MERGER PROPOSED - YOUR VOTE IS VERY IMPORTANT
[START OF TWO-COLUMN PRESENTATION]
The Boards of Directors of Southern Financial Bancorp, Inc. and The
Horizon Bank of Virginia have agreed to merge the two companies. After the
merger, Southern Financial will have total assets of almost $400 million and
will span the area from Fredericksburg to Winchester, Virginia, and have seven
branch offices in Fairfax County, Virginia.
If shareholders of both companies approve the merger, Horizon will
merge into Southern Financial Bank, a bank owned by Southern Financial and
Horizon shareholders will receive 0.63 shares of Southern Financial common stock
for each share of Horizon common stock they own. Southern Financial shareholders
will continue to hold their existing shares of Southern Financial common stock
after the merger. We estimate that upon completion of the merger, approximately
39% of the outstanding Southern Financial common stock will be owned by current
Horizon shareholders and approximately 61% will be owned by persons who are
Southern Financial shareholders just before the merger is completed.
We cannot complete the merger unless shareholders of Horizon approve
the merger agreement and shareholders of Southern Financial approve the issuance
of shares to holders of Horizon common stock.
We have each scheduled meetings for our shareholders to vote on these
matters. In Southern Financial's case, the meeting will be a special meeting of
shareholders at which shareholders will vote to approve issuing Southern
Financial common stock to Horizon's shareholders and to elect three of Horizon's
directors to Southern Financial's board of directors. In Horizon's case, the
meeting will be a special meeting at which shareholders will only be asked to
consider the proposed merger. Whether or not you plan to attend your shareholder
meeting, please take the time to vote by completing and mailing the enclosed
proxy card to us. If you sign, date and mail your proxy card without indicating
how you want to vote, your proxy will be counted as a vote in favor of the
transaction. In the case of Horizon shareholders, if you do not return your
card, the effect will be a vote against the merger. If your shares are held in
"street name," you must instruct your broker in order to vote.
The dates, times and places of the meetings are as follows:
For Southern Financial shareholders:
September 9, 1999, 2:00 p.m.
Fauquier Springs Country Club
Springs Road
Warrenton, Virginia 20186
For Horizon shareholders:
September 9, 1999, 10:00 a.m.
Westwood Country Club
800 Maple Avenue, East
Vienna, Virginia 22180
The document accompanying this letter contains additional information
regarding the merger agreement, the proposed merger and the two companies. We
encourage you to read this entire document carefully.
We strongly support this merger of Southern Financial and Horizon and
appreciate your prompt attention to this very important matter.
/s/ Georgia S. Derrico
Georgia S. Derrico
Chairman and Chief Executive Officer
Southern Financial Bancorp, Inc.
/s/ Richard L. Hall
Richard L. Hall
President and Chief Executive Officer
The Horizon Bank of Virginia
[END OF TWO-COLUMN PRESENTATION]
- --------------------------------------------------------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this document. Any representation to the contrary is a
criminal offense. The securities offered hereby are not savings accounts,
deposits or other obligations of a bank or savings association and are not
insured by the Federal Deposit Insurance Corporation or any other government
agency.
- --------------------------------------------------------------------------------
The date of this joint proxy statement/prospectus is July 28, 1999, and it is
first being mailed to shareholders on or about July 28, 1999.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
37 E. MAIN STREET
WARRENTON, VA 20186
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON SEPTEMBER 9, 1999
A Special Meeting of Shareholders of Southern Financial Bancorp, Inc.
("Southern Financial") will be held on September 9, 1999, at 2:00 p.m., at
Fauquier Springs Country Club, Springs Road, Warrenton, Virginia 20186, for the
following purposes:
(1) To approve the issuance of Southern Financial common stock in
connection with the Agreement and Plan of Reorganization dated
May 3, 1999, as amended, by and between The Horizon Bank of
Virginia ("Horizon") and Southern Financial and Southern
Financial Bank (the "Bank"), a wholly owned subsidiary of
Southern Financial, which agreement provides for Horizon to be
merged with and into the Bank;
(2) To elect three of Horizon's directors to serve on Southern
Financial's board of directors; and
(3) To transact such other business as may properly come before
the special meeting or any adjournment or postponement of the
meeting.
THE SOUTHERN FINANCIAL BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT
SOUTHERN FINANCIAL SHAREHOLDERS VOTE FOR THE PROPOSAL TO APPROVE THE ISSUANCE OF
SHARES OF COMMON STOCK TO SHAREHOLDERS OF HORIZON IN THE MERGER. PLEASE READ THE
ACCOMPANYING JOINT PROXY STATEMENT/PROSPECTUS FOR A DETAILED DESCRIPTION OF THE
PROPOSAL.
Only holders of record of Southern Financial common stock as of the
close of business on July 22, 1999, are entitled to notice of and to vote at the
special meeting and any adjournments or postponements of the meeting.
We direct your attention to the documents submitted with this Notice.
By Order of the Board of Directors
/s/ Mary Henward
Mary Henward
Corporate Secretary
Warrenton, Virginia
July 28, 1999
WHETHER OR NOT YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON, WE
URGE YOU TO DATE, SIGN AND RETURN PROMPTLY THE ENCLOSED PROXY IN THE
ACCOMPANYING ENVELOPE. YOU MAY REVOKE YOUR PROXY AT ANY TIME PRIOR TO ITS
EXERCISE IN THE MANNER PROVIDED IN THE ACCOMPANYING DOCUMENT.
<PAGE>
THE HORIZON BANK OF VIRGINIA
140 PARK STREET, SE
VIENNA, VA 22180
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON SEPTEMBER 9, 1999
A special meeting of shareholders of The Horizon Bank of Virginia
("Horizon") will be held at 10:00 a.m. on September 9, 1999 at the Westwood
Country Club, 800 Maple Avenue, East, Vienna, Virginia 22180, to consider the
following matters:
(1) The proposal to approve the Agreement and Plan of
Reorganization dated May 3, 1999, as amended, by and between
Horizon and Southern Financial Bancorp, Inc. ("Southern
Financial") and Southern Financial Bank (the "Bank"), a wholly
owned subsidiary of Southern Financial, which agreement
provides for Horizon to be merged with and into the Bank; and
(2) Any other business properly brought before the special meeting
or any adjournment or postponement thereof.
YOUR BOARD OF DIRECTORS RECOMMENDS A VOTE IN FAVOR OF THE APPROVAL OF
THE MERGER AGREEMENT.
Only Horizon shareholders of record at the close of business on July
22, 1999 are entitled to notice of, and to vote at, this special meeting and any
adjournments or postponements thereof.
Your attention is directed to the Joint Proxy Statement/Prospectus
delivered with this Notice.
By Order of the Board of Directors
/s/ Harry E. Jagoda
Harry E. Jagoda
Corporate Secretary
Vienna, Virginia
July 28, 1999
REGARDLESS OF WHETHER YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON,
YOU ARE URGED TO VOTE PROMPTLY BY DATING, SIGNING AND RETURNING THE ENCLOSED
PROXY IN THE ACCOMPANYING ENVELOPE. YOU MAY REVOKE YOUR PROXY AT ANY TIME PRIOR
TO ITS EXERCISE IN THE MANNER PROVIDED IN THE ACCOMPANYING JOINT PROXY
STATEMENT/PROSPECTUS.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
CHAPTER I
<S><C>
QUESTIONS AND ANSWERS ABOUT THE MERGER.................................................................. 1
WHO CAN HELP ANSWER YOUR QUESTIONS...................................................................... 3
SUMMARY................................................................................................. 4
The Companies...................................................................................... 4
Issuance of Shares................................................................................. 4
Reasons for the Merger............................................................................. 4
The Meetings....................................................................................... 5
Record Date; Voting Power.......................................................................... 5
Opinion of Horizon's Financial Advisor............................................................. 5
No Right to Appraisal.............................................................................. 6
Southern Financial to Use Pooling-of-Interest Accounting Treatment................................. 6
Comparative Per Share Market Price Information..................................................... 6
Fee for Termination................................................................................ 6
Share Ownership of Management...................................................................... 6
Benefits to Management in the Merger............................................................... 6
Conditions that Must Be Satisfied for the Merger to Occur.......................................... 7
Termination of the Merger Agreement................................................................ 7
Selected Historical Financial Data................................................................. 8
Selected Pro Forma Financial Data.................................................................. 9
Comparative Per Share Data......................................................................... 10
THE MERGER.............................................................................................. 11
Background of the Merger........................................................................... 11
Horizon's Reasons for the Merger................................................................... 13
Southern Financial's Reasons for the Merger and Recommendation of the Southern Financial Board.....
Financial Board.................................................................................... 14
Accounting Treatment............................................................................... 15
Material Federal Income Tax Consequences of the Merger............................................. 15
Absence of Appraisal Rights........................................................................ 16
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION..................................................... 17
OPINION OF THE HORIZON FINANCIAL ADVISOR................................................................ 25
General............................................................................................ 25
Comparable Acquisition Analysis.................................................................... 26
Market Comparable Analysis......................................................................... 27
Dilution Analysis - Pro Forma...................................................................... 28
Present Value Analysis............................................................................. 28
OPINION OF SOUTHERN FINANCIAL'S ADVISOR................................................................. 30
INTERESTS OF CERTAIN PERSONS IN THE MERGER.............................................................. 35
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS........................................................... 36
TERMS OF THE MERGER AGREEMENT........................................................................... 36
Representations and Warranties; Conditions to the Merger........................................... 36
Regulatory Approvals............................................................................... 37
Business Pending the Merger........................................................................ 37
No Solicitation; Board Action...................................................................... 38
Effective Date..................................................................................... 38
Surrender of Stock Certificates.................................................................... 39
<PAGE>
Waiver, Amendment and Termination.................................................................. 39
Resales of Southern Financial Common Stock......................................................... 40
Expenses of the Merger and Termination Fee......................................................... 40
MARKET PRICES AND DIVIDENDS............................................................................. 40
Market Prices...................................................................................... 40
Dividends.......................................................................................... 41
CHAPTER II
INFORMATION ABOUT THE MEETINGS AND VOTING
General........................................................................................... 43
Southern Financial Meeting........................................................................ 43
Horizon Meeting................................................................................... 45
CHAPTER III
DESCRIPTION OF SOUTHERN FINANCIAL
BUSINESS............................................................................................... 47
General........................................................................................... 47
Lending Activities................................................................................ 48
Investment Activities............................................................................. 57
Source of Funds................................................................................... 57
Competition....................................................................................... 59
Employees......................................................................................... 59
The Year 2000..................................................................................... 59
Offices and Other Material Properties............................................................. 61
Legal Proceedings................................................................................. 62
MANAGEMENT'S DISCUSSION AND ANALYSIS................................................................... 62
Overview.......................................................................................... 62
Results of Operations............................................................................. 63
Asset/Liability Management........................................................................ 71
Liquidity and Capital Resources................................................................... 73
Impact of Inflation and Changing Prices........................................................... 73
Special Note Regarding Forward-Looking Information................................................ 74
CHAPTER IV
DESCRIPTION OF HORIZON
BUSINESS................................................................................................ 75
General............................................................................................ 75
Lending Activities................................................................................. 76
Investment Activities.............................................................................. 84
Source of Funds.................................................................................... 84
Competition........................................................................................ 85
Employees.......................................................................................... 85
The Year 2000...................................................................................... 85
Offices and Other Material Properties.............................................................. 87
Legal Proceedings.................................................................................. 87
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS.................................................................... 88
Overview.......................................................................................... 88
Results of Operations............................................................................. 89
Asset/Liability Management........................................................................ 96
Liquidity and Capital Resources................................................................... 97
Impact of Inflation and Changing Prices........................................................... 98
Special Note Regarding Forward-Looking Information................................................ 98
CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors................................................................................. 99
Board Committees....................................................................................... 100
Executive Officers Who Are Not Directors............................................................... 101
Security Ownership of Management....................................................................... 102
Security Ownership of Certain Beneficial Owners........................................................ 104
Director Compensation.................................................................................. 105
Executive Officer Compensation......................................................................... 106
Option Grants in Last Fiscal Year...................................................................... 107
Option Exercises in Last Fiscal Year................................................................... 108
Employment Agreements.................................................................................. 108
Certain Relationships and Related Transactions......................................................... 109
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF SOUTHERN FINANCIAL CAPITAL STOCK........................................................ 110
COMPARATIVE RIGHTS OF SHAREHOLDERS..................................................................... 111
General........................................................................................... 111
Authorized Capital................................................................................ 111
Amendment of Articles of Incorporation or Bylaws.................................................. 112
Mergers, Consolidations and Sales of Assets....................................................... 113
Size and Classification of Board of Directors..................................................... 114
Vacancies and Removal of Directors................................................................ 115
Director Liability and Indemnification............................................................ 115
Special Meetings of Shareholders.................................................................. 117
Shareholder Nominations and Proposals............................................................. 117
Shareholder Voting Rights in General.............................................................. 118
State Anti-Takeover Statutes...................................................................... 118
REGULATION............................................................................................. 120
General........................................................................................... 120
FDIC Regulations.................................................................................. 120
Regulatory Capital Requirement.................................................................... 121
Deposit Insurance................................................................................. 122
Federal Home Loan Bank System..................................................................... 122
Federal Reserve System............................................................................ 122
RESALES OF SOUTHERN FINANCIAL COMMON STOCK............................................................. 123
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS.............................................. 123
<PAGE>
EXPERTS................................................................................................ 123
LEGAL OPINIONS......................................................................................... 124
WHERE YOU CAN FIND MORE INFORMATION.................................................................... 124
</TABLE>
APPENDICES
General
A Agreement and Plan of Reorganization between The Horizon Bank of Virginia
and Southern Financial Bancorp, Inc. and Southern Financial Bank, dated as
of May 3, 1999, as amended
Southern Financial Bancorp, Inc.
B Southern Financial Bancorp, Inc. Financial Statements (including the
audited December 31, 1998 financial statements and the unaudited March 31,
1999 financial statements)
C Opinion of Tucker Anthony Cleary Gull
The Horizon Bank of Virginia
D The Horizon Bank of Virginia Financial Statements (including the audited
December 31, 1998 financial statements and the unaudited March 31, 1999
financial statements)
E Opinion of McKinnon & Company, Inc.
<PAGE>
CHAPTER I
QUESTIONS AND ANSWERS ABOUT THE MERGER
[START OF TWO-COLUMN PRESENTATION]
Q: Why is Horizon merging with Southern Financial?
A: Both the Horizon board of directors and the Southern Financial board of
directors believe the merger is in the best interests of their respective
companies and will provide significant benefits to their respective
shareholders, customers and employees. The boards believe the merger will create
a company with enhanced financial performance which will be better positioned to
be a strong competitor in the rapidly changing and consolidating financial
services industry in Virginia. To review the background and reasons for the
merger in greater detail, see pages 11 through 15.
Q: What will I receive in the merger?
A: HORIZON SHAREHOLDERS:
Horizon shareholders will receive 0.63 shares of Southern Financial common stock
in exchange for each share of Horizon common stock they hold. This is the
"exchange ratio." Southern Financial will not issue fractional shares in the
merger. Instead, Horizon shareholders will receive a cash payment, without
interest, for the value of any fraction of a share of Southern Financial common
stock that they would otherwise be entitled to receive based upon the market
value (as determined in the merger agreement) of a share of Southern Financial
common stock at the time of the merger.
SOUTHERN FINANCIAL SHAREHOLDERS:
Each share of Southern Financial common stock held by Southern Financial
shareholders will continue to represent one share of Southern Financial common
stock following the merger. After the merger, Horizon's former shareholders will
own approximately 39% of Southern Financial's outstanding shares of common stock
and current Southern Financial shareholders will own approximately 61% of
Southern Financial's outstanding shares of common stock.
FOR EXAMPLE:
o IF YOU OWN 100 SHARES OF HORIZON COMMON STOCK, AFTER THE
MERGER YOU WILL RECEIVE 63 SHARES OF SOUTHERN FINANCIAL COMMON STOCK.
o IF YOU OWN 25 SHARES OF HORIZON COMMON STOCK, AFTER THE MERGER
YOU WILL RECEIVE 15 SHARES OF SOUTHERN FINANCIAL COMMON STOCK AND A CHECK FOR
0.75 TIMES THE MARKET VALUE OF ONE SHARE OF SOUTHERN FINANCIAL COMMON STOCK.
o IF YOU OWN 100 SHARES OF SOUTHERN FINANCIAL COMMON STOCK,
AFTER THE MERGER THOSE SHARES WILL CONTINUE TO REPRESENT 100 SHARES OF SOUTHERN
FINANCIAL COMMON STOCK.
Q: What will my dividends be after the merger?
A: In the second quarter of 1999, Southern Financial increased its
quarterly dividend to $0.115 per share. The board intends to continue dividends
at or above this rate. However, Southern Financial cannot assure that these
payments will continue in the future. The Southern Financial board will use its
discretion to decide whether and when to declare dividends and in what amount,
and it will consider all relevant factors in doing so.
Q: What happens as the market price of Southern Financial common stock
fluctuates?
A: The exchange ratio is fixed at 0.63 shares of Southern Financial common
stock for each share of Horizon common stock. Since the market value of Southern
Financial common stock will fluctuate before and after the closing of the
merger, the value of the Southern Financial common stock that Horizon
shareholders will receive in the merger
1
<PAGE>
will fluctuate as well and could increase or decrease. Horizon shareholders
should obtain current market prices for shares of Southern Financial common
stock and shares of Horizon common stock.
Q: When is the merger expected to be completed?
A: We are working to complete the merger during the third quarter of 1999.
Q: What are the tax consequences of the merger to me?
A: HORIZON SHAREHOLDERS:
We expect that the exchange of shares by Horizon shareholders generally will be
tax-free to Horizon shareholders for U.S. federal income tax purposes. Horizon
shareholders will, however, have to pay taxes on cash received for fractional
shares. To review the tax consequences to Horizon shareholders in greater
detail, see page 15. Your tax consequences may depend on your personal
situation. You should consult your tax advisor for a full understanding of the
tax consequences of the merger to you.
SOUTHERN FINANCIAL SHAREHOLDERS:
The merger will have no tax consequences to Southern Financial shareholders.
Q: What am I being asked to vote upon?
A: HORIZON SHAREHOLDERS:
You are being asked to approve the merger agreement which provides for the
merger of Horizon into Southern Financial Bank, a bank owned by Southern
Financial and the issuance of 0.63 shares of Southern Financial common stock for
each outstanding share of Horizon common stock. Approval of the proposal
requires the affirmative vote of a majority of the outstanding shares of Horizon
common stock.
The Horizon board has unanimously approved and adopted the merger agreement. The
Horizon board recommends voting for the approval of the merger agreement.
SOUTHERN FINANCIAL SHAREHOLDERS:
You are being asked to approve the issuance of Southern Financial common stock
to Horizon shareholders in connection with the merger. Approval of the proposal
requires the affirmative vote of a majority of the shares voted, and the shares
voted must represent over 50% of the shares entitled to vote.
You are also being asked to elect three of Horizon's directors to Southern
Financial's board of directors. Those individuals receiving the greatest number
of votes will be elected even if they do not receive a majority. These
individuals will become directors of Southern Financial only if the merger is
completed.
The Southern Financial board has unanimously approved and adopted the merger
agreement and the stock issuance and recommends voting for the approval of the
stock issuance and for the election of the three directors.
Q: What should I do now?
A: Just indicate on your proxy card how you want to vote, and sign and
mail it in the enclosed envelope as soon as possible, so that your shares will
be represented at your meeting.
If you sign and send in your proxy and do not indicate how you want to vote,
your proxy will be voted in the case of the Horizon shareholders in favor of the
proposal to approve and adopt the merger agreement, and, in the case of Southern
Financial shareholders, in favor of the issuance of Southern Financial common
stock in the merger and the election of three of Horizon's directors to Southern
Financial's board of directors.
If you are a Horizon shareholder and you do not sign and send in your proxy or
you abstain, it will have the effect of a vote against the merger, as approval
requires the affirmative vote of a majority of the shares outstanding. If you
are a Southern Financial shareholder and you do not sign and send in your proxy
or you abstain, your shares will not be counted as having voted at the Southern
Financial meeting.
2
<PAGE>
You may attend your shareholders' meeting and vote your shares in person, rather
than voting by proxy. In addition, you may withdraw your proxy up to and
including the day of your shareholders' meeting by following the directions on
pages 43 through 46 and either change your vote or attend your shareholders'
meeting and vote in person.
Q: If my shares are held in "street name" by my broker, will my broker
vote my shares for me?
A: Your broker will vote your shares of Horizon common stock or Southern
Financial common stock only if you provide instructions on how to vote. You
should instruct your broker how to vote your shares, following the directions
your broker provides. If you do not provide instructions to your broker, your
shares will not be voted. If you are a Horizon shareholder and do not provide
instructions to your broker, your shares will not be voted and this will have
the effect of voting against the merger.
Q: Should I send in my stock certificates now?
A: No. If you are a Horizon shareholder, after the merger is completed we
will send you written instructions for exchanging your Horizon common stock
certificates for Southern Financial common stock certificates. If you are a
Southern Financial shareholder, the merger will not require you to take any
action regarding your Southern Financial common stock certificates.
