1997 and 1996:
<PAGE>
<TABLE>
<CAPTION>
1997 1996
<S> <C> ----------- ------------
Assets:
Provision for losses on loans and real estate owned $ 602,857 $ 198,125
Deferred loan fees (186,538) 161,820
Depreciation 111,006 83,923
Other 4,947 --
----------- ------------
Gross deferred tax assets 532,272 443,868
----------- ------------
Liabilities:
FHLB dividend 35,771 35,771
Valuation of loans and securities (17,328) 39,074
Other -- 64,577
----------- ------------
Gross deferred tax liabilities 18,443 139,422
----------- ------------
Net deferred tax assets $513,829 $304,446
=========== ============
</TABLE>
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:
<TABLE>
<CAPTION>
Year Ended
Year Ended December December 31, Six Months Year Ended
31, 1997 1996 Ended December 31, 1995 June 30, 1995
<S> <C>
------------------------------------------------------------------------------------------------------------
Pretax income 34% 34% 34% 34%
State taxes -- -- 2% 5%
Dividends
received deduction (2%) (1%) -- --
--------------------- ----------------- ------------------------- ----------------
Effective tax rate 32% 33% 36% 39%
===================== ================= ========================= ================
</TABLE>
Cash paid for income taxes was $725,000 and $916,000 for the years ended
December 31, 1997 and 1996, respectively.
14. Commitments:
The Bank leases its corporate headquarters and branch facilities under
operating lease agreements expiring in fiscal years through 2002. As of December
31, 1997, future minimum lease payments required under these arrangements,
assuming no extension options are exercised, are as follows:
Years Ending Minimum Lease
December 31, Payments
----------- --------------
1998 $ 378,307
1999 284,553
2000 261,219
2001 189,646
2002 49,944
Thereafter --
Rent expense aggregated $558,704 and $504,647 for the years ended December
31, 1997 and 1996, respectively.
Outstanding loan commitments amounted to $5,393,550 and $9,119,150 at
December 31, 1997 and 1996, respectively. The Bank had commitments from
investors of $1,825,395 and $2,769,800 to purchase loans from the Bank at
December 31, 1997 and 1996, respectively.
At December 31, 1997, the Bank had commercial letters of credit outstanding
in the amount of $2,044,323.
At December 31, 1997, the Bank had unfunded lines of credit of $8,320,196
and undisbursed construction loan funds of $8,125,660.
<PAGE>
15. Quarterly Financial Information (Unaudited - in thousands, except per share
data):
<TABLE>
<CAPTION>
Quarter ended Quarter ended Quarter ended Quarter ended
Dec. 31, 1997 Sep. 30, 1997 Jun. 30, 1997 Mar. 31, 1997
-------------------------------------------------------------------------
<S> <C>
Net interest income $ 2,128 $ 2,081 $ 1,944 $ 1,809
Provision for loan losses 320 255 175 130
Total other income 462 463 401 402
Total other expense 1,429 1,452 1,355 1,346
Net income 579 568 556 503
Earnings per share:
Basic 0.36 0.36 0.35 0.32
Diluted 0.34 0.34 0.34 0.31
Weighted average shares
outstanding:
Basic 1,590,232 1,587,153 1,566,943 1,564,248
Diluted 1,691,107 1,669,150 1,631,054 1,627,704
</TABLE>
<TABLE>
<CAPTION>
Quarter ended Quarter ended Quarter ended Quarter ended
Dec. 31, 1996 Sep. 30, 1996 Jun. 30, 1996 Mar. 31, 1996
------------------ ----------------- ------------------ ------------------
<S> <C>
Net interest income $ 1,773 $ 1,729 $ 1,689 $ 1,648
Provision for loan losses 185 190 160 160
Total other income 360 287 284 255
Total other expense 1,302 2,161 1,284 1,160
Net income 434 (225) 354 391
Earnings per share:
Basic 0.27 (0.15) 0.23 0.25
Diluted 0.27 (0.14) 0.22 0.24
Weighted average shares
outstanding:
Basic 1,563,338 1,560,109 1,529,919 1,523,602
Diluted 1,626,973 1,621,517 1,621,330 1,626,106
</TABLE>
<PAGE>
CORPORATE PROFILE
Southern Financial Bancorp, Inc. and its sole subsidiary, Southern Financial
Bank, merged with Southern Financial Federal Savings Bank on December 1, 1995,
and continues the Savings Bank's ten years of operation from its main office in
Warrenton, Virginia. The Bank serves the Northern Virginia area through its ten
full-service branches located in Herndon (2), Middleburg, Warrenton (2),
Winchester (2), Leesburg, Fairfax, and Woodbridge.