[END OF TWO-COLUMN PRESENTATION]
WHO CAN HELP ANSWER YOUR QUESTIONS
If you want additional copies of this document, or if you want to ask
any questions about the merger, you should contact:
SOUTHERN FINANCIAL SHAREHOLDERS:
Georgia S. Derrico, Chairman
37 E. Main Street
Warrenton, VA 20186
(540) 349-3900
HORIZON SHAREHOLDERS:
Richard L. Hall, President and Chief Executive Officer
The Horizon Bank of Virginia
140 Park Street, SE
Vienna, VA 22180
(703) 255-6000
3
<PAGE>
SUMMARY
This summary highlights selected information from this document and may
not contain all the information that is important to you. For a more complete
understanding of the merger and for a more complete description of the legal
terms of the merger, you should read this entire document carefully, as well as
the additional documents to which we refer you, including the merger agreement.
See "Where you can find more information" (page 124).
[START OF TWO-COLUMN PRESENTATION]
The Companies
Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, Virginia 20186
(540) 349-3900
Southern Financial is a Virginia bank holding company that began
operations in 1995. Southern Financial owns one bank, Southern Financial Bank,
headquartered in Warrenton, Virginia, which opened in 1986 and now operates 13
banking offices in northern Virginia. Southern Financial Bank is a member of the
Federal Reserve System and its deposits are insured by the Federal Deposit
Insurance Corporation. On March 31, 1999, Southern Financial had total assets of
$270 million, total deposits of $243 million, total loans of $137 million and
shareholders' equity of $22 million.
Southern Financial stock is listed and traded on The Nasdaq National
Market under the symbol "SFFB."
The Horizon Bank of Virginia
140 Park Street, SE
Vienna, Virginia 22180
(703) 255-6000
Horizon is a Virginia commercial bank chartered in 1989. It is a member
of the Federal Reserve System, and its deposits are insured by the Federal
Deposit Insurance Corporation. Horizon's headquarters are in Vienna, Virginia.
Horizon operates four branch offices, opened between 1990 and 1998, extending
operations into the neighboring communities of Oakton, McLean, Tyson's Corner,
Fairfax City, Annadale and Falls Church, Virginia. On March 31, 1999, Horizon
had total assets of $129 million, total deposits of $119 million, total loans of
$72 million, and shareholders' equity of $10 million.
Issuance of Shares
The exchange ratio is 0.63 shares of Southern Financial common stock
for each share of Horizon common stock. Accordingly, the 1,659,894 shares of
Horizon common stock will be converted into approximately 1,045,734 shares of
Southern Financial common stock. Fractional shares of Southern Financial common
stock will not be issued, and Horizon shareholders will receive cash payment,
without interest, for the value of any fraction of a share of Southern Financial
common stock that they would otherwise be entitled to receive based upon the
market value of a share of Southern Financial common stock at the time of the
merger.
Reasons for the Merger
The Southern Financial board of directors and the Horizon board of
directors each carefully considered the merger decision and unanimously approved
and adopted the merger agreement. Each board had several reasons for approving
the merger. A few of the reasons are set forth below. For a complete discussion,
see pages 13 through 15.
SOUTHERN FINANCIAL:
o The merger with Horizon will expand Southern Financial's presence in
Fairfax County, a growing region of Virginia, and afford new expansion
opportunities into adjacent areas such as Falls Church.
o The merger will allow Southern Financial to spread certain administrative
and operational costs over a larger base and to realize a limited amount of
direct cost savings.
o The compatibility of Horizon and Southern Financial, including community
bank
4
<PAGE>
operating philosophies and similarity of products and customer orientation.
HORIZON:
o The terms of the merger agreement, including the exchange ratio and the
provisions that will put three Horizon directors on the Southern Financial
board and permit the remainder of Horizon's directors, should they so
desire, to serve on Horizon's advisory board, which will remain in
existence as an advisory board to Southern Financial.
o Southern Financial common stock is more liquid since it is traded on The
Nasdaq National Market while Horizon common stock has been traded only
internally by matching prospective buyers and sellers.
o The fact that Southern Financial has consistently paid cash dividends to
its shareholders in the past.
o The compatibility of Horizon's and Southern Financial's community bank
operating philosophies and the similarity of products and customer
orientation.
o An association with Southern Financial will result in Horizon's
participation in a banking organization with 17 offices in Virginia and the
Board's conclusion that the resulting geographic diversification and
economies of scale would enable Horizon to compete more effectively in the
financial services industry of the future.
o The representation of McKinnon & Company, Inc. to the board that the
exchange ratio is fair from a financial point of view to the Horizon
shareholders.
o The expectation that the merger will be tax-free for federal income tax
purposes to Horizon and its shareholders, except for cash paid instead of
fractional shares.
The Meetings (pages 43 and 45)
SOUTHERN FINANCIAL. The Southern Financial meeting will be held at
Fauquier Springs Country Club, Springs Road, Warrenton, Virginia, at 2:00 p.m.,
local time, on September 9, 1999.
HORIZON. The Horizon meeting will be held at the Westwood Country
Club, 800 Maple Avenue, East, Vienna, Virginia, at 10:00 a.m., local time, on
September 9, 1999.
Record Date; Voting Power (pages 43 and 45)
SOUTHERN FINANCIAL. You are entitled to vote at the Southern Financial
meeting if you owned shares on July 22, 1999, the Southern Financial record
date. On that date, there were 1,633,094 issued and outstanding shares of
Southern Financial common stock held by approximately 253 holders of record.
Southern Financial shareholders are entitled to one vote per share on any matter
that may properly come before the Southern Financial meeting.
HORIZON. You are entitled to vote at the Horizon meeting if you owned
shares on July 22, 1999, the Horizon record date. On that date, there were
1,659,894 issued and outstanding shares of Horizon common stock held by
approximately 487 holders of record. Horizon shareholders are entitled to one
vote per share on any matter that may properly come before the Horizon meeting.
Opinion of Horizon's Financial Advisor (page 25)
At the April 29, 1999, meeting of the Horizon board, McKinnon &
Company, financial advisor to the Horizon board, gave its opinion to the Horizon
board that as of that date, the exchange ratio was fair to the Horizon
shareholders from a financial point of view. McKinnon & Company subsequently
confirmed its April 29, 1999 opinion by delivery to the Horizon board of a
written opinion dated as of the date of this document. A copy of the fairness
opinion, setting forth the information reviewed, assumptions made and matters
considered, is attached to this document as Appendix E. Horizon shareholders
should read the fairness opinion of McKinnon & Company in its entirety.
5
<PAGE>
No Right to Appraisal (page 16)
Under Virginia law, you have no right to an appraisal of the fair value
of your shares in connection with the merger.
Southern Financial to Use Pooling-of-Interest Accounting Treatment (page 15)
We expect that the merger will be accounted for as a pooling of
interests. This will avoid the creation of goodwill relating to the merger and
enable Southern Financial to avoid charges against future earnings resulting
from amortizing goodwill. This accounting method also means that after the
merger Southern Financial will report financial results as if Horizon had always
been combined with Southern Financial.
Comparative Per Share Market Price Information
Horizon common stock is traded in private transactions through a
matching of prospective buyers and sellers. To Horizon management's knowledge,
the last sales of Horizon common stock took place in the fourth quarter of 1998
at an average price of $11.96 per share.
Southern Financial common stock is traded on The Nasdaq National Market
under the symbol "SFFB." Southern Financial common stock is thinly traded. On
March 17, 1999, the last full trading day before Horizon and Southern Financial
issued a joint press release announcing the merger, Southern Financial common
stock closed at $20.75. On July 19, 1999, Southern Financial common stock closed
at $20.63.
Fee for Termination (page 40)
Horizon would be required to pay Southern Financial $1.0 million if the
merger agreement is terminated and before the date of termination Horizon
receives a merger or acquisition proposal or initiates merger or acquisition
discussions with a third party and within 12 months after the date of
termination the Horizon board determines that a merger or acquisition by the
third party is in the best interests of Horizon and its shareholders. No fee is
payable in that situation, however, if Southern Financial wrongfully terminates
the merger agreement. Similarly, no fee is payable if, at the time the merger
agreement terminates, Horizon is entitled to terminate on the basis of a breach
by Southern Financial or there has been a failure to satisfy certain closing
conditions (other than approval by Horizon's shareholders).
This provision is intended to discourage another party from interfering
with the merger agreement between Southern Financial and Horizon.
Share Ownership of Management (page 102)
On the Southern Financial record date, the executive officers and
directors of Southern Financial, including their affiliates, had voting power
with respect to an aggregate of 203,644 shares of Southern Financial common
stock, or approximately 12.5% of the shares of Southern Financial common stock
then outstanding.
On the Horizon record date, the executive officers and directors of
Horizon, including their affiliates, had voting power with respect to an
aggregate of 218,818 shares of Horizon common stock, or approximately 13.2% of
the shares of Horizon common stock then outstanding.
We currently expect that the directors and executive officers of
Southern Financial and Horizon will vote their shares of Southern Financial
common stock and Horizon common stock, respectively, FOR the merger-related
proposals.
Benefits to Management in the Merger (page 35)
When considering the recommendation of the Horizon board, you should be
aware that some Horizon directors and officers have interests in the merger that
differ from the interests of other Horizon shareholders. Three directors of
Horizon, Richard L. Hall, John C. Belotti and Robert P. Warhurst, will become
directors of Southern Financial. Messrs. Belotti and Warhurst will receive an
annual fee of $4,000 for service on the Southern Financial board, $500 for
attendance at
6
<PAGE>
each board meeting and $150 for attendance at each board committee meeting. Mr.
Hall will not receive any compensation other than what he will receive as an
executive officer of Southern Financial following the merger.
The current members of Horizon's advisory board will constitute an
advisory board for Southern Financial's eastern region following the merger. Any
directors of Horizon (other than Messrs. Hall, Belotti and Warhurst) who want to
serve also will be on the eastern region advisory board. Advisory board members
will receive fees of $100 per meeting.
In connection with the merger, Southern Financial will employ Richard
L. Hall, President and Chief Executive Officer of Horizon, as Executive Vice
President with responsibility for operations in the eastern region, which will
be comprised of Horizon's four branches and Southern Financial's branch in the
City of Fairfax. On the effective date of the merger, Mr. Hall's current
employment arrangement with Horizon will be terminated, and Mr. Hall will
receive a lump sum payment in the amount of $413,114 in satisfaction of all of
Horizon's obligations under that arrangement.
The Horizon board was aware of these and other interests and considered
them before approving and adopting the merger agreement.
Conditions that Must Be Satisfied for the Merger to Occur (page 36)
The following conditions must be met for us to complete the merger:
o approval by Southern Financial shareholders of the issuance of shares of
Southern Financial common stock in connection with the merger and the
election of three of Horizon's directors to Southern Financial's board of
directors;
o approval by Horizon shareholders of the merger agreement;
o the continuing effectiveness of Southern Financial's registration statement
filed with the Securities and Exchange Commission;
o receipt by Southern Financial of a letter from its accountants stating that
the merger qualifies for pooling-of-interests accounting treatment; and
o receipt of an opinion of Southern Financial's counsel that the merger will
be treated for U.S. federal income tax purposes as a reorganization within
the meaning of Section 368 of the Internal Revenue Code of 1986, as
amended.
We cannot complete the merger unless we obtain the approval of the
Board of Governors of the Federal Reserve System and the Virginia State
Corporation Commission. Southern Financial intends to file applications with the
Federal Reserve Board and the Virginia State Corporation Commission as soon as
possible. While we cannot predict whether or when we will obtain all required
regulatory approvals, we see no reason why the approvals will not be obtained in
a timely manner.
Unless prohibited by law, either Horizon or Southern Financial could
elect to waive a condition that has not been satisfied and complete the merger
anyway.
Termination of the Merger Agreement (page 39)
We can agree to terminate the merger agreement at any time without
completing the merger. Either company may also terminate the merger agreement
if:
o the merger is not completed on or before February 29, 2000; or
o any event occurs which renders impossible, in a material way, the
satisfaction by one company of one or more of the conditions described
above, unless the other company waives such satisfaction.
In addition, there are other situations in which one or both parties may
terminate the merger.
[END OF TWO-COLUMN PRESENTATION]
7
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
We are providing the following information to help you analyze the
financial aspects of the merger. We derived this information from audited
financial statements for 1996 through 1998 and unaudited financial statements
for the three months ended March 31, 1999. This information is only a summary,
and you should read it in conjunction with the information about Southern
Financial that begins on page 47, Southern Financial's historical financial
statements in Appendix B, the information about Horizon that begins on page 75,
and Horizon's historical financial statements in Appendix D. You should not rely
on the three-month information as being indicative of results expected for the
entire year.
SOUTHERN FINANCIAL - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
1999 1998 1998 1997 1996
---------------------------------- -----------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $ 2,374 $ 2,078 $ 8,526 $ 7,962 $ 6,839
Net income 698 630 2,659 2,206 954
Diluted net income per share 0.41 0.37 1.55 1.33 0.59
Cash dividends per share 0.11 0.08 0.37 0.28 0.24
Book value per share 13.31 11.77 12.87 11.47 10.32
Total assets 269,744 233,220 258,843 226,598 190,809
Shareholders' equity 21,635 19,038 20,923 18,543 16,401
</TABLE>
HORIZON - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
1999 1998 1998 1997 1996
---------------------------------- -----------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $ 1,158 $ 1,237 $ 5,111 $ 4,948 $ 4,114
Net income 189 188 694 602 406
Diluted net income per share 0.11 0.12 0.42 0.38 0.26
Cash dividends per share - - - - -
Book value per share 6.01 5.60 5.92 5.75 5.36
Total assets 129,313 116,657 145,411 127,418 119,360
Shareholders' equity 9,877 9,163 9,703 8,965 8,349
</TABLE>
8
<PAGE>
SELECTED PRO FORMA FINANCIAL DATA
The following table sets forth certain unaudited pro forma combined
financial data for Southern Financial giving effect to the merger accounted for
as a pooling of interests. This information should be read in conjunction with
the historical financial statements of Southern Financial and Horizon, including
respective notes thereto, appearing elsewhere in this joint proxy
statement/prospectus. See "Pro Forma Financial Information" on page 17. The pro
forma financial data may not be indicative of the results that actually would
have occurred had the merger been consummated on the dates indicated or that may
be obtained in the future.
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
1999 1998 1998 1997 1996
--------------------------------- -------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $ 3,532 $ 3,315 $ 13,637 $ 12,910 $ 10,953
Net income 887 818 3,353 2,808 1,360
Diluted net income per share 0.32 0.30 1.22 1.06 0.52
Cash dividends per share 0.11 0.08 0.37 0.28 0.24
Book value per share 11.84 10.65 11.52 10.59 9.62
Total assets 399,057 349,877 404,254 354,016 310,169
Shareholders' equity 31,512 28,201 30,626 27,508 24,750
</TABLE>
9
<PAGE>
COMPARATIVE PER SHARE DATA
The following unaudited financial information reflects certain
comparative per share data relating to (i) net income, cash dividends, and book
value per common share for both Southern Financial and Horizon on a historical
basis, (ii) net income and book value per common share on a pro forma basis for
Southern Financial assuming the Horizon merger had been effected for the periods
presented, and (iii) net income and book value per common share on a pro forma
equivalent basis per common share for Horizon assuming the Horizon merger has
been effected for the periods indicated and accounted for as a pooling of
interests. See "The Merger - Accounting Treatment" on page 15. The pro forma
data reflects the conversion of each share of Horizon common stock into 0.63
shares of Southern Financial common stock. The information shown below should be
read in conjunction with the historical financial statements of Southern
Financial and Horizon, including the respective notes thereto, and in
conjunction with the unaudited pro forma financial statements, including the
notes thereto, appearing elsewhere in this joint proxy statement/prospectus. See
"Pro Forma Financial Information" on page 17.
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
1999 1998 1998 1997 1996
------------------------------ ------------------------------------------
<S> <C> <C> <C> <C> <C>
Per Common Share:
Net Income Basic
Southern Financial - Historical 0.43 0.39 1.66 1.39 0.61
Horizon - Historical 0.12 0.12 0.43 0.39 0.26
Pro Forma Combined 0.34 0.32 1.28 1.10 0.53
Horizon Pro Forma Equivalent 0.18 0.19 0.68 0.61 0.42
Net Income Diluted
Southern Financial - Historical 0.41 0.37 1.55 1.33 0.59
Horizon - Historical 0.11 0.12 0.42 0.38 0.26
Pro Forma Combined 0.32 0.30 1.22 1.06 0.52
Horizon Pro Forma Equivalent 0.18 0.19 0.67 0.61 0.41
Cash Dividends Declared:
Southern Financial - Historical 0.11 0.08 0.37 0.28 0.24
Horizon - Historical - - - - -
Pro Forma Combined 0.11 0.08 0.37 0.28 0.24
Horizon Pro Forma Equivalent 0.07 0.05 0.23 0.18 0.15
Book Value:
Southern Financial - Historical 13.31 11.77 12.87 11.47 10.32
Horizon - Historical 6.01 5.60 5.92 5.75 5.36
Pro Forma Combined 11.84 10.65 11.52 10.59 9.62
Horizon Pro Forma Equivalent 9.54 8.89 9.39 9.13 8.51
</TABLE>
10
<PAGE>
THE MERGER
Background of the Merger
In fall of 1998, the board of directors of Horizon determined that in
order for it to best serve its shareholders, customers and employees, it should
engage in a strategic planning process. To that end, on September 30, 1998, the
board appointed four of its members, John C. Belotti, Richard L. Hall, W. Bruce
Jennings, and Michael A. Miranda to a special committee (with Mr. Belotti to
serve as chairman) and authorized the special committee to seek a suitable
investment advisor to aid Horizon in long-term objectives. Subsequently, the
committee selected McKinnon & Company, Inc. ("McKinnon & Company"), an
experienced Virginia investment banking company with which the board was
familiar, to serve as a financial advisor to the board and the special
committee. Since early 1995, McKinnon & Company had met periodically with the
former chief executive officer of Horizon on strategic matters and beginning in
1997 had met with Mr. Hall to discuss the possibility of Horizon raising
additional capital through a public stock offering.
On October 15, 1998, William J. McKinnon, Jr., President of McKinnon &
Company, met with the special committee to discuss alternatives available to
Horizon. Mr. McKinnon advised the committee that based upon Horizon's capital
needs, its historical financial performance and the projected financial
performance for Horizon in 1998, raising additional capital through a
supplemental stock offering would be difficult to accomplish at a price
approaching prices resulting from recent transactions in Horizon stock. Mr.
McKinnon advised that Horizon has experienced lower returns on assets and equity
over the four years ending December 31, 1998 than the average community bank in
Virginia and, at September 30, 1998, had a higher level of non-performing assets
to total assets and a lower level of reserve for loan losses as a percentage of
non-performing assets than the average Virginia community bank. Mr. McKinnon
also indicated that Horizon's growth in loan volume was also less than that of
the average community bank in 1998. Accordingly, Mr. McKinnon advised the
committee that it estimated the true trading range for Horizon's stock to be
between $5-1/2 to $6-1/2 per share based upon comparable public trading levels
of Virginia community banks, particularly those in Horizon's market, including
some which had recently conducted public offerings of stock.
After discussing other options, including recent mergers and comparable
community banks, Mr. McKinnon advised the committee that the possibility of a
merger with another financial institution would be more likely to enhance
shareholder value than seeking to expand the operations of Horizon through a
public stock issue or the further alternative of continuing in the present mode
of operations. Mr. McKinnon advised the committee that the price at which
Horizon stock had been trading in the recent past was at a level approaching the
estimated "change of control" or merger value of Horizon and, as explained
above, was in excess of a reasonable going concern value of the stock.
On November 18, 1998, Mr. McKinnon met with the board and the members
of the committee. Based upon the advice from Mr. McKinnon that it would be
unlikely for Horizon to be in a position to seek additional capital to provide
support for its existing operations and operations in the future, the board
asked McKinnon & Company to submit a proposal to serve as Horizon's financial
advisor in a possible merger with another entity. McKinnon & Company submitted a
proposed contract to serve as Horizon's financial advisor dated November 19,
1998 and on December 3, 1998 Mr. Hall accepted the contract on behalf of the
board of directors.
During November and December, 1998 McKinnon & Company prepared a
package of information on Horizon and, subsequent to December 3, 1998 and
additional conversations with Mr. Hall and the board and the committee,
contacted approximately fourteen financial institutions which
11
<PAGE>
McKinnon & Company thought might have an interest in merging with or acquiring
Horizon. The financial institutions contacted ranged from those with
approximately $200 million in assets to institutions with over $20 billion in
assets. In mid-December, 1998 the committee and Mr. McKinnon met over a period
of three days with the three financial institutions which expressed the most
interest in Horizon. In late December 1998 and January 1999, Mr. Hall met with
each of the institutions expressing the most interest in Horizon, and Mr.
McKinnon and the committee met again with these three institutions to discuss
philosophy, culture, structure and strategic fit as well as operating results
and anticipated outlook for financial results.
In February 1999 each of these three institutions was asked to and did
subsequently submit written expressions of interest in acquiring or merging with
Horizon. Southern Financial submitted an indication of interest in a tax free
stock exchange of 0.6 shares of Southern Financial for each share of Horizon.
The written expression of interest submitted by Southern Financial was
substantially better than the proposals made by the other two interested
parties. Southern Financial offered a higher price for Horizon's shares, more
places on its board of directors for representatives from the board of Horizon
and more assurances about the future operations of the bank after a merger.
After a discussion with the committee regarding the three letters of
interest, the committee authorized Mr. McKinnon to go back to Southern Financial
and ask for an exchange ratio of 0.63 shares. On March 8, 1999, Southern
Financial submitted an increased offer of 0.63 shares and on March 10, 1999 Mr.
McKinnon met with the committee and board of directors of Horizon to consider
the offer. The board of directors voted on March 10, 1999 to enter into the
letter of intent with Southern Financial. On March 16 and March 17
representatives from Southern Financial's and Horizon's management teams and
financial advisors met to do due diligence regarding the possible merger of
Southern Financial and Horizon. On March 18, 1999 the letter of intent was
signed by Horizon and Southern Financial and a public press release was made
regarding the proposed merger.
In late March and early April additional due diligence meetings were
held at Southern Financial and Horizon, a definitive agreement was negotiated
which included added protections concerning the benefit plans for Horizon's
employees after the merger, assurances concerning the continued membership and
operation of Horizon's advisory board after the merger, and an employment
agreement for Mr. Hall. On April 14, 1999, following about four weeks of due
diligence by the respective companies and the respective financial advisors, a
board of directors meeting was held by Horizon to review the definitive
agreement, employment contract and due diligence reports. Horizon's legal,
accounting and financial advisors were present and each reported to the board.
McKinnon & Company reviewed the entire process and issued a verbal fairness
opinion that the proposed merger with Southern Financial was fair to and in the
best interest of Horizon and its shareholders from a financial point of view. At
the conclusion of that meeting, the board of directors authorized the committee
to continue to negotiate with Southern Financial to resolve remaining issues
identified in its review of the merger agreement and to report back to the
board.
On April 29, 1999, following an advisory board meeting at Horizon held
that same day, the full board of directors of Horizon met again to consider the
merger agreement with Southern Financial. After receiving a report from its
legal advisor on the status of the remaining issues under the merger agreement,
and in reliance upon the presentation that had been made by McKinnon & Company
in the earlier advisory board meeting concerning the fairness of the proposed
transaction to Horizon and its shareholders from a financial point of view, the
board voted unanimously to approve the merger agreement provided that any
remaining issues under Mr. Hall's proposed employment agreement with Southern
Financial after the merger had been resolved and Horizon could receive a final
fairness opinion from McKinnon & Company at the time of closing as a condition
of closing. These two matters were
12
<PAGE>
subsequently resolved, and on May 3, 1999 the merger agreement was executed by
Horizon and Southern Financial.
In June 1999 Southern Financial concluded that it would be advisable to
modify the employment arrangement with Mr. Hall that was reflected in the May 3,
1999 merger agreement. The merger agreement contemplated that Mr. Hall would
enter into an employment contract with Southern Financial Bank on the date the
merger is completed. Under that employment contract, Mr. Hall would have been
entitled to a substantial severance benefit if his employment by Southern
Financial Bank terminated for any reason other than death or disability within a
year after the completion of the merger. Southern Financial concluded that the
employment agreement would have created a substantial financial incentive for
Mr. Hall to resign as an officer of Southern Financial Bank within one year. It
is not Southern Financial's desire that Mr. Hall have any financial incentive to
resign after the merger is completed. Based on those concerns, Southern
Financial proposed that Mr. Hall receive a lump sum cash payment at the time the
merger is completed in satisfaction of Horizon's obligations to him under his
current employment contract with Horizon. Following discussions with Horizon
directors and Mr. Hall, the merger agreement was amended on June 30, 1999. The
amendment deletes any employment contract between Mr. Hall and Southern
Financial Bank and provides that Mr. Hall will receive a cash payment of
$413,114, which will be paid and expensed at the time the merger is completed.
That amount is slightly less than the amount provided under his present contract
with Horizon, the reduction being made to avoid adverse federal income tax
consequences to Mr. Hall and Southern Financial.
Horizon's Reasons for the Merger
In deciding to enter into the merger agreement with Southern Financial,
the Horizon board of directors considered a number of factors. The board did not
assign any relative or specific weights to the factors considered. The principal
factors that led to the Horizon board of directors to approve the merger with
Southern Financial were:
o The terms of the merger agreement, including the exchange ratio
pursuant to which shares of Horizon stock will be exchanged for shares
of Southern Financial stock and the provisions that will place three
Horizon directors on the Southern Financial board and permit the
remainder of the Horizon directors, should they so desire, to serve on
Horizon's advisory board, which board will remain in existence as an
advisory board to Southern Financial.
o The fact that Southern Financial common stock is more liquid since it
is traded on The Nasdaq National Market while Horizon common stock has
been traded only through a procedure that matched prospective buyers
and sellers.
o The compatibility of Horizon's and Southern Financial's community bank
operating philosophies and the similarity of products and customer
orientation of the two institutions.
o The association with Southern Financial will result in Horizon's
participation in a banking organization with 17 offices in Virginia and
the resulting geographic diversification and economies of scales which
will enable Horizon to compete more effectively in the delivery of
financial services in the future.
o Information received from McKinnon & Company concerning the financial
condition, results of operations and prospects of Southern Financial
and Horizon, the ability of the combined entity to compete in the
relevant banking markets, the market price of Southern Financial stock
and certain non-financial factors concerning employees of Horizon.
13
<PAGE>
o The fact that Southern Financial has consistently paid cash dividends
to its shareholders in the past while the shareholders of Horizon have
only received stock dividends on their investment.
o The representation of McKinnon & Company to the Horizon board that the
exchange ratio pursuant to which the shares of Horizon stock will be
exchanged for shares of Southern Financial is fair from a financial
point of view to the Horizon shareholders.
o The expectation that the merger will be tax-free for federal income tax
purposes to Horizon and its shareholders, except for cash paid instead
of fractional shares.
Other material factors considered were the well-capitalized position
and earnings of Southern Financial; the compatibility of the management of the
two organizations and the fact that each institution would contribute
complimentary business strengths resulting in a well-diversified and
well-managed institution; the additional resources that will enable Horizon to
increase the number of financial services to consumers and businesses; and the
larger capital base resulting from the combined institution and its resulting
larger lending limits that will permit Horizon to better serve its customer
base.
Based upon the above, the Horizon board of directors concluded that a
merger with Southern Financial would be in the best interest of Horizon and its
shareholders and would further its goal of enhancing shareholder value.
The Horizon board believes that the merger is in the best interest of
Horizon and the Horizon shareholders. The Horizon board recommends that Horizon
shareholders vote TO APPROVE the merger.
Southern Financial's Reasons for the Merger and Recommendation of the Southern
Financial Board
Southern Financial believes that external growth through acquisitions
of other community banks can enhance Southern Financial's existing branch
network and allow Southern Financial to extend its community banking philosophy
to other communities. Horizon operates in Fairfax County, one of Virginia's most
rapidly growing counties. The acquisition of Horizon expands Southern
Financial's market penetration in Fairfax County extensively. Fairfax County has
experienced a high level of bank consolidation in recent years. Southern
Financial believes that this consolidation provides an opportunity for it to
capture market share from regional and super-regional banks who are less focused
on the needs of the community and less flexible in responding to those customer
needs. Southern Financial believes its community banking philosophy combined
with Horizon's market presence in Fairfax County will benefit shareholders of
both Southern Financial and Horizon as well as customers and potential customers
in Fairfax County. The growth afforded Southern Financial through the
acquisition of Horizon will continue the expansion Southern Financial has
undertaken since its founding in 1986. The acquisition will expand Southern
Financial's existing banking activities in Fairfax County, enhancing Southern
Financial's market position and creating opportunities to achieve operating
efficiencies in those markets.
Horizon's deposit structure has a high level of transaction accounts.
These low cost deposits will significantly expand Southern Financial's core
deposits and allow Southern Financial to reduce its dependence on higher cost
sources of funds. Horizon also holds a high level of Fed Funds. Southern
Financial envisions deployment of these low-yielding assets into higher yielding
securities and loans which will add to profitability. Southern Financial may
also use some of Horizon's excess liquidity to reduce Southern Financial's level
of wholesale funding which will reduce funding costs. Southern
14
<PAGE>
Financial expects to realize cost reductions from the elimination of duplicative
back office functions and other corporate overhead and through the consolidation
of certain operations. Southern Financial also anticipates that an expansion of
its Small Business Association ("SBA") lending activities will result from an
expanded market presence in Fairfax County.
Although Southern Financial believes that cost reductions and revenue
enhancements are achievable, no assurance can be given that cost reductions and
revenue enhancements will actually be achieved; that cost reductions and revenue
enhancements will actually be achieved within the time frame planned by Southern
Financial; or that any cost reductions and revenue enhancements will not be
offset by declining revenues or other charges to earnings. If those cost
reductions and revenue enhancements are not achieved, or if they are not
achieved within the time frame planned by Southern Financial, Southern
Financial's earnings after the acquisition would be less than Southern Financial
anticipates.
The Southern Financial board believes that the merger is in the best
interest of Southern Financial and the Southern Financial shareholders. The
Southern Financial board unanimously recommends that Southern Financial
shareholders vote TO APPROVE the issuance of shares of Southern Financial common
stock to holders of Horizon common stock pursuant to the merger agreement and
the election of three of Horizon's directors to Southern Financial's board of
directors.
Accounting Treatment
We anticipate that the merger will be accounted for as a pooling of
interests for accounting and financial reporting purposes. Under this method of
accounting, recorded assets and liabilities of Southern Financial and Horizon
are carried forward at their previously recorded amounts, income of the combined
corporations will include income of Southern Financial and Horizon for the
entire fiscal year in which the merger occurs, and the reported income of the
separate companies for prior periods will be combined. No recognition of
goodwill in the combination is required of any party to the merger.
For the merger to qualify as a pooling of interests, it must satisfy a
number of conditions. If any of the conditions to pooling-of-interests
accounting is not satisfied, then the merger would not qualify for
pooling-of-interests accounting treatment, and a condition to the obligation of
Southern Financial to consummate the merger would not be satisfied. Southern
Financial and Horizon have agreed that they will use their respective best
efforts to ensure that the merger will qualify for pooling-of-interests
accounting treatment. In addition, certain affiliates of Southern Financial and
Horizon have agreed that they will not sell any Southern Financial common stock
or Horizon common stock within 30 days before the effective date of the merger,
nor sell any Southern Financial common stock until such time as Southern
Financial has published financial results covering at least 30 days of the
combined operations of Southern Financial and Horizon after the merger.
Material Federal Income Tax Consequences of the Merger
The following is a discussion of all material federal income tax
consequences of the merger under the Internal Revenue Code of 1986, as amended,
to Horizon shareholders who receive Southern Financial common stock solely in
exchange for Horizon common stock and cash instead of fractional shares. The
discussion does not deal with all aspects of federal taxation that may be
relevant to particular Horizon shareholders. Certain tax consequences of the
merger may vary depending upon the particular circumstances of each Horizon
shareholder and other factors.
You are urged to consult with your tax advisor to determine the
particular tax consequences of the merger to you.
15
<PAGE>
This summary is based on current law and the advice of Williams,
Mullen, Clark & Dobbins, legal counsel to Southern Financial. The advice in this
summary is based on, among other things, certain customary assumptions and
representations relating to certain facts and circumstances of, and the
intentions of the parties to the merger. Neither Southern Financial nor Horizon
has requested a ruling from the Internal Revenue Service in connection with the
merger. To meet a condition to consummation of the merger, Southern Financial
and Horizon will receive from Williams, Mullen, Clark & Dobbins an opinion as to
certain federal income tax consequences of the merger. Such opinion is not
binding on the Internal Revenue Service.
In the opinion of counsel, the merger will constitute a tax-free
reorganization under Section 368(a) of the Internal Revenue Code, if consummated
in the manner set forth in the merger agreement. Accordingly, among other
things, in the opinion of such counsel:
o The merger will constitute a reorganization within the meaning of
Section 368(a) of the Internal Revenue Code;
o No gain or loss will be recognized by Southern Financial or Horizon as
a result of the merger;
o No gain or loss will he recognized by a Horizon shareholder to the
extent he or she receives Southern Financial common stock solely in
exchange for his Horizon common stock pursuant to the merger;
o The tax basis of the Southern Financial common stock received by each
Horizon shareholder will be the same as the tax basis of the Horizon
common stock surrendered in exchange therefor; and
o The holding period for each share of Southern Financial common stock
received by each Horizon shareholder in exchange for Horizon common
stock will include the period for which the shareholder held the
Horizon common stock exchanged therefor, provided the Horizon common
stock is a capital asset in the hands of the holder at the effective
date of the merger.
Any cash received by you instead of fractional shares could result in
taxable income to you. The receipt of that cash will generally be treated as a
sale or exchange of the stock resulting in capital gain or loss measured by the
difference between the cash received and an allocable portion of the basis of
the stock relinquished. The receipt of the cash may be treated as a dividend and
taxed as ordinary income in certain limited situations.
Absence of Appraisal Rights
Under Section 6.1-43 of the Virginia Banking Act, shareholders of
Horizon will not be entitled to dissent from the merger and obtain the
judicially determined fair value of their shares of Horizon.
16
<PAGE>
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION
SOUTHERN FINANCIAL AND HORIZON
The following unaudited pro forma condensed financial statements have
been prepared on a consolidated basis based upon the historical financial
statements of Southern Financial and Horizon. The pro forma combined information
gives effect to the merger accounted for as a pooling of interests, and is based
on the issuance of 1,045,734 shares of Southern Financial common stock in
connection with the merger, which in turn is based on the number of shares of
Horizon common stock outstanding at June 30, 1999. The number of shares of
Southern Financial common stock to be issued in connection with the merger is
subject to certain adjustments described elsewhere in this joint proxy
statement/prospectus. Any difference in the number of shares of Southern
Financial common stock issued in connection with the merger would affect the pro
forma financial information set forth below.
The pro forma financial statements should be read in conjunction with
the separate historical financial statements and the related notes thereto of
Southern Financial in Appendix B and Horizon's historical financial statements
included in Appendix D. There are no adjustments necessary to the historical
results of operations as a result of these transactions. The pro forma combined
financial position and results of operations are not necessarily indicative of
the results which would actually have been attained if the Horizon merger had
occurred in the past or which may be attained in the future.
17
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED BALANCE SHEET
MARCH 31, 1999
<TABLE>
<CAPTION>
Southern Financial Horizon Adjustments Consolidated
----------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Assets
Cash and due from banks $ 6,306 $ 7,324 $ 13,630
Overnight earning deposits 1,050 13,701 14,751
Investment securities, available-for-sale 83,676 10,596 94,272
Investment securities, held-to-maturity 33,703 20,737 54,440
Loans held for sale 991 - 991
Loans receivable, net 136,353 71,849 208,202
Federal Home Loan Bank stock, at cost 1,254 - 1,254
Premises and equipment, net 2,870 3,101 5,971
Other assets 3,541 2,005 5,546
----------------------------------------------------------------------
Total assets $ 269,744 $ 129,313 $ 399,057
======================================================================
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 242,689 $ 118,819 $ 361,508
Advances from Federal Home Loan Bank 3,000 - 3,000
Other liabilities 2,420 617 3,037
----------------------------------------------------------------------
Total liabilities 248,109 119,436 367,545
----------------------------------------------------------------------
Commitments
Stockholders' equity:
Preferred stock - - -
Common stock 16 4,108 (4,098) 26
Capital in excess of par value 15,649 4,233 4,098 23,980
Retained earnings 5,987 1,542 - 7,529
Accumulated other comprehensive income 454 (6) - 448
Treasury stock, at cost (471) - - (471)
----------------------------------------------------------------------
Total stockholders' equity 21,635 9,877 - 31,512
----------------------------------------------------------------------
Total liabilities and stockholders' equity $ 269,744 $ 129,313 $ - $ 399,057
======================================================================
</TABLE>
18
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR THREE MONTHS ENDED MARCH 31, 1999
<TABLE>
<CAPTION>
Southern Financial Horizon Combined
---------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans $ 3,109 $ 1,598 $ 4,707
Investment securities 1,805 633 2,438
---------------------------------------------------------
Total interest income 4,914 2,231 7,145
---------------------------------------------------------
Interest expense:
Deposits 2,437 1,073 3,510
Borrowings 103 - 103
---------------------------------------------------------
Total interest expense 2,540 1,073 3,613
---------------------------------------------------------
Net interest income 2,374 1,158 3,532
Provision for loan losses 275 66 341
---------------------------------------------------------
Net interest income after provision for loan losses 2,099 1,092 3,191
---------------------------------------------------------
Other income:
Fee income 403 330 733
Gain on sale of loans 272 - 272
Gain on sale of investment securities - - -
Other 11 4 15
---------------------------------------------------------
Total other income 686 334 1,020
---------------------------------------------------------
Other expense:
Employee compensation and benefits 896 527 1,423
Premises and equipment 482 249 731
Deposit insurance assessments 34 - 34
Advertising 75 - 75
Other 303 364 667
---------------------------------------------------------
Total other expense 1,790 1,140 2,930
---------------------------------------------------------
Income before income taxes 995 286 1,281
Provision for income taxes 297 97 394
---------------------------------------------------------
Net income $ 698 $ 189 $ 887
=========================================================
Earnings per common share:
Basic $ 0.43 $ 0.12 $ 0.34
Diluted 0.41 0.11 0.32
Weighted average shares outstanding:
Basic 1,603,220 1,640,197 2,636,544
Diluted 1,685,143 1,665,170 2,734,200
</TABLE>
19
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR THREE MONTHS ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
Southern Financial Horizon Combined
---------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans $ 3,106 $ 1,639 $ 4,745
Investment securities 1,457 442 1,899
---------------------------------------------------------
Total interest income 4,563 2,081 6,644
---------------------------------------------------------
Interest expense:
Deposits 2,446 844 3,290
Borrowings 39 - 39
---------------------------------------------------------
Total interest expense 2,485 844 3,329
---------------------------------------------------------
Net interest income 2,078 1,237 3,315
Provision for loan losses 225 64 289
---------------------------------------------------------
Net interest income after provision for loan losses 1,853 1,173 3,026
---------------------------------------------------------
Other income:
Fee income 344 261 605
Gain on sale of loans 138 - 138
Gain on sale of investment securities - - -
Other 7 3 10
---------------------------------------------------------
Total other income 489 264 753
---------------------------------------------------------
Other expense:
Employee compensation and benefits 658 503 1,161
Premises and equipment 427 229 656
Deposit insurance assessments 30 - 30
Advertising 48 - 48
Other 248 423 671
---------------------------------------------------------
Total other expense 1,411 1,155 2,566
---------------------------------------------------------
Income before income taxes 931 282 1,213
Provision for income taxes 301 94 395
---------------------------------------------------------
Net income $ 630 $ 188 $ 818
=========================================================
Earnings per common share:
Basic $ 0.39 $ 0.12 $ 0.32
Diluted 0.37 0.12 0.30
Weighted average shares outstanding:
Basic 1,592,548 1,572,318 2,583,108
Diluted 1,709,010 1,598,309 2,715,945
</TABLE>
20
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
Southern Financial Horizon Combined
---------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans $ 12,365 $ 7,189 $ 19,554
Investment securities 6,366 1,938 8,304
---------------------------------------------------------
Total interest income 18,731 9,127 27,858
---------------------------------------------------------
Interest expense:
Deposits 9,935 4,016 13,951
Borrowings 270 - 270
---------------------------------------------------------
Total interest expense 10,205 4,016 14,221
---------------------------------------------------------
Net interest income 8,526 5,111 13,637
Provision for loan losses 975 326 1,301
---------------------------------------------------------
Net interest income after provision for loan losses 7,551 4,785 12,336
---------------------------------------------------------
Other income:
Fee income 1,433 786 2,219
Gain on sale of loans 796 - 796
Gain on sale of investment securities 68 - 68
Other 50 12 62
---------------------------------------------------------
Total other income 2,347 798 3,145
---------------------------------------------------------
Other expense:
Employee compensation and benefits 2,921 1,937 4,858
Premises and equipment 1,783 938 2,721
Deposit insurance assessments 124 - 124
Advertising 185 42 227
Other 1,142 1,614 2,756
---------------------------------------------------------
Total other expense 6,155 4,531 10,686
---------------------------------------------------------
Income before income taxes 3,743 1,052 4,795
Provision for income taxes 1,084 358 1,442
---------------------------------------------------------
Net income $ 2,659 $ 694 $ 3,353
=========================================================
Earnings per common share:
Basic $ 1.66 $ 0.43 $ 1.28
Diluted 1.55 0.42 1.22
Weighted average shares outstanding:
Basic 1,597,815 1,620,817 2,618,930
Diluted 1,713,815 1,633,548 2,742,950
</TABLE>
21
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Southern Financial Horizon Combined
---------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans $ 11,568 $ 7,022 $ 18,590
Investment securities 5,437 1,509 6,946
---------------------------------------------------------
Total interest income 17,005 8,531 25,536
---------------------------------------------------------
Interest expense:
Deposits 8,709 3,583 12,292
Borrowings 334 - 334
---------------------------------------------------------
Total interest expense 9,043 3,583 12,626
---------------------------------------------------------
Net interest income 7,962 4,948 12,910
Provision for loan losses 880 385 1,265
---------------------------------------------------------
Net interest income after provision for loan losses 7,082 4,563 11,645
---------------------------------------------------------
Other income:
Fee income 1,447 518 1,965
Gain on sale of loans 192 - 192
Gain on sale of investment securities - 1 1
Other 89 10 99
---------------------------------------------------------
Total other income 1,728 529 2,257
---------------------------------------------------------
Other expense:
Employee compensation and benefits 2,532 2,014 4,546
Premises and equipment 1,840 918 2,758
Deposit insurance assessments 109 - 109
Advertising 214 18 232
Other 887 1,230 2,117
---------------------------------------------------------
Total other expense 5,582 4,180 9,762
---------------------------------------------------------
Income before income taxes 3,228 912 4,140
Provision for income taxes 1,022 310 1,332
---------------------------------------------------------
Net income $ 2,206 $ 602 $ 2,808
=========================================================
Earnings per common share:
Basic $ 1.39 $ 0.39 $ 1.09
Diluted 1.33 0.38 1.06
Weighted average shares outstanding:
Basic 1,577,243 1,557,744 2,558,622
Diluted 1,657,706 1,571,446 2,647,717
</TABLE>
22
<PAGE>
SOUTHERN FINANCIAL AND HORIZON
PRO FORMA COMBINED STATEMENTS OF INCOME
FOR YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
Southern Financial Horizon Combined
---------------------------------------------------------
(Dollars in thousands, except per share data)
<S> <C> <C> <C>
Interest income:
Loans $ 10,308 $ 6,129 $ 16,437
Investment securities 4,306 1,551 5,857
---------------------------------------------------------
Total interest income 14,614 7,680 22,294
---------------------------------------------------------
Interest expense:
Deposits 7,433 3,566 10,999
Borrowings 342 - 342
---------------------------------------------------------
Total interest expense 7,775 3,566 11,341
---------------------------------------------------------
Net interest income 6,839 4,114 10,953
Provision for loan losses 695 211 906
---------------------------------------------------------
Net interest income after provision for loan losses 6,144 3,903 10,047
---------------------------------------------------------
Other income:
Fee income 950 393 1,343
Gain on sale of loans 210 - 210
Gain on sale of investment securities - 7 7
Other 26 7 33
---------------------------------------------------------
Total other income 1,186 407 1,593
---------------------------------------------------------
Other expense:
Employee compensation and benefits 2,148 1,859 4,007
Premises and equipment 1,591 738 2,329
Deposit insurance assessments 1,085 - 1,085
Advertising 143 52 195
Other 940 1,044 1,984
---------------------------------------------------------
Total other expense 5,907 3,693 9,600
---------------------------------------------------------
Income before income taxes 1,423 617 2,040
Provision for income taxes 469 211 680
---------------------------------------------------------
Net income $ 954 $ 406 $ 1,360
=========================================================
Earnings per common share:
Basic $ 0.61 $ 0.26 $ 0.53
Diluted 0.59 0.26 0.52
Weighted average shares outstanding:
Basic 1,544,338 1,551,890 2,522,029
Diluted 1,621,958 1,564,956 2,607,880
</TABLE>
23
<PAGE>
Notes to Pro Forma Combined Financial Information
(1) The pro forma combined information presented is not necessarily
indicative of the results of operations or the financial position that
would have resulted had the merger been consummated at the beginning of
the periods indicated, nor is it necessarily indicative of the results
of operations in future periods or the future financial position of the
combined entities.