The principal business of the state chartered capital stock commercial bank is
the taking of deposits from the general public through the Bank's home and
branch offices. These deposits and other borrowed funds are then used for the
financing of business loans and consumer loans, mortgage-backed securities, and
origination of adjustable rate and 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, DC suburbs. Southern Financial's income is derived primarily from
interest and fees earned in connection with its lending activities. Its
principal expenses are interest paid on savings deposits and other borrowed
funds and operating expenses.
Southern Financial has expanded its commercial lending program, and has become
one of the region's leading lenders in the Small Business Administration's 504
and 7(a) programs. The 504 and 7(a) programs offer borrowers access to 90%
financing of an entire project. These programs carry low credit risk and provide
small businesses with the opportunity to expand and create new jobs in the local
community.
At December 31, 1997, the consolidated balance sheet of Southern Financial
Bancorp, Inc. had total assets in excess of $18 million, and stockholders'
equity in excess of $ million. Southern Financial Bancorp, Inc. is a
publicly-held bank holding company which is traded on the NASDAQ National Market
System under the symbol SFFB. Southern Financial had 1,591,679 shares of common
stock outstanding as of December 31, 1997. There are four market makers for
Southern Financial Bancorp, Inc. including Ferris, Baker, Watts, Inc.; Friedman,
Billings, Ramsey & Co.; Herzog, Heine, Geduld, Inc.; Scott & Stringfellow; and
Ryan, Lee & Company, Inc.
<PAGE>
Bank Offices & Branches
Main Office
37 E. Main Street
Warrenton, Virginia 20186
(540) 349-3900
Tricia Dove, Manager
<TABLE>
<CAPTION>
Branches
<S> <C>
362 Elden Street 526 E. Market Street
Herndon, Virginia 20170 Leesburg, Virginia 20175
(703) 478-5300 (703) 777-7080
Michelle Buckles, Assistant Vice President Diane Holmes, Manager
101 W. Washington Street 4021 University Drive
Middleburg, Virginia 20117 Fairfax, Virginia 22030
(540) 687-3500 (703) 352-7479
Heather Lyne, Manager Guylaine Daguilh, Manager
35 W. Piccadilly Street 322 Lee Highway
Winchester, Virginia 22601 Warrenton, Virginia 20186
(504) 667-1100 (540) 341-3634
Terri Hirst, Manager Nancy Albert, Manager
2545 Centreville Road, Q-18 13542 Minnieville Road
Herndon, Virginia 20171 Woodbridge, Virginia 22912
(504) 713-1300 (703) 680-6100
Dawn Brown, Manager Susan B. Nelson, Manager
1095 Millwood Pike
Winchester, Virginia 22602
(540) 665-1690
Sharon Horne, Manager
</TABLE>
<PAGE>
Banking Services
Home Mortgage Loans
Competitive rates and terms can help make the purchase or refinance of your home
more affordable.
Construction Loans
Southern Financial specializes in home construction loans and lets you be your
own general contractor.
Small Business Administration Loans
With as little as 10%, a small business can afford to expand under SBA's
economic development programs. We specialize in the 504 and 7(a) programs.
Consumer Loans
Creditworthy customers may choose from a variety of terms with competitive
rates. Southern Financial offers both secured and unsecured consumer loans.
Statement Savings
A flexible savings plan that provides both interest and easy access to funds.
Totally Free Checking
A non-interest bearing checking account that has no monthly service charge, no
minimum balance requirement, and unlimited check writing.
Premier Checking
An interest bearing checking account, paying interest on daily collected funds
of $500 and greater, with unlimited check writing. A monthly service charge is
imposed if the balance falls below $500 during the statement period.
Management Checking
A non-interest bearing account with unlimited check writing. A monthly
service charge is imposed if the balance falls below $1000 during the
statement period. Cancelled checks are included in the statement.
Commercial Checking
A checking account for individual businesses featuring a low minimum balance
requirement, and tailored for your specific business needs.
Money Market Accounts
Flexibility, liquidity, and competitive interest rates are key features of our
money market accounts. No fixed terms or penalties for withdrawals (up to three
per month).
Individual Retirement Accounts
Southern Financial offers IRA, SEP, and Keogh accounts as investment options for
your retirement plans.
Certificates of Deposit
Competitive interest rates and a variety of terms to meet any investment need.
Southern Financial customers are also offered the following services:
Free Automated Teller Machine Use (Honor, Plus)
Direct Deposit
Safe Deposit Boxes
Travelers Cheques
Overdraft Protection
Visa Cards
Direct Teller
PC Banking
<PAGE>
Board of Directors
Georgia S. Derrico
Chairman of the Board & CEO
Southern Financial Bank
Neil J. Call John L. Marcellus, Jr.