(2) It is assumed that the merger will be accounted for on a
pooling-of-interests accounting basis and, accordingly, the related pro
forma adjustments have been calculated using the exchange ratio,
whereby Southern Financial will issue 0.63 shares of Southern Financial
common stock for each share of Horizon common stock.
(3) Per share data for all periods has been computed based on the combined
historical income applicable to common shareholders of Southern
Financial and Horizon using the historical weighted average shares
outstanding, adjusted to equivalent shares of Southern Financial common
stock.
(4) Pro forma combined balance sheet adjustments reflect (i) the issuance
of shares of Southern Financial common stock and (ii) the elimination
of Horizon common stock.
24
<PAGE>
OPINION OF THE HORIZON FINANCIAL ADVISOR
General
Horizon's board of directors retained McKinnon & Company in an
engagement letter dated November 19, 1998 to serve as its financial advisor and
to evaluate the terms of the merger agreement, and McKinnon & Company has
rendered its opinion to the board of directors of Horizon that the terms of the
merger agreement are fair from a financial point of view to the Horizon
shareholders. In developing its opinion, McKinnon & Company reviewed and
analyzed material bearing upon the financial and operating conditions of
Horizon, Southern Financial, and on a pro forma basis, Horizon and Southern
Financial combined, and material proposed in connection with the merger
agreement including, among other things, the following:
o the merger agreement;
o the registration statement;
o Horizon's and Southern Financial's financial results for fiscal years
1991 through 1998, and certain documents and information deemed
relevant to McKinnon & Company's analysis;
o discussions with senior management of Horizon and Southern Financial
regarding past and current business operations of, and outlook for,
Horizon and Southern Financial, including trends, the terms of the
proposed merger, and related matters;
o the reported price and trading activity of Horizon and Southern
Financial stock and financial and stock market information (when
available) for Horizon and Southern Financial with similar information
for certain other companies, and securities that are publicly traded;
o the financial terms of certain recent business combinations which
McKinnon & Company deemed comparable in whole or in part;
o the relationship of prices paid to relevant financial data such as net
worth, loans, deposits and earnings in certain bank and bank holding
company affiliations and acquisitions in Maryland, North Carolina and
Virginia in recent years and the deal price relative to the seller's
price one day prior to the announcement of the deals; and
o other published information and other factors and information which
McKinnon & Company deemed relevant.
No instruction or limitations were given or imposed in connection with
the scope of the examination or investigations made by McKinnon & Company in
arriving at its findings. McKinnon & Company has performed such other studies
and analyses it deemed appropriate, including an analysis of the pro forma
financial impact of the merger on Horizon and Southern Financial. A copy of
McKinnon & Company's opinion, which sets forth the assumptions made, matters
considered and qualifications made on the review undertaken, is attached as
Appendix E hereto and should be read in its entirety.
McKinnon & Company used the information gathered to evaluate the
financial terms of the merger using standard valuation methods, including
discounted cash flow analysis, market comparable analysis, comparable
acquisition analysis and dilution analysis.
25
<PAGE>
Comparable Acquisition Analysis
McKinnon & Company compared the relationship of prices paid to relevant
financial data such as net worth, assets, deposits and earnings in 13 bank and
bank holding company mergers and acquisitions in Maryland, North Carolina and
Virginia since December 31, 1997, representing all such transactions known to
McKinnon & Company to have occurred during this period involving banks and bank
holding companies, with the proposed merger and found the consideration to be
received from Southern Financial's to be within the relevant pricing ranges
acceptable for such recent transactions. As a generalization, Horizon has
consistently experienced significantly lower returns on assets and equity over
the four years ended December 31, 1998 than the average community bank in
Virginia and, at September 30, 1998, had a significantly higher level of
non-performing assets to total assets and a significantly lower level of reserve
for loan losses as a percentage of non-performing assets than the average
Virginia community bank. Horizon's growth in loan volume was also significantly
less than that of the average community bank in 1998.
From the 13 bank and bank holding company transactions in 1998 and
through the first quarter of 1999 either closed or pending in Maryland, Virginia
and North Carolina, McKinnon & Company has developed a group of 11 small
transactions, ranging in deal value from $2.5 million to $82.7 million and in
asset size from $28 million to $294 million, and two larger transactions each
exceeding $500 million in deal value and over $2 billion in assets of the
selling institution. The 11 smaller transactions included seven in Virginia
(including the two most recent which were near Horizon's primary market area)
and four in Maryland, while the two larger transactions were in Virginia.
Specifically, based on the 11 smaller transactions in Virginia and Maryland
either completed or pending in 1998 and early 1999, other than the merger, the
price to book value, price to last twelve months' earnings, price to deposits
and price to assets were as follows:
<TABLE>
<CAPTION>
Horizon/ Two Recent Seven Four Comparables
Southern Financial (1) In Market Virginia Maryland Overall
---------------------- --------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
Deal Price/
Book Value 227.49% 199.81% 221.62% 281.64% 248.29%
Deal Price/
LTM Earnings 35.82x 40.73x 29.79x 29.43x 29.63x
Deal Price/
Deposits 21.09% 28.81% 32.82% 27.30% 30.45%
Deal Price/
Assets 17.52% 24.79% 27.62% 23.35% 25.72%
</TABLE>
______________
(1) Based upon a value of $13.07 per share of Horizon common stock,
calculated by multiplying the exchange ratio of 0.63 shares of Southern
Financial common stock per share of Horizon common stock by the closing
price of $20.75 per share of Southern Financial common stock on March
17, 1999.
Among the smaller bank transactions the most comparable transaction in
terms of size, geographical proximity, age and time of the transaction was
Security Bank (Manassas), which had a price to book of 208.33% compared with
227.49% for the merger and a price to earnings of 40.12x compared to 35.82x for
the merger.
Among the two larger transactions in Virginia, the average price to
book was 373.82% compared with 227.49% for the merger; the average price to
earnings was 27.82 times compared with 35.82 times
26
<PAGE>
for the merger; the average price to deposits was 48.95% compared with 21.09%
for the merger; and the average price to assets was 31.11% compared with 17.52%
for the merger.
Market Comparable Analysis
McKinnon & Company analyzed the performance and financial condition of
Southern Financial relative to two groups including the following 18 large and
52 small financial institutions: First Union Corporation; Wachovia Corporation;
BB&T Corp.; First Virginia Bank, Inc.; Centura Banks, Inc.; Mercantile
Bankshares, Inc.; Keystone Financial; One Valley Bancorp; Riggs National Corp.;
Provident Bankshares; United Bankshares, Inc.; Susquehanna Bancshares; F&M
National Corporation; First Charter Corporation; F&M Bancorp; FCNB Corp.; First
Community Bankshares; and Union Bankshares Corp. (collectively the "Large Bank
Group"); and a group of 52 community banks, primarily in Virginia, with some in
North Carolina, Maryland and the District of Columbia (collectively the "Small
Bank Group"). Among the financial information compared was information relating
to equity to assets, loans to deposits, net interest margin, non-performing
assets, total assets, non-accrual loans, loan loss reserve and asset growth
rates. Additional information compared for the trailing twelve month period
ended September 30, 1998 was:
<TABLE>
<CAPTION>
Average of Average of Average Overall
Southern Large Bank Small Bank Comparable
Financial Group Group Bank Groups
<S> <C> <C> <C> <C>
Price/
Book Value 162.0% 238.0% 178.8% 194.0%
Price/
LTM Earnings 13.3x 17.7x 15.4x 16.0x
Return on
Average
Assets 1.10% 1.31% 1.32% 1.32%
Return on
Average
Equity 13.46% 14.04% 11.37% 12.00%
Dividend
Yield 2.14% 1.52% 2.07% 2.20%
</TABLE>
Overall, in the opinion of McKinnon & Company, Southern Financial's
operating and financial ratios were generally in line with the Small Bank Group
and in line with the Large Bank Group while its common stock was priced by the
market at a discount to the average Large and Small Bank Group. Southern
Financial's equity to asset ratio was less than the Small Bank Group and Large
Bank Group (8.1% for Southern Financial, 9.5% for the Large Bank Group and 10.6%
for the Small Bank Group); it's net interest margin (3.67%) was also less than
the Large Bank Group (4.35%) and Small Bank Group (4.45%); it's level of
non-performing assets to total assets (0.55%) was in line with the Large Bank
Group (0.51%) and the Small Bank Group (0.56%); and it's reserves to
non-performing assets (160.0%) was higher than the Small Bank Group (133.1%) and
less than the Large Bank Group (222.1%). With a price to earnings ratio of 13.3
times trailing twelve months earnings Southern Financial's common stock was
priced below the Large Bank Group (17.7 times) and the Small Bank Group (15.4
times). Southern Financial's price to book ratio of 162.0% was also at a
discount to the Large Bank Group (238.1%) and the Small Bank Group (178.8%).
Accordingly, Horizon shareholders will receive Southern Financial common stock
that is reasonably valued when compared to the Large Bank Group and to the Small
Bank Group.
27
<PAGE>
Dilution Analysis - Pro Forma
McKinnon & Company analyzed certain pro forma effects of the merger
based upon earnings forecasts of Horizon and Southern Financial, as well as
estimated cost savings and revenue enhancements totaling $600,000 expected to
result from the merger. This analysis indicated that the transaction, excluding
one time merger costs, would be dilutive to earnings per share of Southern
Financial in 1999 and accretive in each year thereafter, once the projected cost
savings and projected revenue enhancements are realized, and that the merger
would be dilutive to Southern Financial's book value per share. The actual
results achieved by Southern Financial may vary from projected results.
Specifically, estimated earnings per share are expected to be diluted 2.98% in
1999 and book value per share is expected to be diluted 9.71%. The pro forma
effect on Horizon on dividends and market value is an increase in the cash
dividend of approximately $.26 per share and an increase in the market value of
8.97% to $13 per share from the recent prices of $11.93 per share, and
approximately 96.23% above the estimated trading price of $6.625 per share if
Horizon traded at the same multiple of trailing earnings as the comparable Large
and Small Bank Groups. Transactions in Horizon stock have resulted in a sale
price significantly above where, in McKinnon & Company's estimate, it would
trade in a competitive open market among dealers. Southern Financial's cash
dividend payout ratio is 26% compared with an average of 31% among the
comparable Large and Small Bank Groups. McKinnon & Company concluded from this
that the transaction would have a significant positive impact on Horizon and the
Horizon shareholders in that the market value of Southern Financial's common
stock to be received by the Horizon shareholders, after giving effect to the
exchange ratio, would represent a substantial increase in the market value of
Horizon's common stock, although there can be no assurance that pro forma
amounts are indicative of the future and there is no assurance that anticipated
cost savings will occur.
Present Value Analysis
McKinnon & Company performed an analysis to determine a range of
present values per share of Horizon common stock assuming Horizon continued to
operate as an independent community bank. This range was determined by present
valuing the estimated value of Horizon common stock at the end of year 2003.
McKinnon & Company used earnings reported by Horizon for 1998. The net income
projections were grown using an earnings growth rate of 8% for years 1999
through 2003. The future value of Horizon common stock at the end of year 2003
was determined by applying a range of price-to-earnings multiples of 15.0 to
17.0 to year 2003 projected earnings. These values were discounted to present
value using discount rates of 11% to 13%, which McKinnon & Company viewed as the
appropriate discount rate range for a commercial bank with Horizon's
characteristics. Based upon the above assumptions, the value of Horizon common
stock ranged from approximately $6.33 to $7.60 per share on a stand-alone basis.
28
<PAGE>
Terminal Price/Earnings Multiple
Discount
Rate 15.0x 15.5x 16.0x 16.5x 17.0x
---- ----- ----- ----- ----- -----
11.00% $6.94 $7.10 $7.27 $7.44 $7.60
11.50% 6.78 6.94 7.10 7.27 7.43
12.00% 6.63 6.78 6.94 7.10 7.26
12.50% 6.48 6.63 6.78 6.94 7.09
13.00% 6.33 6.48 6.63 6.78 6.93
The summary set forth above includes the material factors considered,
but does not purport to be a complete description of the presentation by
McKinnon & Company to the Horizon board of directors or of the analyses
performed by McKinnon & Company. The preparation of a fairness opinion involves
various determinations as to the most appropriate and relevant methods of
financial analysis and the application of those methods to the particular
circumstances and, therefore, such an opinion is not readily susceptible to
partial analysis or summary description. Accordingly, notwithstanding the
separate factors summarized above, McKinnon & Company believes that its analyses
must be considered as a whole and that selecting portions of its analyses and
the factors considered by it, without considering all analyses and factors,
would create an incomplete view of the process underlying the preparation of its
opinion. As a whole, these various analyses contributed to McKinnon & Company's
opinion that the terms of the merger agreement are fair from a financial point
of view to the Horizon shareholders.
McKinnon & Company is an investment banking firm that specializes in
Virginia community banks. In 11 years McKinnon & Company has been lead managing
underwriter in approximately 34 public stock offerings for Virginia community
banks and thrifts and has served as financial advisor, including providing
fairness opinions, to numerous Virginia community banks and thrifts. McKinnon &
Company, as part of its investment banking business, is engaged in the
evaluation of businesses, particularly banks and thrifts, and their securities,
in connection with mergers and acquisitions, initial public offerings, private
placements and evaluations for estate and corporate recapitalizations. McKinnon
& Company is also a market maker in Virginia community bank stocks listed on The
Nasdaq National Market, The Nasdaq SmallCap Market and the OTC Bulletin Board,
but not in Horizon common stock. McKinnon & Company believes it has a thorough
working knowledge of the banking industry throughout Virginia. McKinnon &
Company is also a market maker in Southern Financial's common stock on The
Nasdaq National Market.
Pursuant to an engagement letter dated November 19, 1998, between
Horizon and McKinnon & Company, in exchange for its services, McKinnon & Company
shall receive a contingent fee of 1% of the market value paid for Horizon,
payable at the closing or effective date of the merger. This investment advisory
fee is a legal obligation of Horizon and is 1% of the fair market value of the
consideration to be paid to the shareholders of Horizon on the date the merger
becomes effective for McKinnon & Company's services as independent financial
advisor in connection with the merger, including the rendering of a fairness
opinion to Horizon's board of directors. McKinnon & Company has already been
paid $10,000 at the time the merger agreement was signed, which fee will be
deducted from the above contingent fee payable on the effective date of the
merger.
29
<PAGE>
OPINION OF SOUTHERN FINANCIAL'S ADVISOR
Tucker Anthony Cleary Gull ("Tucker Anthony") was retained by Southern
Financial in March 1999 for the purpose of providing financial advice and
consultation in connection with a potential acquisition of Horizon, including
assistance in developing an overall strategy for the acquisition of Horizon,
providing advice on the valuation of Horizon and the merger transaction
structure, providing assistance in bid presentations, negotiations and related
strategy and analysis, and, if appropriate, the rendering of a fairness opinion
in connection with a proposed acquisition. Southern Financial selected Tucker
Anthony for a number of reasons including its familiarity with Southern
Financial. Southern Financial also considered Tucker Anthony's experience and
reputation in the area of valuation and financial advisory work generally, and
in relation to financial institutions specifically. Tucker Anthony is a
nationally recognized investment banking firm and is regularly engaged in the
valuation of businesses and their securities in connection with mergers and
acquisitions, leveraged buyouts, negotiated underwritings, private placements
and valuations for corporate and other purposes. From time to time, Tucker
Anthony and its affiliates may hold long or short positions in Southern
Financial common stock.
Tucker Anthony has rendered written opinions to the board of directors
of Southern Financial to the effect that, as of April 16, 1999 and as of the
date of this document, the consideration to be paid to the holders of Horizon
common stock in the merger pursuant to the agreement is fair, from a financial
point of view, to the holders of Southern Financial common stock. The full text
of the fairness opinion dated as of the date of this document, setting forth the
assumptions made, procedures followed, matters considered and certain
limitations on the review undertaken by Tucker Anthony, is included as Appendix
C of this document. Holders of Southern Financial common stock are urged to read
the fairness opinion in its entirety. This opinion is directed to the board of
directors of Southern Financial only and does not constitute a recommendation to
any holder of Southern Financial common stock as to how such shareholder should
vote at the meeting. Southern Financial and Tucker Anthony do not believe any
person other than Southern Financial's board of directors has the legal right to
rely on the opinion and, absent any controlling precedent, would resist any
assertion otherwise. The April 16, 1999 opinion is substantially identical to
the opinion attached to this document as Appendix C.
As compensation for its services as financial advisor, including
issuance of the opinions, Southern Financial has agreed to pay Tucker Anthony a
total of $125,000, of which amount $85,000 has been paid as of the date of this
document. Southern Financial has also agreed to reimburse Tucker Anthony for its
out-of-pocket expenses and to indemnify Tucker Anthony against certain
liabilities arising out of its services.
In arriving at its opinion dated as of the date hereof, Tucker Anthony,
among other things:
o reviewed the merger agreement;
o reviewed the registration statement on Form S-4, including this
document;
o reviewed certain historical financial and other information concerning
Southern Financial for the five fiscal years ended December 31, 1998,
and the quarter ended March 31, 1999, including Southern Financial's
reports on Forms 10-K and 10-Q;
o reviewed certain historical financial and other information concerning
Horizon for the five fiscal years ended December 31, 1998 and for the
fiscal quarter ended March 31, 1999;
30
<PAGE>
o held discussions with the senior management of Southern Financial and
Horizon with respect to their past and current financial performance,
financial condition and future prospects;
o reviewed certain internal financial data, projections and other
information of Southern Financial and Horizon including financial
projections prepared by management;
o analyzed certain publicly available information of other financial
institutions that it deemed comparable or otherwise relevant to its
inquiry, and compared Southern Financial and Horizon from a financial
point of view with certain of these institutions;
o compared the consideration to be paid by Southern Financial pursuant to
the merger agreement with the consideration paid in other acquisitions
of financial institutions that it deemed comparable or otherwise
relevant to its inquiry;
o reviewed publicly available earnings estimates, historical trading
activity and ownership data of Southern Financial common stock and
considered the prospects for dividends and price movement; and
o conducted such other financial studies, analyses and investigations and
reviewed such other information as it deemed appropriate to enable it
to render its opinion.
In its review, it also took into account an assessment of general
economic, market and financial conditions and certain industry trends and
related matters. Tucker Anthony's opinions were necessarily based upon
conditions as they existed and could be evaluated on the date thereof and the
information made available to Tucker Anthony through the date thereof. No
limitations were imposed by the boards of directors of Southern Financial or
Horizon upon Tucker Anthony with respect to the investigations made or
procedures followed by Tucker Anthony in its review and analysis. In its review
and analysis and in arriving at its opinions, Tucker Anthony assumed and relied
upon the accuracy and completeness of all the financial information publicly
available or provided to it by Southern Financial and Horizon, and did not
attempt to verify any of such information. Tucker Anthony assumed (i) that the
financial projections of Southern Financial and Horizon provided to it with
respect to the results of operations likely to be achieved by each company were
prepared on a basis reflecting the best currently available estimates and
judgments of Southern Financial's and Horizon's management as to future
financial performance and results, and (ii) that such forecasts and estimates
would be realized in the amounts and in the time periods estimated. Tucker
Anthony also assumed, without independent verification, that the current and
projected aggregate reserves for possible loan losses for Southern Financial and
Horizon were adequate to cover such losses. Tucker Anthony did not make or
obtain any independent evaluations or appraisals of any assets or liabilities of
Southern Financial, Horizon or any of their respective subsidiaries nor did it
verify any of Southern Financial's or Horizon's books or records or review any
individual loan credit files.
On April 16, 1999, Tucker Anthony made a presentation, and subsequently
rendered a written fairness opinion, to Southern Financial's board of directors.
Set forth below is a summary of the main elements of the financial analyses
performed by Tucker Anthony in connection with rendering its written opinion of
April 16, 1999. It does not purport to be a complete description of the analyses
performed by Tucker Anthony or of the presentation of Tucker Anthony to Southern
Financial's board of directors. In connection with its opinion dated as of the
date of this document, Tucker Anthony performed procedures to update certain
analyses and reviewed the assumptions on which such analyses were based and the
factors considered. Taken as whole, Tucker Anthony believes these analyses
support the conclusion that the consideration to be paid to holders of Horizon
common stock is fair, from a financial point of view, to the holders of Southern
Financial common stock.
31
<PAGE>
Acquisition Price/Exchange Ratio Analysis. Tucker Anthony considered
the ranges of possible acquisition prices and exchange ratios, which could
result under the merger and the impact of these on its analyses.
Stock Trading Analysis. Tucker Anthony examined the historical trading
prices, trading volume activity, market pricing multiples of Southern Financial
common stock, and compared the historical trading prices of Southern Financial
common stock in relation to movements in certain stock indices, specifically an
index of Southern Financial's selected reference companies; an index of
Horizon's selected reference companies; the Nasdaq Community Bank Index; and the
Standard & Poor 500 Index.
Contribution Analysis. Tucker Anthony analyzed the contribution of each
of Southern Financial and Horizon to among other things, the stockholders'
equity and after-tax net income of the pro forma combined company. This analysis
showed that, among other factors, Horizon would have contributed 36%, 32%, and
21% of the assets, stockholders' equity and net income of the pro forma combined
company as of and for the 12 months ended December 31, 1998, respectively. This
compared with a proposed ownership of 39% of the combined company to be held by
the holders of Horizon common stock following the merger.
Pro Forma Merger Analysis. Based on projections provided by Southern
Financial, Tucker Anthony analyzed certain pro forma effects of the merger. This
analysis indicated that, while the merger would be dilutive to tangible book
value per share, the merger would be accretive to earnings in the first full
year following the close of the merger, without consideration of the
nonrecurring charges to be incurred in connection with certain merger costs. In
this analysis, Tucker Anthony assumed that Southern Financial performed in
accordance with the earnings forecasts and achieved expected synergies provided
to Tucker Anthony by Southern Financial's senior management.
Analysis of Selected Publicly Traded Companies. Tucker Anthony compared
selected financial data and financial ratios of Southern Financial and Horizon
to the corresponding data and ratios of certain publicly traded institutions.
The institutions included in the comparison to Southern Financial were:
o Bourbon Bancshares, Inc.; o Codorus Valley Bancorp, Inc.;
o DNB Financial Corp.; o ECB Bancorp, Inc.;
o First Leesport Bancorp, Inc.; o Four Oaks Fincorp, Inc.;
o Guaranty Financial Corp.; o Mid Penn Bancorp, Inc.;
o Norwood Financial Corp.; o People's Financial Corp.;
o United Bancorp, Inc.; o Union National Financial Corp.; and
o Virginia Commerce Bank.
The institutions included in the comparison to Horizon were:
o Annapolis National Bancorp; o Bank of Essex;
o Capital Bank; o Central Virginia Bankshares;
o Heritage Bancorp, Inc.; o Madison Bancshares Group, Ltd.;
o Marathon Financial Corp.; and o Rockingham Heritage Bank.
The selected banks, as groups, exhibited certain characteristics --
including asset size, geographic proximity and business risk -- similar to those
exhibited by Southern Financial and Horizon, respectively.
32
<PAGE>
The comparison of Southern Financial to its selected peer group showed
among other things that based on financial data as of December 31, 1998 for
Southern Financial and December 31, 1998 for its selected peer group:
o the ratio of Southern Financial's net loans to assets was 51.1%
compared to an average of 64.8% for its peer group;
o the ratio of Southern Financial's loan loss reserves to non-performing
assets was 103.4% compared to 330.6% for its peer group;
o the ratio of Southern Financial's loan loss reserves to loans was 1.5%
compared to an average of 1.4% for its peer group;
o the ratio of Southern Financial's equity to total assets was 8.1% as
compared to an average of 9.5% for its peer group;
o the latest quarter annualized return on assets for Southern Financial
was 1.09% compared to an average of 1.04% for its peer group;
o the latest quarter annualized return on equity for Southern Financial
was 13.51%, compared to an average of 11.23% for its peer group;
o the ratio of Southern Financial's market price to its book value per
common share was 158% compared to an average of 176% for its peer
group;
o the price/earnings ratio for the trailing twelve months earnings for
Southern Financial was 13.1x, compared to an average of 16.7x for its
peer group; and
o the average latest quarter annualized dividend yield for Southern
Financial was 2.0% as compared to 2.6% for its peer group.
The comparison of Horizon to its selected peer group showed among other
things that based on financial data as of December 31, 1998 for Horizon and
December 31, 1998 for its selected peer group:
o the ratio of Horizon's net loans to assets was 51.4% compared to an
average of 68.5% for its peer group;
o the ratio of Horizon's loan loss reserves to non-performing assets was
81.0% compared to 198.8% for its peer group;
o the ratio of Horizon's loan loss reserves to loans was 1.3% compared to
an average of 1.2% its peer group;
o the ratio of Horizon's equity to total assets was 6.7% as compared to
an average of 11.4% its peer group;
o the latest quarter annualized return on assets for Horizon was 0.65%
compared to an average of 0.97% for its peer group; and
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<PAGE>
o the latest quarter annualized return on equity for Horizon was 9.13%,
compared to an average of 9.07% for its peer group.
Analysis of Selected Acquisition Transactions. Tucker Anthony reviewed
and performed analysis on 131 unassisted acquisitions of bank institutions in
the U.S. (the "Selected U.S. Transactions") with a transaction size ranging from
$10.0 million to $30.0 million announced since January 1, 1998, and 51
unassisted acquisitions of bank institutions in Virginia and the surrounding
states (the "Selected Regional Transactions") announced since January 1, 1998,
comparing the target financial institutions' capital structure and profitability
to Horizon's current results of operations and financial condition. The Selected
U.S. Transactions and Selected Regional Transactions were chosen because they
represented merger and acquisition transactions which involved target financial
institutions exhibiting certain characteristics -- including asset size,
geographic proximity and business risk -- similar to those exhibited by Horizon.
Excluding the highest and lowest ratios, the target financial institutions
involved in the Selected U.S. Transactions and the Selected Regional
Transactions had an average return on assets for the latest twelve months prior
to announcement date of 1.23% and 1.14% and an average return on equity for the
latest twelve months prior to announcement date of 13.13% and 11.93%,
respectively, as compared to 0.51% and 7.44%, respectively, for Horizon. Set
forth below is a summary of the analysis with respect to the Selected U.S.
Transactions and the Selected Regional Transactions.
<TABLE>
<CAPTION>
Selected U.S. Selected Regional
Transactions Transactions
Southern Financial Horizon
--------------------------------------------------- --------------------------------
Offer Offer
Offer (1) Median Percentile (2) Median Percentile (2)
--------- ------ -------------- ------ --------------
<S> <C> <C> <C> <C> <C>
Price/Trailing
Twelve Months Earnings 30.3x 19.3x 85.6% 24.2x 74.7%
Price/Book Value 216.9% 248.6% 33.8% 293.3% 22.4%
Price/Tangible
Book Value 219.0% 250.4% 34.4% 311.1% 22.5%
- --------------------------
</TABLE>
(1) Based upon value of $12.84 per share of Southern Financial common stock
(based on the April 15, 1999 closing price of Southern Financial common
stock of $20.375).
(2) Position of the Southern Financial offer in relation to percentile
rankings of the Selected U.S. Transactions and the Selected Regional
Transactions, respectively.
The foregoing is a summary of the main elements of the financial
analyses performed by Tucker Anthony, but it does not purport to be a complete
description of such analyses. The preparation of a fairness opinion involves
various determinations as to the most appropriate and relevant methods of
financial analysis and the application of these methods to the particular
circumstances and, therefore, such an opinion is not readily susceptible to a
summary description. Accordingly, notwithstanding the separate factors
summarized above, Tucker Anthony believes that its analyses must be considered
as a whole and that selecting portions of its analyses and factors considered by
it, without considering all analyses and factors, or attempting to ascribe
relative weights to some or all of such analyses or factors, could create an
incomplete view of the evaluation process underlying Tucker Anthony's opinion.
In addition, Tucker Anthony may have used the various analyses for different
purposes and may have deemed various assumptions more or less probable than
other assumptions, so that the ranges of valuations resulting from any
particular analysis described above should not be taken to be Tucker Anthony's
view of the actual value of Horizon to Southern Financial. The fact that any
specific analysis has been referred to in the
34
<PAGE>
summary above is not meant to indicate that such analysis was given more weight
than any other analyses.
In performing its analyses, Tucker Anthony made numerous assumptions
with respect to industry performance, general business and economic conditions,
and other matters, many of which are beyond the control of Southern Financial
and Horizon. The analyses performed by Tucker Anthony are not necessarily
indicative of actual values or actual future results, which may be significantly
more or less favorable than those suggested by such analyses. Such analyses were
prepared solely as a part of Tucker Anthony's analysis of the fairness, from a
financial point of view, to the holders of Southern Financial common stock of
the consideration to be paid in the merger to the holders of Horizon common
stock, and were provided to Southern Financial's board of directors in
connection with the delivery of Tucker Anthony's opinion. The analyses do not
purport to be appraisals or to reflect the prices at which Horizon or Southern
Financial might actually be sold or the prices at which any securities may trade
at the present time or at any time in the future. In addition, as described
above, Tucker Anthony's opinion is just one of the many factors taken into
consideration by Southern Financial's board of directors (see "-Recommendation
of the Southern Financial Board and Reasons for the Merger" and "-Background of
the Merger").
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Certain members of Horizon's management, as well as certain members of
the Horizon board of directors, have interests in the merger in addition to
their interests as shareholders of Horizon. These interests are described below.
In each case, the Horizon board was aware of these potential interests, and
considered them, among other matters, in approving the merger agreement and the
transactions contemplated thereby.
Indemnification. Southern Financial has generally agreed to indemnify
the officers and directors of Horizon to the same extent and on the same
conditions as they are entitled to from Horizon before the merger. Southern
Financial also has agreed to provide directors' and officers' liability
insurance for the present officers and directors of Horizon comparable to the
coverage currently provided by Horizon before the merger.
Directors of Horizon. Two Horizon directors (Messrs. Belotti and
Warhurst) who will serve on the Southern Financial board initially will receive
annual retainers and monthly fees for service on Southern Financial's board.
Based on the existing schedule utilized by Southern Financial, these individuals
will receive an annual fee of $4,000, $500 for attendance at each board meeting
and $150 for attendance at each board committee meeting. Richard L. Hall, the
President and Chief Executive Officer of Horizon, will also serve on the
Southern Financial board, but will not receive any compensation other than what
he will receive as an executive officer of Southern Financial following the
merger.
In addition, the current members of Horizon's advisory board, and any
directors of Horizon (other than Messrs. Hall, Belotti and Warhurst) who want to
serve on the advisory board, will constitute an advisory board for Southern
Financial's eastern region following the merger and will receive fees of $100
per meeting.
Employment Arrangement. In connection with the merger, Southern
Financial will employ Richard L. Hall, President and Chief Executive Officer of
Horizon, as Executive Vice President with responsibility for operations in the
eastern region, which will be comprised of Horizon's four branches and Southern
Financial's branch in the City of Fairfax. On the effective date of the merger,
Mr. Hall's
35
<PAGE>
current employment arrangement with Horizon will be terminated, and Mr. Hall
will receive a lump sum payment in the amount of $413,114 in satisfaction of all
of Horizon's obligations under that arrangement.
Employee and Benefit Plan. Southern Financial will coordinate the
participation of Horizon's employees in its employee benefit plans and programs.
To further this participation, Southern Financial may establish, amend or
continue certain plans and programs, including plans and programs of Horizon,
that provide coverages and benefits as favorable as the coverages and benefits
that Horizon's employee benefit plans and programs currently provide. In the
alternative, Southern Financial may permit Horizon's employees to participate in
Southern Financial's employee benefit plans and programs on substantially the
same basis as Southern Financial's employees. Subject to restrictions and
limitations that applicable law may impose, Southern Financial will treat the
service of a Horizon employee with Horizon as service with Southern Financial
for purposes of all employee benefit plans and programs. Southern Financial will
also honor Horizon's obligations for all accrued and unused vacation, sick leave
and personal leave and all employment, severance, consulting and other
compensation contracts and agreements that Horizon has previously disclosed to
Southern Financial.
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS
Both Southern Financial and Horizon are corporations subject to the
provisions of the Virginia State Corporation Act. Horizon's shareholder's rights
are presently governed by Horizon's articles of incorporation and bylaws. Upon
consummation of the merger and Horizon's shareholders becoming shareholders of
Southern Financial, shareholder's rights will be governed by the articles of
incorporation and bylaws of Southern Financial.
There are a few material differences between the rights of a Horizon
shareholder under Horizon's articles of incorporation and bylaws, on the one
hand, and the rights of a Southern Financial shareholder under the articles of
incorporation and bylaws of Southern Financial, on the other hand, which are
disclosed in the section "Comparative Rights of Shareholders" on page 111.
TERMS OF THE MERGER AGREEMENT
The following is a summary description in the material aspects of the
merger agreement. This description does not purport to be complete and is
qualified in its entirety by reference to Appendix A that contains the full
merger agreement. We urge you to read Appendix A in its entirety.
Representations and Warranties; Conditions to the Merger
The merger agreement contains representations and warranties by
Southern Financial and Horizon, including representations and warranties with
respect to their individual organizations, authorizations to enter into the
merger agreement, capitalization, financial statements and pending and
threatened litigation. These representations and warranties, except as otherwise
provided in the merger agreement, will not survive the effective date of the
merger.
The obligations of Southern Financial and Horizon to consummate the
merger are subject to the following conditions, among others:
o approval of the merger agreement by the requisite shareholder vote of
the Horizon shareholders;
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<PAGE>
o approval of the stock issuance by the requisite shareholder vote of the
Southern Financial shareholders;
o receipt of all necessary regulatory approvals not conditioned or
restricted in a manner that, in the judgment of the boards of directors
of Southern Financial or Horizon, materially adversely affects the
economic or business benefits of the merger so as to render inadvisable
or unduly burdensome consummation of the merger;
o the absence of certain actual or threatened proceedings before a court
or other governmental body relating to the merger;
o the receipt of an opinion of counsel as to certain federal income tax
consequences of the merger;
o the receipt of a letter from Southern Financial's accountants to the
effect that the merger will qualify for pooling-of-interests accounting
treatment under generally accepted accounting principles;
o performance by the other company of its obligations under the merger
agreement;
o the accuracy, in all material respects, of the representations and
warranties of the other company contained in the merger agreement;
o the receipt of certain opinions and certificates from the other
company;
o the receipt by Southern Financial of a final fairness opinion from
Tucker Anthony; and
o the receipt by Horizon of a final fairness opinion from McKinnon &
Company.
Regulatory Approvals
As indicated above, the merger is conditioned on the prior approval of
the merger by the Board of Governors of the Federal Reserve System and the
Virginia State Corporation Commission. Southern Financial intends to file
applications with the Federal Reserve and the Virginia State Corporation
Commission as soon as possible. While we cannot predict whether or when we will
obtain all required regulatory approvals, we see no reason why the approvals
will not be obtained in a timely manner. However, there can be no assurance that
the necessary approvals will be obtained, or that any approval will not be
conditioned in a manner which makes consummation of the merger, in the judgment
of the board of directors of Southern Financial or Horizon, inadvisable or
unduly burdensome.
Business Pending the Merger
Until the effective date of the merger, each of Southern Financial and
Horizon has agreed that it will operate its business substantially as presently
operated, in the ordinary course of business, and will use its best efforts to
preserve intact its relationships with persons having business dealings with it.
In addition, until the effective date, Horizon has agreed not to take, without
Southern Financial's consent, certain specific actions in connection with the
ongoing operation of its business. Specifically, Horizon may not:
37
<PAGE>
o declare or pay dividends on its capital stock;
o enter into any merger, consolidation or business combination (other
than the merger with Southern Financial) or any acquisition or
disposition of a material amount of assets or securities or solicit
proposals in respect thereof;
o amend its charter or bylaws (except as may be required by the merger
agreement with Southern Financial);
o issue any capital stock, except upon exercise of rights, warrants or
options issued pursuant to existing employee benefits plans, programs
or arrangements or effect any stock split or otherwise change its
capitalization; or
o purchase or redeem any of its capital stock.
No Solicitation; Board Action
Horizon has agreed not to (i) encourage, solicit or initiate
discussions or negotiations with any person other than Southern Financial
concerning any merger, share exchange, sale of substantial assets, tender offer,
sale of shares of capital stock or similar transaction involving Horizon, (ii)
enter into any agreement with any third party providing for a business
combination transaction, equity investment or sale of a significant amount of
assets, or (iii) furnish any information to any other person relating to or in
support of such transaction.
Horizon also agreed that it will promptly communicate to Southern
Financial the terms of any proposal which it may receive in respect to any of
the foregoing transactions.
Horizon would be required to pay Southern Financial $1 million if the
merger agreement is terminated and before the date of termination Horizon
receives a merger or acquisition proposal or initiates merger or acquisition
discussions with a third party and within 12 months after the date of
termination the Horizon board determines that a merger or acquisition by the
third party is in the best interests of Horizon and its shareholders. No payment
will be due, however, if Horizon terminates the merger agreement because
Southern Financial enters into an agreement to be acquired. Additionally, no fee
is payable, however, if Southern Financial wrongfully terminates the merger
agreement. Similarly, no fee is payable if, at the time the merger agreement
terminates, Horizon is entitled to terminate on the basis of a breach by
Southern Financial or there has been a failure to satisfy certain closing
conditions (other than approval by Horizon's shareholders). See "- Expenses of
the Merger and Termination Fee" on page 40.
Effective Date
If the merger is approved by the shareholders of Horizon, all required
governmental and other consents are obtained and the other conditions to the
merger are satisfied or waived, the merger will be consummated and made
effective on the date and at the time indicated on the certificate of merger
issued by the Virginia State Corporation Commission pursuant to the Virginia
Stock Corporation Act. See "The Merger - Representations and Warranties;
Conditions to the Merger" on page 36.
It is anticipated that the effective date of the merger will occur in
the third quarter of 1999.
38
<PAGE>
Surrender of Stock Certificates
As soon as practicable after the merger, Southern Financial will cause
Chase Mellon Shareholder Services, its exchange agent, to mail to you a letter
of transmittal and instructions for use to surrender the certificates
representing shares of Horizon common stock in exchange for certificates
representing shares of Southern Financial common stock.
Horizon shareholders should not send in their certificates until they
receive such instructions.
Promptly after surrender of one or more certificates for Horizon common
stock, together with a properly completed letter of transmittal, you will
receive a certificate or certificates representing the number of shares of
Southern Financial common stock to which you are entitled and, where applicable,
a check for the amount payable in cash instead of issuing a fractional share.
Lost, stolen, mutilated or destroyed certificates will be treated in accordance
with the existing procedures of Southern Financial.