Executive Vice President Retired President &
MacKenzie Partners Chairman of the Board
Oneida, Ltd.
David de Give R. Roderick Porter
Senior Vice President/Treasurer President
Southern Financial Bank FX Concepts
Virginia Jenkins Michael P. Rucker
Owner Executive
V. Jenkins Interiors Caterpillar, Inc.
Bank Officers
Georgia S. Derrico
Chairman of the Board & CEO
David de Give William H. Lagos
Senior Vice President/ Senior Vice President/
Treasurer Controller
Linda W. Sandridge Laura L. Vergot
Senior Vice President/ Senior Vice President/
Commercial Lending Branch Development
Virginia M. Carter Lynette D. Ridgley
Vice President/ Vice President/
Information Systems Corporate Affairs
<PAGE>
CORPORATE INFORMATION
CORPORATE OFFICE:
37 East Main Street
Warrenton, Virginia 20186
(540) 349-3900
FAX: (540) 349-3904
ANNUAL REPORT ON FORM 10-K:
The Bank's Annual Report on Form 10-K to the Securities and Exchange Commission
will be furnished without charge to stockholders upon written request to:
Lynette D. Ridgley
Investor Relations
37 E. Main Street
Warrenton, Virginia 20186
REGISTRAR & STOCK TRANSFER AGENT:
Inquiries regarding stock transfer, lost certificates, or changes in name and/or
address should be directed to the stock transfer agent and registrar:
Chase Mellon Shareholder Services
450 West 33rd Street
15th Floor
New York, New York 10001
(800) 526-0801
ANNUAL MEETING:
The annual meeting of stockholders of Southern Financial Bancorp, Inc. will
be held on April 23, 1998 at the Fauquier Springs Country Club, Springs Road,
Warrenton, Virginia commencing at two o'clock pm.
STOCK DATA:
NASDAQ Symbol SFFB
As of December 14, 1993, the Common Stock of Southern Financial Federal Savings
Bank commenced trading on the NASDAQ Small Cap Stock Market under the symbol
SFFB. On February 21, 1995, the Common Stock commenced trading on the NASDAQ
National Market under the symbol SFFB. On December 1, 1995, Southern Financial
Federal Savings Bank merged into Southern Financial Bank, a wholly owned
subsidiary of Southern Financial Bancorp, Inc. The Bancorp's Common Stock
continues to be traded under the NASDAQ National Market under the symbol SFFB.
As of December 1, 1997, there were approximately 274 stockholders of record, not
including the number of persons or entities whose stock is held in nominee or
"street" name through various brokerage firms or banks. The following table sets
forth the high and low stock prices for the periods indicated:
1997
HIGH LOW
1ST Quarter $15.25 $13.25
2nd Quarter 17.00 12.75
3rd Quarter 21.50 16.00
4th Quarter 23.00 19.25
<PAGE>
MARKET MAKERS
Ferris, Baker, Watts, Inc. Friedman, Billings, Ramsey & Co.
(202) 429-3545 (703) 312-9531
Scott & Stringfellow Herzog, Heine, Geduld, Inc.
(800) 552-7757 (800) 221-3600
Ryan, Lee & Company, Inc.
(703) 847-3100
<PAGE>
Exhibit 23 (a)
Consent of KPMG Peat Marwick LLP
The Board of Directors
Southern Financial Bancorp, Inc.
We consent to the incorporation by reference in Registration Statement
Nos. 33-80285 and 33-80287 on Form S-8, and 333-00916 on Form S-3 of
Southern Financial Bancorp, Inc. of our report dated February 3, 1998,
relating to the consolidated balance sheet of Southern Financial
Bancorp as of December 31, 1997, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows
for the year then ended, which report appears in the December 31, 1997
annual report on Form 10-K of Southern Financial Bancorp, Inc.
KPMG Peat Marwick LLP
Washington, D.C.
March 30, 1998
Exhibit 23 (b)
Consent of Arthur Andersen LLP
The Board of Directors
Southern Financial Bancorp, Inc.
As independent public accountants, we hereby consent to the use of our
report dated February 4, 1997, included in Southern Financial Bancorp,
Inc.'s Form 10-K for the year ended December 31, 1997, and to all
references to our Firm included in this Form 10-K. It should be noted
that we have not audited any financial statements of Southern Financial
Bancorp, Inc. subsequent to December 31, 1996, or performed any audit
procedures subsequent to the date of our report.
Arthur Andersen LLP
Washington, D. C.
March 30, 1998
<PAGE>
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.
Arthur Andersen LLP
Washington, D. C.
February 4, 1997
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