After the merger, you will be entitled to vote the number of shares of
Southern Financial common stock into which your Horizon common stock has been
converted, regardless of whether you have surrendered your Horizon certificates.
The merger agreement provides, however, that no dividend or distribution payable
to the holders of record of Southern Financial common stock at or as of any time
after the effective date of the merger will be paid to the holder of any Horizon
certificate until such holder physically surrenders such certificate, promptly
after which time all such dividends or distributions will be paid, without
interest.
Waiver, Amendment and Termination
At any time on or before the effective date of the merger, any term or
condition of the merger may be waived by the party which is entitled to the
benefits thereof and without shareholder approval. The merger agreement may be
amended at any time before the merger by agreement of the parties whether before
or after the shareholder meetings. Any material change in a material term of the
merger agreement would require a resolicitation of Horizon's shareholders. Such
a material change would include, but not be limited to, a decrease in the
exchange ratio or a change in the tax consequences to Horizon's shareholders.
The merger agreement may be terminated by Southern Financial or
Horizon, whether before or after the approval of the merger by the shareholders
of Horizon:
o by mutual consent of Horizon and Southern Financial;
o unilaterally by Horizon or Southern Financial, if the merger has not
occurred on or before February 29, 2000; or
o unilaterally by Horizon or Southern Financial if the satisfaction in
any material respect of one or more conditions to the obligation of
that party is rendered impossible of satisfaction. In the event of
termination, the merger agreement shall become null and void, except
that certain provisions thereof relating to expenses and
confidentiality of information exchanged between the parties shall
survive any such termination.
39
<PAGE>
Resales of Southern Financial Common Stock
All shares of Southern Financial common stock received by Horizon
shareholders in connection with the merger will be freely transferable, except
that Southern Financial common stock received by persons who are deemed to be
"affiliates" of Horizon for purposes of Rule 145 under the Securities Act of
1933, as amended (the "Securities Act"). To the best knowledge of Horizon and
Southern Financial, the only persons who may be deemed to be affiliates of
Horizon subject to these limitations are the directors and executive officers of
Horizon.
Expenses of the Merger and Termination Fee
In general, whether or not the merger is consummated, Horizon and
Southern Financial will pay their own expenses incident to preparing, entering
into and carrying out the merger agreement, and preparing and filing the
registration statement of which this joint proxy statement/prospectus is a part.
If the merger agreement terminates and, prior to the date of
termination Horizon solicits or receives a business combination inquiry or
proposal from a third party and, within 12 months after the merger agreement
terminates the Horizon board determines that a business combination with the
third party is in the best interests of Horizon and its shareholders, Horizon
shall pay Southern Financial $1 million. No payment will be due, however, if the
merger agreement is terminated by Horizon because Southern Financial enters into
an agreement to be acquired. Additionally, no payment will be due if Southern
Financial wrongfully terminates the merger agreement or, if at the time the
merger agreement terminates, Horizon is entitled to terminate or refuse to close
on the grounds that Southern Financial has breached any representation or
warranty in the merger agreement. Finally, no payment will be due if there has
been a failure to satisfy certain closing conditions, including a failure of
Southern Financial's shareholders to approve the issuance of Southern Financial
common stock to Horizon's shareholders; a failure to obtain regulatory approval;
if the Securities and Exchange Commission issues a stop order or threatens to
issue a stop order concerning this joint proxy statement/prospectus; if counsel
to Southern Financial does not issue an opinion that the merger is tax free to
the shareholders of Horizon; or if Southern Financial's accountants do not issue
a letter to the effect that the merger will qualify for pooling-of-interests
accounting treatment under generally accepted accounting principles.
This provision is intended to discourage another party from interfering
with the merger agreement between Southern Financial and Horizon.
If either party willfully and materially breaches the merger agreement,
that party must pay the costs associated with this transaction incurred by the
non-breaching party. If the merger agreement is terminated because Horizon
shareholders did not approve the merger agreement or Southern Financial
shareholders did not approve the Stock Issuance, then the party whose
shareholders failed to grant such approval will pay 50% of the costs and
expenses of the other party, except that such reimbursement will not exceed a
total of $100,000.
MARKET PRICES AND DIVIDENDS
Market Prices
Horizon common stock is traded on a quarterly basis in private
transactions by matching prospective buyers and sellers. To Horizon management's
knowledge, the last sales of Horizon common stock took place in the fourth
quarter of 1998 at an average price of $11.96 per share.
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<PAGE>
Southern Financial common stock is listed and traded on The Nasdaq
National Market under the symbol "SFFB."
The following table sets forth the high, low, and closing sales prices
of the common stock as reported by The Nasdaq National Market for the periods
listed.
Southern Financial
<TABLE>
<CAPTION>
----------------------------------------- ------------- -------------- -------------
High Low Closing
----------------------------------------- ------------- -------------- -------------
<S> <C> <C> <C>
1999
----------------------------------------- ------------- -------------- -------------
3rd Quarter (through July 19, 1999) $20.63 $20.00 $20.63
----------------------------------------- ------------- -------------- -------------
2nd Quarter 22.25 19.75 20.38
----------------------------------------- ------------- -------------- -------------
1st Quarter 22.00 19.50 20.31
----------------------------------------- ------------- -------------- -------------
----------------------------------------- ------------- -------------- -------------
1998
----------------------------------------- ------------- -------------- -------------
4th Quarter 24.75 21.00 21.00
----------------------------------------- ------------- -------------- -------------
3rd Quarter 27.00 24.00 24.50
----------------------------------------- ------------- -------------- -------------
2nd Quarter 27.25 25.25 26.13
----------------------------------------- ------------- -------------- -------------
1st Quarter 30.00 20.00 25.50
----------------------------------------- ------------- -------------- -------------
----------------------------------------- ------------- -------------- -------------
1997
----------------------------------------- ------------- -------------- -------------
4th Quarter 23.00 19.25 22.00
----------------------------------------- ------------- -------------- -------------
3rd Quarter 21.50 16.00 21.00
----------------------------------------- ------------- -------------- -------------
2nd Quarter 17.00 12.75 16.50
----------------------------------------- ------------- -------------- -------------
1st Quarter 15.00 13.50 13.87
----------------------------------------- ------------- -------------- -------------
</TABLE>
The closing price of Southern Financial common stock on The Nasdaq
National Market on March 17, 1999, the last full trading day preceding the
public announcement of the proposed merger, was $20.75 per share. The closing
price of Southern Financial common stock on The Nasdaq National Market on July
19, 1999, the latest practicable date before the date of this joint proxy
statement/prospectus was $20.63 per share.
Dividends
The following table reflects the cash dividends declared per share
during each quarter on Southern Financial common stock for the periods
indicated. Horizon has not paid cash dividends.
Southern Financial
- ------------------- ---------------- ---------------- ----------------
1999 1998 1997
- ------------------- ---------------- ---------------- ----------------
Fourth Quarter -- $.10 $.08
- ------------------- ---------------- ---------------- ----------------
Third Quarter -- .095 .07
- ------------------- ---------------- ---------------- ----------------
Second Quarter $.115 .09 .07
- ------------------- ---------------- ---------------- ----------------
First Quarter .11 .08 .06
- ------------------- ---------------- ---------------- ----------------
Certain state law restrictions are imposed on distributions of
dividends to shareholders of Southern Financial. Southern Financial shareholders
are entitled to receive dividends as declared by the Southern Financial board of
directors. However, no such distribution may be made if, after giving effect
41
<PAGE>
to the distribution, it would not be able to pay its debts as they become due in
the usual course of business or its total assets would be less than its total
liabilities. There are similar restrictions with respect to stock repurchases
and redemptions.
Banks have limitations imposed upon all "capital distributions,"
including cash dividends, payments to repurchase or otherwise acquire its
shares, payments to shareholders of another institution in a cash-out merger,
and other distributions charged against capital. As of March 31, 1999, Southern
Financial Bank had the capacity to pay no more than $4.7 million in total
dividends to its sole shareholder, Southern Financial, and Horizon had the
capacity to pay $1.5 million in total dividends to its shareholders.
Similarly, Southern Financial Bank and Horizon each are subject to
legal limitations on capital distributions including the payment of dividends,
if, after making such distribution, the institution would become
"undercapitalized" (as such term is used in the statute). For all state member
banks of the Federal Reserve seeking to pay dividends, the prior approval of the
applicable Federal Reserve Bank is required if the total of all dividends
declared in any calendar year will exceed the sum of the bank's net profits for
that year and its retained net profits for the preceding two calendar years.
Federal law also generally prohibits a depository institution from making any
capital distribution (including payment of a dividend or payment of a management
fee to its holding company) if the depository institution would thereafter fail
to maintain capital above regulatory minimums. Federal Reserve Banks are also
authorized to limit the payment of dividends by any state member bank if such
payment may be deemed to constitute an unsafe or unsound practice. In addition,
under Virginia law no dividend may be declared or paid that would impair a
Virginia chartered bank's paid-in capital. The Virginia State Corporation
Commission has general authority to prohibit payment of dividends by a Virginia
chartered bank if it determines that the limitation is in the public interest
and is necessary to ensure the bank's financial soundness.
Following the consummation of the merger, most of the revenues of
Southern Financial and Southern Financial's ability to pay dividends to its
shareholders will depend on dividends paid to it by Southern Financial Bank and
Horizon. Based on the current financial condition of Southern Financial Bank and
Horizon, Southern Financial expects that the above-described provisions will
have no impact on Southern Financial's ability to obtain dividends from Southern
Financial Bank and Horizon or on Southern Financial's ability to pay dividends
to its shareholders.
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<PAGE>
CHAPTER II
INFORMATION ABOUT THE MEETINGS AND VOTING
General
We are furnishing this document in connection with the solicitation of
proxies by the board of directors of Southern Financial for use at the special
meeting of Southern Financial shareholders including any adjournments or
postponements thereof, to be held on September 9, 1999, and by the board of
directors of Horizon for use at the special meeting of Horizon shareholders
including any adjournments or postponements thereof, to be held on September 9,
1999, at the times and places set forth in the accompanying notices.
The purpose of the Horizon meeting is to consider and vote upon the
Agreement and Plan of Reorganization, dated May 3, 1999, as amended, among
Horizon, Southern Financial and Southern Financial Bank, a Virginia corporation
and a wholly owned subsidiary of Southern Financial. The merger agreement is
attached to this document as Appendix A. For a description of the merger
agreement, see "Terms of the Merger Agreement" on page 36.
The merger agreement provides that Horizon will merge with and into
Southern Financial Bank. In the merger, each share of common stock, par value
$2.50 per share, of Horizon then outstanding will be converted into the right to
receive 0.63 shares (the "exchange ratio") of common stock, par value $0.01 per
share, of Southern Financial. Southern Financial will pay cash in lieu of
fractional shares.
Southern Financial Meeting
General. The Southern Financial meeting will be held on September 9,
1999 at 2:00 p.m., local time, at Fauquier Springs Country Club, Springs Road,
Warrenton, Virginia. At the Southern Financial meeting, holders of Southern
Financial common stock will be asked, in accordance with the rules of The Nasdaq
Stock Market, to consider and vote upon a proposal to approve the issuance of
Southern Financial common stock in connection with the merger (the "Stock
Issuance"); to elect three of Horizon's directors to Southern Financial's board;
and to transact such other business as may properly come before the special
meeting or any adjournment or postponement of the meeting.
The Nasdaq Stock Market requires shareholder approval of the Stock
Issuance because the number of shares of Southern Financial common stock to be
issued in the merger is expected to exceed 20% of the shares of Southern
Financial common stock outstanding immediately prior to the effective date of
the merger. Southern Financial shareholders may also be asked to vote upon a
proposal to adjourn or postpone the Southern Financial meeting for the purpose
of, among other things, allowing additional time for the solicitation of proxies
from Southern Financial shareholders to approve the Stock Issuance.
Record Date; Voting Power. Only holders of record of shares of Southern
Financial common stock at the close of business on July 22, 1999 are entitled to
notice of and to vote at the Southern Financial meeting. On such date, there
were 1,633,094 issued and outstanding shares of Southern Financial common stock
held by approximately 253 holders of record. Holders of record of Southern
Financial common stock on the Southern Financial record date are entitled to one
vote per share on any matter that may properly come before the Southern
Financial meeting. Brokers who hold shares of Southern Financial common stock as
nominees will not have discretionary authority to vote such shares in favor of
the Stock Issuance in the absence of instructions from the beneficial owners
thereof. Any shares of Southern Financial common stock for which a broker has
submitted an executed proxy but for which
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<PAGE>
the beneficial owner thereof has not given instructions on voting to such broker
are referred to as "broker non-votes."
Vote Required. The approval of the Stock Issuance at the Southern
Financial meeting requires a greater number of votes cast in favor of the matter
than the number of votes cast opposing such matter, provided that the total
number of votes cast on such matter represents over 50% of the shares entitled
to vote on the proposal. In the election of three of Horizon's directors to
Southern Financial's board of directors, those individuals receiving the
greatest number of votes will be elected even if they do not receive a majority.
These individuals will become directors of Southern Financial only if the merger
is completed.
Broker non-votes and abstentions will be counted for purposes of
establishing the presence of a quorum at the Southern Financial meeting.
Abstentions and broker non-votes will not, however, be deemed to have been cast
either "for" or "against" the proposal for approval of the Stock Issuance
considered at the meeting and, since approval of the proposal requires the
affirmative vote of a majority of the votes cast at the Southern Financial
meeting, will have no effect on the approval of the Stock Issuance, unless the
total number of votes cast does not exceed 50% of the shares entitled to vote.
The Southern Financial board urges Southern Financial shareholders to complete,
date and sign the accompanying proxy and return it promptly in the enclosed,
postage-paid envelope.
On the Southern Financial record date, the executive officers and
directors of Southern Financial, including their affiliates, had voting power
with respect to an aggregate of 203,644 shares of Southern Financial common
stock or approximately 12.5% of the shares of Southern Financial common stock
then outstanding. We expect that such directors and officers will vote all of
such shares in favor of the approval of the Stock Issuance. In addition, on the
Southern Financial record date, the directors and executive officers of Horizon
did not beneficially own any shares of Southern Financial common stock.
Recommendation of the Southern Financial Board. The Southern Financial
board has unanimously approved and adopted the merger agreement and the
transactions contemplated thereby, including the Stock Issuance. The Southern
Financial board believes that the merger agreement and the transactions
contemplated thereby, including the Stock Issuance, are fair to and in the best
interests of Southern Financial and the Southern Financial shareholders and
recommends that the Southern Financial shareholders vote "FOR" approval of the
Stock Issuance. (See "The Merger - Southern Financial's Reasons for the Merger
and Recommendation of the Southern Financial Board" on page 14).
Solicitation and Revocation of Proxies. A form of proxy is enclosed
with this document. All shares of Southern Financial common stock represented by
properly executed proxies will, unless such proxies have been previously
revoked, be voted in accordance with the instructions indicated on such proxies.
If no instructions are indicated, such shares will be voted FOR approval of the
Stock Issuance and in the discretion of the proxy holder as to any other matter
which may properly come before the Southern Financial meeting.
EACH HOLDER OF SOUTHERN FINANCIAL COMMON STOCK IS REQUESTED TO
COMPLETE, DATE AND SIGN THE ACCOMPANYING PROXY AND RETURN IT PROMPTLY TO
SOUTHERN FINANCIAL IN THE ENCLOSED, POSTAGE-PAID ENVELOPE.
Any Southern Financial shareholder that has previously delivered a
properly executed proxy may revoke such proxy at any time before its exercise. A
proxy may be revoked either by (i) filing with the secretary of Southern
Financial prior to the Southern Financial meeting, at Southern Financial's
principal executive offices, a written revocation of such proxy or a duly
executed proxy bearing a later date or (ii) attending the Southern Financial
meeting and voting in person. Presence at the Southern Financial meeting will
not revoke a shareholder's proxy unless such shareholder votes in person.
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The cost of soliciting proxies will be borne by Southern Financial.
Proxies may be solicited by personal interview, mail or telephone. In addition,
Southern Financial may reimburse brokerage firms and other persons representing
beneficial owners of shares of Southern Financial common stock for their
expenses in forwarding solicitation materials to beneficial owners. Proxies may
also be solicited by certain of Southern Financial's executive officers,
directors and regular employees, without additional compensation, personally or
by telephone or facsimile transmission.
Other Matters. Southern Financial is unaware of any matter to be
presented at the Southern Financial Meeting other than the proposal to approve
the Stock Issuance. If other matters are properly presented at the Southern
Financial meeting, the persons named in the enclosed form of proxy will have
authority to vote all properly executed proxies in accordance with their
judgment on any such matter, including, without limitation, any proposal to
adjourn or postpone the Southern Financial meeting, provided that no proxy that
has been designated to vote against approval and adoption of the merger
agreement and the Stock Issuance will be voted in favor of any proposal to
adjourn or postpone the Southern Financial meeting for the purpose of soliciting
additional proxies to approve and adopt the issuance of stock to Horizon's
shareholders.
Horizon Meeting
General. The Horizon meeting will be held on September 9, 1999 at 10:00
a.m., local time, at the Westwood Country Club, 800 Maple Avenue, East, Vienna,
Virginia. At the Horizon meeting, holders of Horizon common stock will be asked
to consider and vote upon a proposal to approve the merger agreement. Horizon
shareholders may also he asked to vote upon a proposal to adjourn or postpone
the Horizon meeting for the purpose of, among other things, allowing additional
time for the solicitation of proxies from Horizon shareholders to approve the
merger agreement.
Record Date; Voting Power. Only holders of record of shares of Horizon
common stock at the close of business on July 22, 1999 are entitled to notice of
and to vote at the Horizon meeting. As of such date, there were 1,659,894 issued
and outstanding shares of Horizon common stock held by approximately 487 holders
of record. Holders of record of Horizon common stock on the Horizon record date
are entitled to one vote per share on any matter that may properly come before
the Horizon meeting. Brokers who hold shares of Horizon common stock as nominees
will not have discretionary authority to vote such shares in the absence of
instructions from the beneficial owners thereof. Any such shares of Horizon
common stock for which a broker has submitted an executed proxy but for which
the beneficial owner thereof has not given instructions on voting to such broker
are referred to as "broker non-votes."
Vote Required. The presence in person or by proxy of the holders of a
majority of the shares of Horizon common stock outstanding on the Horizon record
date will constitute a quorum for the transaction of business at the Horizon
meeting. Abstentions and broker non-votes will be counted for purposes of
establishing the presence of a quorum at the Horizon meeting. The approval of
the proposal to approve the merger agreement requires the affirmative vote of
holders of a majority of the shares of Horizon common stock outstanding on the
Horizon Record Date. Broker non-votes and abstentions will be counted and will
have the effect of a vote against the proposal to approve the merger agreement.
On the Horizon record date, the executive officers and directors of
Horizon, including their affiliates, had voting power with respect to an
aggregate of 218,818 shares of Horizon common stock or approximately 13.18% of
the shares of Horizon common stock then outstanding. We currently expect that
such directors and officers will vote all of such shares in favor of the
proposal to approve the merger agreement. In addition, on the Horizon record
date, the directors and executive officers of Southern Financial did not
beneficially own any shares of Horizon common stock.
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<PAGE>
Recommendation of the Horizon Board. The Horizon board has unanimously
approved and adopted the merger agreement. The Horizon board believes that the
merger is fair to and in the best interests of Horizon and the Horizon
shareholders and recommends that the Horizon shareholders vote "FOR" approval of
the merger agreement and the transactions contemplated thereby. See "The Merger
- - Horizon's Reasons for the Merger" on page 13.
Solicitation and Revocation of Proxies. A form of proxy is enclosed
with this document. All shares of Horizon common stock represented by properly
executed proxies (whether through the return of the enclosed proxy card or by
telephone) will, unless such proxies have been previously revoked, be voted in
accordance with the instructions indicated on such proxies. If no instructions
are indicated, such shares will be voted FOR approval of the merger agreement
and in the discretion of the proxy holder as to any other matter which may
properly come before the Horizon meeting.
EACH HOLDER OF HORIZON COMMON STOCK IS REQUESTED TO VOTE BY COMPLETING,
DATING AND SIGNING THE ACCOMPANYING PROXY CARD AND RETURNING IT PROMPTLY TO
HORIZON IN THE ENCLOSED, POSTAGE-PAID ENVELOPE. HORIZON SHAREHOLDERS SHOULD NOT
SEND STOCK CERTIFICATES WITH THEIR PROXY CARDS.
Any Horizon shareholder that has previously delivered a properly
executed proxy may revoke such proxy at any time before its exercise. A proxy
may be revoked either by (i) filing with the secretary of Horizon prior to the
Horizon meeting, at Horizon's principal executive offices, either a written
revocation of such proxy or a duly executed proxy bearing a later date or (ii)
attending the Horizon meeting and voting in person. Presence at the Horizon
meeting will not revoke a shareholder's proxy unless such shareholder votes in
person.
The cost of soliciting proxies will be borne by Horizon. Proxies may be
solicited by personal interview, mail or telephone. In addition, Horizon may
reimburse brokerage firms and other persons representing beneficial owners of
shares of Horizon common stock for their expenses in forwarding solicitation
materials to beneficial owners. Proxies may also be solicited by certain of
Horizon's executive officers, directors and regular employees, without
additional compensation, personally or by telephone or facsimile transmission.
Other Matters. Horizon is unaware of any matter to be presented at the
Horizon meeting other than the proposal to approve the merger agreement. If
other matters are properly presented at the Horizon meeting, the persons named
in the enclosed form of proxy will have authority to vote all properly executed
proxies in accordance with their judgment on any such matter, including, without
limitation, any proposal to adjourn or postpone the Horizon meeting, provided
that no proxy that has been designated to vote against approval of the merger
agreement will be voted in favor of any proposal to adjourn or postpone the
Horizon meeting for the purpose of soliciting additional proxies to approve the
merger agreement.
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CHAPTER III
DESCRIPTION OF SOUTHERN FINANCIAL
BUSINESS
General
Southern Financial is incorporated in Virginia. On December 1, 1995,
Southern Financial 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 material activity of Southern Financial is to own and
control all of the capital stock of Southern Financial Bank. References to
Southern Financial include the activities of Southern Financial Bank.
Headquartered in Warrenton, Virginia, Southern Financial serves the
retail and commercial financial market as a deposit and loan specialist from 13
full service offices located in Warrenton, Herndon, Middleburg, Winchester,
Leesburg, Fairfax, Sterling, Woodbridge, Manassas and Fredericksburg, Virginia.
Southern Financial's defined market area forms a semi-circle to the west of the
metropolitan Washington, D.C. area roughly centered on Warrenton. The counties
included in the defined market area where Southern Financial currently operates
branches include: Loudoun, Fauquier, Fairfax, Frederick and Prince William and
the cities of Fredericksburg and Winchester. 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 Southern Financial'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, Connecticut and White Plains, New York 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 Southern Financial 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. Southern Financial
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. Southern Financial is an active commercial lender that often
lends in conjunction with the SBA 7(a) and 504 loan programs. In addition,
Southern Financial is an active residential construction lender and offers its
retail clients a full menu of permanent residential mortgage loan alternatives.
Southern Financial also invests funds in mortgage-backed securities, securities
issued by agencies of the Federal Government, obligations of counties and
municipalities and corporate obligations.
The principal sources of funds for Southern Financial'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 investment securities, Federal Home Loan Bank advances
and other borrowed money.
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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. Southern Financial's principal
expenses include interest paid on deposits and advances from the Federal Home
Loan Bank and other borrowings, and operating expenses.
Lending Activities
The principal lending activity of Southern Financial is the origination
of loans on commercial real estate primarily through various lending programs of
the SBA. Southern Financial is a Preferred Lender in the Richmond District of
SBA and a Certified Lender in the Washington, D.C. District of SBA. In addition,
Southern Financial 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. Southern Financial
also makes owner-occupied residential construction loans secured by first liens
on the properties to which they relate. At December 31, 1998, approximately 80%
of Southern Financial's total loan portfolio, or $107.3 million, consisted of
loans secured by real estate. Southern Financial also makes commercial business
and secured and unsecured consumer loans.
Commercial Real Estate Lending
SBA Lending. Approximately 68% ($44.2 million) of Southern Financial's
nonresidential 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 SBA. The SBA in cooperation with banks and other lending
institutions, finances the expansion of small businesses. As noted above,
Southern Financial is a Preferred Lender in the Richmond District of SBA and a
Certified Lender in the Washington, D.C. District of SBA.
SBA 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 80% of the loan balance under the 7(a) program. At December 31, 1998,
Southern Financial had $3.4 million in SBA 7(a) real estate loans, which
represents 5.2% of total nonresidential mortgage loans receivable.
The 504 loan program is used to finance long-term fixed assets,
primarily real estate and large/heavy equipment. The 504 loan program is an
economic development program designed to create new jobs or retain existing
jobs. The credit structure of the 504 loan program gives borrowers access to 90%
financing of the project. Fifty percent is provided by the financial institution
(in the form of a first lien position) and 40% is provided by the certified
development company (the 504 representative) with a second lien position. The
borrower provides the remaining 10% of the funds required for the project. Of
Southern Financial's $64.9 million in non-residential mortgages, 62.8% ($40.8
million) are 504 loans. During the year ended December 31, 1998, Southern
Financial originated $12 million in loans under the 504 loan program.
Commercial Permanent Lending. Southern Financial offers an extensive
array of commercial real estate loans. These loans are serving both the investor
and owner occupied facility market. At December 31, 1998, approximately 32%
($20.7 million) of Southern Financial's non-residential mortgages are investor
and owner-occupied real estate loans. These loans are secured by real estate
with collateral loan-to-values averaging less than 70%.
Commercial Construction Lending. Southern Financial is involved in
financing the construction phase of small business projects prior to the project
being approved by the SBA. To a lesser extent, Southern Financial also provides
commercial construction financing for projects outside of the SBA
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programs. At December 31, 1998, approximately 8% of Southern Financial's loan
portfolio consisted of nonresidential construction loans.
Commercial Business Lending
In general, commercial business loans involve somewhat more credit risk
than do residential mortgage loans and real estate backed commercial loans and,
therefore, usually yield a higher return to Southern Financial. The increased
credit risk for commercial business 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 mortgage loans. Therefore, Southern Financial
utilizes the SBA 7(a) loan program to reduce the inherent risk associated with
this type of lending. At December 31, 1998, Southern Financial had $24.8 million
in commercial business loans, which represent 18% of Southern Financial's total
loans receivable. Of $24.8 million in non-mortgage business loans, 70% ($17.3
million) are SBA 7(a) loans backed by a guaranty of 75% or 80%. During the year
ended December 31, 1998, Southern Financial originated and closed $11.9 million
in loans under the SBA 7(a) loan program and sold $8 million on the secondary
market.
Residential Lending
Southern Financial makes fixed and adjustable rate, first mortgage
loans with terms up to 30 years. It offers second mortgages in conjunction with
its own first mortgages or those of other lenders. 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 two 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. Southern Financial requires private mortgage insurance for loans
exceeding 80% of the appraised value.
Residential mortgage loans are secured by single-family homes. At
December 31, 1998, loans secured by residential property, both permanent and
construction, totaled $31.2 million, which represented approximately 23% of
total loans receivable. Approximately 19% of the total loans receivable
consisted of loans secured by permanent mortgages on one-to-four family
residential property.
Consumer Lending
Southern Financial offers various types of secured and unsecured
consumer loans. These loans are offered as a convenience to its customer base
since these products are not the focus of Southern Financial's lending
activities. At December 31, 1998, Southern Financial had $2.4 million in
consumer loans which represents 2% of the 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, 1998. 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.
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Loan Portfolio Composition
The following table sets forth the composition of Southern Financial's
loan portfolio at the dates indicated:
<TABLE>
<CAPTION>
At March 31,
1999 1998
Amount Percent Amount Percent
------------------------- ---------------------------
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 26,277 19% $ 29,602 23%
Nonresidential 67,764 49% 57,640 44%
Construction:
Residential 5,733 4% 5,438 4%
Nonresidential 13,613 10% 14,122 11%
------------- ------------- ------------ ------------
Total Mortgage 113,387 81% 106,802 81%
------------- ------------- ------------ ------------
Nonmortgage:
Business 23,611 17% 21,769 17%
Consumer 2,401 2% 2,407 2%
------------- ------------- ------------ ------------
Total Nonmortgage 26,012 19% 24,176 19%
------------- ------------- ------------ ------------
Gross Loans 139,399 100% 130,978 100%
Less:
Deferred Fees 899 632
Allowance for Loan Losses 2,147 2,151
------------- ------------
Total Loans Receivable, Net $136,353 $128,195
============= ============
</TABLE>
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<TABLE>
<CAPTION>
At December 31, At June 30,
1998 1997 1996 1995 1995
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------------------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage:
Residential $26,046 19% $30,421 24% $35,033 32% $37,583 35% $40,123 43%
Nonresidential 64,890 48% 57,160 43% 46,549 42% 36,742 35% 29,216 31%
Construction:
Residential 5,185 4% 6,534 5% 5,616 5% 8,516 8% 8,460 9%
Nonresidential 11,214 8% 13,161 10% 7,510 7% 11,029 10% 5,941 6%
----------- --------- ---------- -------- ---------- --------- --------- ------- -------- -------
Total Mortgage 107,335 80% 107,276 82% 94,708 86% 93,870 88% 83,740 89%
----------- --------- ---------- -------- ---------- --------- --------- ------- -------- -------
Nonmortgage:
Business 24,773 18% 21,253 16% 12,198 11% 9,265 9% 7,601 9%
Consumer 2,425 2% 3,093 2% 3,294 3% 2,761 3% 2,238 2%
----------- --------- ---------- -------- ---------- --------- --------- ------- -------- -------
Total Nonmortgage 27,198 20% 24,346 18% 15,492 14% 12,026 12% 9,839 11%
----------- --------- ---------- -------- ---------- --------- --------- ------- -------- -------
Gross Loans 134,533 100% 131,622 100% 110,200 100% 105,896 100% 93,579 100%
Less:
Deferred Fees 837 627 412 455 442
Allowance for Loan Losses 2,051 2,037 1,501 1,190 1,057
----------- ---------- ---------- --------- --------
Total Loans Receivable, Net $131,645 $128,958 $108,287 $104,251 $92,080
=========== ========== ========== ========= ========
</TABLE>
The following table sets forth the scheduled maturity of selected loans
as of March 31, 1999:
<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> <C> <C> <C> <C> <C>
Construction:
Residential $ 5,733 $ - $ - $ - $ - $ 5,733
Nonresidential 13,613 - - - - 13,613
Business 12,811 2,498 2,791 959 4,552 23,611
------------- ------------- ------------- ------------- ------------- -------------
Total $ 32,157 $ 2,498 $ 2,791 $ 959 $ 4,552 $ 42,957
============= ============= ============= ============= ============= =============
</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
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creditworthiness, likelihood of repayment and proximity to market areas served
indicate that such extensions of credit will provide acceptable profitability to
Southern Financial.
Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All property valuations are performed by independent outside
appraisers who are reviewed by the Vice President of Real Estate Lending who
reports his findings annually to Southern Financial's board of directors.
It is Southern Financial's policy to retain a mortgage creating a valid
lien on real estate and to obtain a title insurance policy that insures the
property is free of encumbrances. Also required from the borrower 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.
The aggregate amount of loans that Southern Financial may make to one
borrower is limited to 15% of Southern Financial's unimpaired capital and
surplus. The maximum amount of loans that Southern Financial could have made to
one borrower as of December 31, 1998 was approximately $3.1 million based on 15%
of its unimpaired capital and surplus. As of December 31, 1998, the largest
aggregate amount of such loans by Southern Financial to any one borrower was
$3.1 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
52
<PAGE>
the default, including commencing foreclosure action with respect to mortgage
loans and repossessions of collateral in the case of consumer loans.
If foreclosure is effected, the property is sold at a public auction in
which Southern Financial may participate as a bidder. If Southern Financial is
the successful bidder, the acquired real estate property is then included in its
real estate owned account until it is sold. Such assets are carried at the lower
of cost or fair value net of estimated selling costs. To the extent there is a
decline in value, that amount is charged to operating expense.
Past Due 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 March 31, At December 31, At June 30,
1999 1998 1998 1997 1996 1995 1995
------------ ------------ ----------- ----------- ------------ ----------- -----------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Accruing Loans 90 Days
or More Delinquent
Residential $ - $ 107 $ - $ - $ - $ 878 $ 607
Nonresidential 82 2,500 - - 28 - 196
Business 207 115 225 1 - - -
Consumer 6 - 11 - - 3 2
------------ ------------ ------------ ----------- ------------ ----------- -----------
Total 295 2,722 236 1 28 881 805
============ ============ ============ =========== ============ =========== ===========
Nonperforming Loans
Residential - 492 291 443 321 541 -
Nonresidential 1,019 1,000 1,033 1,002 1,257 - -
Business 500 - 659 - 49 - 39
Consumer - - - - 7 50 15
------------ ------------ ------------ ----------- ------------ ----------- -----------
Subtotal 1,519 1,492 1,983 1,445 1,634 591 54
------------ ------------ ------------ ----------- ------------ ----------- -----------
Real Estate Owned
Residential 72 166 72 176 340 357 387
------------ ------------ ------------ ----------- ------------ ----------- -----------
Total Nonperforming Assets $ 1,591 $ 1,658 $ 2,055 $ 1,621 $ 1,974 $ 948 $ 441
============ ============ =========== =========== ============ =========== ============
Nonperforming Assets
To Total Assets 0.59% 0.71% 0.91% 0.72% 1.03% 0.58% 0.28%
============ ============ ============ =========== ============ =========== ===========
</TABLE>
Southern Financial's loss and delinquency experience on its residential
real estate loan portfolio has been limited by a number of factors, including
its underwriting standards. Whether Southern Financial's loss and delinquency
experience will increase significantly depends upon the value of the real estate
securing its loans, economic factors such as an increase in unemployment as well
as the overall economy of the region. As a result of economic conditions and
other factors beyond its control, Southern Financial's future loss and
delinquency experience cannot be accurately predicted. However, management has
provided an allowance for loan losses which it believes will be adequate to
absorb future losses.
53
<PAGE>
At December 31, 1998, loans totaling $1.7 million were classified as
potential problem loans that are not reported in the table above. The loans are
subject to management attention and their classification is reviewed on a
quarterly basis. At December 31, 1998, all of the potential problem loans were
adequately secured in the opinion of management.
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. Southern Financial 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.
54
<PAGE>
The following table summarizes activity in Southern Financial's
allowance for loan losses during the periods indicated.
<TABLE>
<CAPTION>
Six Months
Three Months Ended Year Ended Ended Year Ended
March 31, December 31, December 31, June 30,
1999 1998 1998 1997 1996 1995 1995
--------- --------- --------- --------- --------- --------- ---------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Allowance at Beginning of Period $ 2,051 $ 2,037 $ 2,037 $ 1,501 $ 1,190 $ 1,057 $ 1,008
Provision for Losses 275 225 975 880 695 150 60
Charge-offs:
Residential -- (111) (221) (65) (8) -- --
Nonresidential (50) -- (261) (200) (300) -- --
Business (319) -- (492) (77) (38) (16) --
Consumer (12) -- (3) (27) (43) (1) (11)
--------- --------- --------- --------- --------- --------- ---------
Total Charge-offs (381) (111) (977) (369) (389) (17) (11)
--------- --------- --------- --------- --------- --------- ---------
Recoveries:
Residential 1 -- -- 12 -- -- --
Nonresidential 200 -- -- -- -- -- --
Business 1 -- 13 6 3 -- --
Consumer -- -- 3 7 2 -- --
--------- --------- --------- --------- --------- --------- ---------
Total Recoveries 202 -- 16 25 5 -- --
--------- --------- --------- --------- --------- --------- ---------
Net Charge-offs (179) (111) (961) (344) (384) (17) (11)
--------- --------- --------- --------- --------- --------- ---------
Allowance at End of Period $ 2,147 $ 2,151 $ 2,051 $ 2,037 $ 1,501 $ 1,190 $ 1,057
========= ========= ========= ========= ========= ========= =========
Loans at End of Period $ 138,500 $ 130,346 $ 133,696 $ 130,995 $ 109,788 $ 105,441 $ 93,137
Ratio of Allowance to Loans 1.55% 1.65% 1.53% 1.56% 1.37% 1.13% 1.13%
</TABLE>
The following table summarizes the composition of the Allowance for
Loan Losses.
<TABLE>
<CAPTION>
At March 31,
1999 1998
Amount Percent Amount Percent
--------------- ---------------- ---------------- ---------------
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 28 1.30% $ 172 7.99%
Nonresidential 903 42.04% 1,244 57.78%
Construction:
Residential 23 1.09% 22 1.04%
Nonresidential 56 2.60% 47 2.20%
Nonmortgage:
Business 707 32.95% 436 20.28%
Consumer 37 1.72% 41 1.92%
Unallocated 393 18.30% 189 8.79%
--------------- ---------------- ---------------- ---------------
Allowance for Loan Losses $ 2,147 100.00% $ 2,151 100.00%
=============== ================ ================ ===============
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
At December 31, At June 30,
1998 1997 1996 1995 1995
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
----------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage:
Residential $ 68 3% $ 140 7% $ 152 10% $ 413 35% $ 79 7%
Nonresidential 751 37% 1,162 57% 708 47% 249 21% 188 18%
Construction:
Residential 21 1% 27 1% 23 2% 123 10% 254 24%
Nonresidential 46 2% 43 2% 131 9% 133 11% 227 21%
Nonmortgage:
Business 687 33% 438 22% 382 25% 219 18% 262 25%
Consumer 38 2% 41 2% 105 7% 53 4% 47 4%
Unallocated 440 21% 186 9% -- --% -- --% -- --%
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Allowance for Loan Losses $2,051 100% $2,037 100% $1,501 100% $1,190 100% $1,057 100%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
Southern Financial 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.
56
<PAGE>
Investment Activities
The following table sets forth the investment portfolio as of the
periods indicated:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998 1998 1997 1996
-------------- -------------- --------------- -------------- --------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Available-for-sale securities:
(at estimated fair value)
FHLMC preferred stock $ - $ 3,859 $ 3,808 $ 3,866 $ 4,310
FHLMC MBS 9,739 3,053 11,996 - -
GNMA MBS 3,373 9,097 3,826 - -
FNMA MBS 25,807 1,738 29,671 782 903
Collateralized mortgage obligations 19,346 - 1,527 - -
Commercial MBS 20,116 - 18,044 - -
Obligations of counties and municipalities 3,331 - 3,234 - -
Corporate obligations 969 - 989 - -
U.S. Government agency obligations 995 - 949 - -
-------------- -------------- --------------- -------------- --------------
$ 83,676 $ 17,747 $ 74,044 $ 4,648 $ 5,213
============== ============== =============== ============== ==============
Held-to-maturity securities:
(at amortized cost)
FHLMC MBS $ 3,663 $ 5,587 $ 4,091 $ 6,078 $ 7,300
GNMA MBS 21,798 39,233 24,305 42,471 27,388
FNMA MBS 6,200 25,230 6,780 27,075 21,982
Collateralized mortgage obligations 83 3,235 1,015 4,203 6,547
Obligations of counties and municipalities 1,959 - 1,960 - -
U.S. Government agency obligations - 654 - 642 2,000
------------- --------------- ---------------- -------------- --------------
$ 33,703 $ 73,939 $ 38,151 $ 80,469 $ 65,217
============= =============== ================ ============== ==============
</TABLE>
Source of Funds
Deposits
Deposit accounts have been the primary source of 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
Federal Home Loan Bank advances. Borrowings may be used as an alternative source
of lower costing funds or to fund the origination of certain assets.
57
<PAGE>
The following tables show the average balances and rates (presented on
a monthly average basis) for Southern Financial's deposits for the periods
indicated:
<TABLE>
<CAPTION>
(amounts in thousands) March 31, 1999
---------------------------------------------
Average Average
Balance Rate
----------------- -----------------
<S> <C> <C>
Demand $ 21,280 0.00%
Interest checking 19,201 0.89%
Money market and savings 28,483 2.75%
Certificates of deposit 167,215 5.34%
-----------------
Total $236,180
=================
Weighted average rate 4.18%
=================
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
(amounts in thousands) 1998 1997 1996
---------------------------- ---------------------------- ----------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------- ------------ ------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Demand $ 16,315 0.00% $ 9,878 0.00% $ 6,658 0.00%
Interest checking 17,479 1.22% 15,720 1.18% 14,755 1.44%
Money market and savings 25,369 3.05% 22,834 3.33% 21,066 3.37%
Certificates of deposit 155,208 5.76% 135,863 5.71% 115,672 5.63%
------------- ------------- ------------
Total $ 214,370 $ 184,296 $ 158,151
============= ============= ============
Weighted average rate 4.63% 4.73% 4.70%
============ ============ ============
</TABLE>
The following table sets forth by time remaining until maturity
Southern Financial's certificates of deposit of $100,000 or more at March 31,
1999:
Time Deposits of
Maturity Period $100,000 or More
- ------------------------------------------ -----------------------
(amounts in thousands)
Three months or less $ 34,743
Over three months through twelve months 21,865
Over twelve months 4,187
-----------------------
Total $ 60,795
=======================
58
<PAGE>
Borrowings
Borrowings consist of short-term advances from the Federal Home Loan
Bank of Atlanta. The following table sets forth information regarding Southern
Financial's borrowings for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
1999 1998 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Ending Balance $ 3,000 $ - $ 3,500 $ 4,000 $ 8,500
Average Balance for the Period 8,383 2,832 4,907 5,979 6,077
Maximum Month-end Balance
During the Period 4,500 5,000 13,500 8,500 12,000
Average Interest Rate for the Period 4.91% 5.58% 5.50% 5.59% 5.63%
Weighted Average Interest Rate at
the End of the Period 5.75% - 5.15% 5.95% 6.57%
</TABLE>
Competition
Southern Financial experiences substantial competition in attracting
and retaining savings deposits and in lending funds. The primary factors in
competing for savings deposits 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, 1998, Southern Financial employed 79 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
Until recently, many companies had operating computer applications
which used only two digits to identify a year in the date field. These
applications were designed and developed without considering the potential
impact of the rapidly approaching millennium. If these fields were not corrected
computer applications could fail or create a magnitude of erroneous results in
the Year 2000. Therefore, in order to effectively address the Year 2000
concerns, Southern Financial's board of directors approved a plan to mitigate
the risks associated with the Year 2000.
This plan, which is managed as outlined by the Federal Financial
Institutions Examination Council ("FFIEC") addresses the essential five phases:
Awareness, Assessment, Renovation, Validation and Implementation.
59
<PAGE>
The Awareness and Assessment phases of the plan were completed in 1998.
Southern Financial has ensured that customers received statement stuffers and
newsletters apprising them of the status of the plan. Year 2000 status updates
have been incorporated into Southern Financial's web site,
www.southernfinancialbank.com, and are regularly updated. Southern Financial
contacted its material business partners to determine their state of readiness
and the potential impact on Southern Financial by sending letters to them
requesting updates on their own year 2000 initiatives. Through these endeavors,
systems were upgraded and tested to ensure meeting Year 2000 readiness. Those
systems that did not meet Year 2000 requirements have been replaced.
The phases of the plan that include Renovation, Validation and
Implementation were completed by December 31, 1998. Southern Financial completed
upgrading and/or replacements of its branch operating computer systems ahead of
schedule. The upgrades and/or replacements of the computers were necessitated by
the requirement to perform end-to-end testing with Intrieve, Inc. ("Intrieve"),
Southern Financial's data processing system provider, on November 8, 1998. All
Intrieve-related systems passed the Year 2000 performance test. Additionally,
the EFT operating systems have been tested to confirm the capability to receive
and send account information. EFT systems include the ATM Network and Direct
Teller System. Through a partnership with Intrieve, OnLine Resources
Corporation, ("ORCC"), based in McLean, Virginia, manages Southern OnLine, the
bank's remote banking service, with all transactions flowing through the EFT
system. ORCC received Year 2000 certification in February 1999. Testing between
Intrieve and ORCC will be scheduled for the second quarter of 1999. Since
Intrieve is responsible for the major portion of the plan, continued focus will
be directed throughout 1999. Intrieve is actively addressing all issues
associated with this time critical issue. Intrieve has completed the upgrades
for its mission critical system for Year 2000 readiness. Additionally,
throughout 1999, Intrieve will continue to test and further develop their
systems.
Southern Financial, as well as Intrieve, is focusing on the completion
of its Year 2000 contingency plan, which is due for completion June 30, 1999.
This critical phase of the contingency plan provides the details concerning how
Southern Financial will operate in the event there are system failures and power
failures. Southern Financial's contingency plan will outline how the branches
and the corporate office will function if circumstances are presented which
affect the normal course of business. On the other hand, while unlikely, it is
acknowledged that Southern Financial's failure to successfully implement its
Year 2000 plan or to adequately assess the likelihood of events relating to the
Year 2000 issue, could have a material adverse impact on operations. Therefore,
based on the severity of the situation, Intrieve could readily implement their
disaster recovery systems to permit continuing to provide data processing
services. Additionally, Intrieve has implemented two additional services, the
first being a special trial balance run on December 25, 1999. This information
will prove to be critical if system communications are affected on the first day
of business in Year 2000. Secondly, Intrieve will provide a communications
connectivity test opportunity on January 1, 2000 from 11:00 a.m. to 1:00 p.m.
EST. The purpose of this test is to verify transmission functionality before
opening the doors for business on January 3, 2000. All branches will participate
in this critical test as a means of preventative action.
The total costs associated with becoming Year 2000 compliant are
expected to be less than $100 thousand and are not expected to have a material
impact on the results of operations. As of December 31, 1998, Southern Financial
had incurred approximately $50 thousand of costs to become Year 2000 compliant.
Intrieve has made substantial investments in software and hardware to become
Year 2000 compliant. Costs related to these investments have not been passed on
to Southern Financial.
The costs of the project and the date on which Southern Financial plans
to complete the contingency plan are based on management's best estimates. There
can be no assurance that these estimates will be achieved and actual results
could differ from those plans.
60
<PAGE>
Offices and Other Material Properties
At March 31, 1999, Southern Financial conducted its business from its
main office in Warrenton, Virginia and 12 branch offices. The following table
sets forth certain information with respect to the offices of Southern Financial
as of March 31, 1999:
<TABLE>
<CAPTION>
=================================================================================================
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
=================================================================================================
<S> <C> <C> <C>
Home Office:
37 E. Main Street Leased September February
Warrenton, VA 2003 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 2003 1995
1095 Millwood Pike Owned N/A July
Winchester, VA 1996
46910 Community Plaza Leased May April
Sterling, VA 2008 1998
2062 Plank Road Leased September January
Fredericksburg, VA 2016 1999
10175 Hastings Drive Leased September March
Manassas, VA 2004 1999
=================================================================================================
</TABLE>
61
<PAGE>
Legal Proceedings
Southern Financial is not a party to, nor is any of their property the
subject of, any material pending legal proceedings incidental to its business
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
Southern Financial.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview
Southern Financial's net income was $698 thousand for the three months
ended March 31, 1999, compared to $630 thousand for the three months ended March
31, 1998, an increase of $68 thousand, or 10.7%. Diluted earnings per share were
$0.41 and $0.37 for the three months ended March 31, 1999 and 1998,
respectively. The weighted average number of diluted shares of common stock
outstanding were 1,685,143 and 1,709,010 for the same periods in 1999 and 1998,
respectively.
Net income for the year ended December 31, 1998, was a record $2.7
million ($1.55 diluted earnings per share), an increase of 21% over earnings of
$2.2 million ($1.33 diluted earnings per share) for the year ended December 31,
1997. Total assets increased 14% to $258.8 million at December 31, 1998, from
$226.6 million at December 31, 1997. Total loans outstanding and loans held for
sale increased to $132.2 million from $130.4 million at December 31, 1997.
Investment securities rose from $85.2 million at December 31, 1997, to $112.6
million at December 31, 1998, an increase of 32%. Deposits increased 15%, rising
to $231.9 million at December 31, 1998, from $202.2 million at December 31,
1997. Since December 31, 1997, the number of deposit accounts has increased from
22,319 to 23,382, or 5%.
Balance sheet. Total assets of Southern Financial at March 31, 1999
were $269.7 million, an increase of $10.9 million, or 4.2%, from total assets of
$258.8 million at December 31, 1998. Total liabilities increased by $10.2
million, or 4.3%, to $248.1 million at March 31, 1999 from $237.9 million at
December 31, 1998. The growth in total assets resulted primarily from increases
of $4.8 million in investment securities and $4.7 million in loans receivable
from December 31, 1998 to March 31, 1999.
Total assets were $258.8 million at December 31, 1998, an increase of
$32.2 million, or 14.2%, from $226.6 million at December 31, 1997. This growth
was due to an increase in investment securities of $27.4 million, or 32.2%, to
$112.6 million at December 31, 1998 from $85.2 million at December 31, 1997, and
an increase in loans receivable of $2.7 million, or 2.1%, to $131.6 million at
December 31, 1998 from $129 million at December 31, 1997. Total liabilities
increased $29.9 million, or 14.4%, to $237.9 million at December 31, 1998 from
$208.1 million at December 31, 1997.
Loans. Total loans receivable increased by $4.7 million to $136.3
million at March 31, 1999 from $131.6 million at December 31, 1998, as new loan
originations more than offset loan sales and prepayments of residential mortgage
loans during the period. In this period Southern Financial sold the guaranteed
portion of some of the SBA loans that it held in portfolio. These sales totaled
$2.8 million. Residential mortgage loans (permanent and construction) increased
$779 thousand from $31.2 million at December 31, 1998, to $32 million at March
31, 1999. Non-residential construction mortgage loans increased by $2.4 million,
or 21.4%, to $13.6 million at March 31, 1999, from $11.2 million at December
62
<PAGE>
31, 1998. Non-residential permanent mortgage loans increased by $2.9 million to
$67.8 million at March 31, 1999, from $64.9 million at December 31, 1998.
Non-mortgage business loans decreased $1.2 million to $23.6 million at March 31,
1999, from $24.8 million at December 31, 1998.
Loans receivable, net of deferred fees and allowance for losses, were
$131.6 million at December 31, 1998, an increase of $2.7 million, or 2.1%, from
$128.9 million at December 31, 1997. During the year ended December 31, 1998,
Southern Financial continued to emphasize loan originations connected with
various lending programs of the SBA. In addition, Southern Financial sold for
the first time the guaranteed portion of some of its SBA loans. These sales
totaled $8.2 million. Also during 1998, new mortgage loan originations did not
fully offset sales and prepayments of residential mortgage loans. As a result,
the growth in the loan portfolio occurred in non-mortgage business loans, which
increased by $3.5 million, and in loans secured by nonresidential property,
which increased by $7.7 million, or 13.5% over 1997. Residential mortgage loans
decreased from $30.4 million at December 31, 1997 to $26.0 million at December
31, 1998, a decrease of $4.4 million. The weighted average interest rate on
total loans receivable decreased to 9.01% at December 31, 1998 from 9.37% at
December 31, 1997.
Investment securities. Investment securities available-for-sale
increased from $74.4 million at December 31, 1998, to $83.7 million at March 31,
1999. There were purchases of $20.1 million of investment securities, all of
which were designated as available-for-sale. There were repayments and
amortization of $10.8 million of investment securities available-for-sale during
the period. Investment securities held-to-maturity decreased by $4.4 million to
$33.7 million at March 31, 1999, from $38.2 million at December 31, 1998. This
decrease resulted from repayments and amortization during the period.
The portfolio of investment securities at December 31, 1998 consisted
of $38.2 million in securities classified as held-to-maturity and $74.4 million
classified as available-for-sale. The portfolio of securities held-to-maturity
consisted of FNMA, GNMA and FHLMC mortgage-backed securities, collateralized
mortgage obligations, and obligations of counties and municipalities. The
investment securities classified as available-for-sale consisted of FNMA, GNMA,
and FHLMC mortgage-backed securities, collateralized mortgage obligations,
commercial mortgage-backed securities, obligations of counties and
municipalities, corporate debt securities, and obligations of
government-sponsored agencies. Southern Financial reclassified $18.2 million of
investment securities from held-to-maturity to available-for-sale on October 1,
1998, in connection with the adoption of SFAS 133.
Liabilities. The increase in total assets was funded by an increase in
customer deposits of $10.8 million, or 4.6%, to $242.7 million at March 31, 1999
from $231.9 million at December 31, 1998. The increase in assets was funded
primarily by an increase in customer deposits. Deposits at December 31, 1998
were $231.9 million, an increase of $29.7 million, or 14.7%, over deposits of
$202.2 million at December 31, 1997. The weighted average interest rate for all
accounts decreased to 4.18% at December 31, 1998 from 4.79% at December 31,
1997. The increase in deposits reflects the April 1998 opening of a new branch
in Sterling, as well as growth in Southern Financial's customer base at all
branches.
Advances from the Federal Home Loan Bank of Atlanta totaled $3.5
million at December 31, 1998, a decrease of $.5 million from $4.0 million at
December 31, 1997.
Results of Operations
The operating results of Southern Financial depend primarily on its net
interest income, which is the difference between interest and dividend income on
interest-earning assets, such as loans and investments, and interest expense on
interest-bearing liabilities such as deposits and borrowings. Operating results
are also affected by the level of its noninterest income, including income or
loss from
63
<PAGE>
the sale of loans and fees and service charges on deposit accounts, and by the
level of its operating expenses, including compensation, premises and equipment,
deposit insurance assessments and income taxes. The following tables provide
information regarding changes in interest income and interest expense, as well
as the underlying components of interest-earning assets and interest-bearing
liabilities.
The following table presents, for periods indicated, average balances
of and weighted average yields on interest-earning assets and average balances
of and weighted average effective rates paid on interest-bearing liabilities.
Calculations have been made utilizing month-end average balances for loans and
investment securities and daily average balances for borrowings and deposits,
and the effect of the interest rate swaps entered into during the three months
ended March 31, 1999 is reflected in the average rate on deposits. Loan balances
do not include non-accrual loans. See additional details regarding the interest
rate swaps under the discussion of Southern Financial's quantitative and
qualitative disclosures about market risk.
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
-----------------------------------------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
------------------------------ -------------------------------
($ in thousands)
<S> <C> <C> <C> <C>
Interest-earning assets
Loans receivable $ 135,549 9.30 % $ 128,222 9.82 %
Investment securities 118,759 6.16 91,549 6.45
--------------- ---------- --------------- ------------
Total interest-earning assets 254,308 7.84 219,771 8.42
--------------- ---------- --------------- ------------
Interest-bearing liabilities
Deposits 236,180 4.18 205,984 4.82
Borrowings 8,383 4.91 2,832 5.58
--------------- ---------- --------------- ------------
Total interest-bearing liabilities 244,563 4.21 208,816 4.83
--------------- ---------- --------------- ------------
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 9,745 10,955
--------------- ---------------
Interest rate spread 3.63 3.59
---------- ------------
Interest margin 3.79 3.83
---------- ------------
</TABLE>
64
<PAGE>
Average Balances, Yields and Rates
(in thousands)
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31 December 31 December 31
1998 1997 1996
----------------------------------------------------------------------------
Average Average Average Average Average Average
balance yield/rate balance yield/rate balance yield/rate
------------------------------------------------- ------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans receivable $128,602 9.61 % $118,809 9.74 % $ 106,254 9.70 %
Investments 105,072 6.06 83,900 6.48 67,910 6.35
---------------------- ---------------------- ---------------------
Total interest-earning assets 233,674 8.02 202,709 8.39 174,164 8.39
---------------------- ---------------------- ---------------------
Interest-bearing liabilities
Deposits 214,370 4.63 184,296 4.73 158,151 4.70
Borrowings 4,907 5.50 5,979 5.59 6,077 5.63
---------------------- ---------------------- ---------------------
Total interest-bearing liabilities 219,277 4.65 190,275 4.76 164,228 4.73
---------------------- ---------------------- ---------------------
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 14,397 12,434 9,936
------------ ------------ -----------
Interest rate spread 3.37 3.63 3.66
--------- --------- ---------
Interest margin 3.66 3.92 3.93
--------- --------- ---------
</TABLE>
The following table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to changes in volume (changes in volume
multiplied by old rate) and changes in rate (changes in rate multiplied by old
volume). The dollar changes in interest income and interest expense attributable
to changes in rate/volume (change in rate multiplied by change in volume) have
been allocated between rate and volume variances based on the percentage
relationship of such variances to each other. The effect of the interest rate
swaps entered into during the three months ended March 31, 1999 is reflected in
interest expense on deposits.
<TABLE>
<CAPTION>
Three Months Ended
March 31, 1999
Compared to Three Months Ended
March 31, 1998
------------------------------------------------------
Volume Rate Total
---------------- -------------- ---------------
($ in thousands)
<S> <C> <C> <C>
Interest income
Loans receivable $ 171 $ (168) $ 3
Investment securities 415 (67) 348
---------------- -------------- ---------------
Total interest income 586 (235) 351
---------------- -------------- ---------------
Interest expense
Deposits 339 (348) (9)
Borrowings 69 (6) 63
---------------- -------------- ---------------
Total interest expense 408 (354) 54
---------------- -------------- ---------------
Net interest income 178 119 297
================ ============== ===============
</TABLE>
65
<PAGE>
Rate /Volume Analysis
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1998 Year ended December 31, 1997
compared compared
to year ended December 31, 1997 to year ended December 31, 1996
-------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest income
Loans Receivable $ 954 $ (156) $ 798 $ 1,218 $ 42 $ 1,260
Investments 1,299 (371) 928 1,035 95 1,130
-------------------------------------------------------------------------------
Total interest income 2,253 (527) 1,726 2,253 137 2,390
-------------------------------------------------------------------------------
Interest expense
Deposits 1,411 (186) 1,225 1,229 47 1,276
Borrowings (59) (5) (64) (6) (2) (8)
-------------------------------------------------------------------------------
Total interest expense 1,352 (191) 1,161 1,223 45 1,268
-------------------------------------------------------------------------------
Net interest income 901 (336) 565 1,030 92 1,122
-------------------------------------------------------------------------------
</TABLE>
Comparison of the Quarter Ended March 31, 1999
With the Quarter Ended March 31, 1998
General. Southern Financial's net income was $698 thousand for the
three months ended March 31, 1999, compared to $630 thousand for the three
months ended March 31, 1998, an increase of $68 thousand, or 10.7%. Diluted
earnings per share were $0.41 and $0.37 for the three months ended March 31,
1999 and 1998, respectively. The weighted average number of diluted shares of
common stock outstanding were 1,685,143 and 1,709,010 for the same periods in
1999 and 1998, respectively.
Net interest income. Net interest income before provision for loan
losses for the three months ended March 31, 1999 was $2.4 million, an increase
of $296 thousand, or 14.3%, from $2.1 million for the three months ended March
31, 1998. The increase resulted primarily from growth in average
interest-earning assets, which was partially offset by a decrease in interest
margin. Total interest-earning assets in the three months ended March 31, 1999
averaged $254.3 million as compared to $219.8 million for the same period in
1998. For the three months ended March 31, 1999, the interest rate spread was
3.63%, an increase of 4 basis points from 3.59% for the three months ended March
31, 1998. The yield on interest-earning assets for the three months ended March
31, 1999 was 7.84%, a decrease of 58 basis points from the same period last
year. The cost of interest-bearing liabilities decreased by 62 basis points to
4.21% for the three months ended March 31, 1999 from 4.83% for the three months
ended March 31, 1998.
Total interest income. Total interest income increased by $351 thousand,
or 7.9%, to $4.9 million for the three months ended March 31, 1999 from $4.6
million for the three months ended March 31, 1998. This increase was primarily
due to an increase of $27.2 million in average investment securities to $118.8
million for the three months ended March 31, 1999 from $91.5 million for the
three months ended March 31, 1998. The yield on average investment securities
decreased 29 basis points from 6.45% for the quarter ended March 31, 1998, to
6.16% for the quarter ended March 31, 1999. Average loans receivable increased
by $7.3 million from $128.2 million in the three months ended March 31, 1998 to
$135.5 million in the three months ended March 31, 1999. The yield on average
loans receivable was 9.30% for the three months ended March 31, 1999, a decrease
of 52 basis points from a yield of 9.82% for the same period last year.
66
<PAGE>
Total interest expense. Total interest expense increased by $54
thousand, or 2.2%, to $2.54 million for the three months ended March 31, 1999
from $2.49 million for the three months ended March 31, 1998. Customer deposits
averaged $236.2 million for the three months ended March 31, 1999, up $30.2
million from $206 million for the three months ended March 31, 1998. The average
effective rate paid on deposits decreased by 64 basis points to 4.18% in the
1999 period from 4.82% in the 1998 period. Average borrowings were $8.4 million
for the three months ended March 31, 1999, an increase of $5.6 million from $2.8
million for the three months ended March 31, 1998. The average effective rate
paid on borrowings decreased to 4.91% for the three months ended March 31 1999
from 5.58% for the same period in 1998.
Provision for loan losses. The provision for loan losses for the three
months ended March 31, 1999 was $275 thousand, as compared to $225 thousand for
the three months ended March 31, 1998. The provision for loan losses is a
current charge to earnings to increase the allowance for loan losses. Southern
Financial 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 three months ended March 31, 1999, Southern Financial's
volume of non-residential mortgage loans has increased, and these loans tend to
carry a higher risk classification. The increase in the provision for loan
losses reflects the growth in the portfolio of non-residential mortgage loans.
It is the opinion of Southern Financial that the allowance for loan losses at
March 31, 1999 remains adequate. Although Southern Financial 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
Southern Financial's results of operations. The allowance for loan losses at
March 31, 1999 was $2.15 million, or 1.54% of total loans receivable, versus
$2.05 million at December 31, 1998, which was 1.52% of total loans receivable.
During the three months ended March 31, 1999 charge-offs amounted to
$380 thousand compared to $111 thousand during the same period last year. These
charge-offs were related to non-mortgage business loans. Recoveries amounted to
$202 thousand during the three months ended March 31, 1999, most of which was
related to one non-residential mortgage loan that was charged off in 1996.
Other income. Other income for the three months ended March 31, 1999
was $686 thousand as compared to $489 thousand for the three months ended March
31, 1998, an increase of $197 thousand, or 40.2%. Gain on sale of loans
increased by $135 thousand from $138 thousand during the three months ended
March 31, 1998, to $273 thousand for the three months ended March 31, 1999. This
increase was primarily the result of the sale of the guaranteed portion of SBA
loans on which gains have been recognized. Fee income increased $59 thousand
during the three months ended March 31, 1999, compared to the same period last
year, primarily because of more loan-related income.
Other expenses. Other expense increased by $380 thousand, or 26.9%, to
$1.8 million for the three months ended March 31, 1999 from $1.4 million for the
three months ended March 31, 1998, primarily because of expenses related to
operating three new branches that have been open since April 1998. Employee
compensation and benefits increased by $239 thousand, or 36.4%, reflecting
normal wage increases for existing personnel and the cost of staffing the three
new branches. Expenses for premises and equipment increased by $50 thousand, or
20.3%, primarily because of the new branches. Advertising expense increased by
$27 thousand, or 56.6%, primarily because Southern Financial commenced its
internet banking promotion.
67
<PAGE>
Comparison of the Year Ended December 31, 1998
With the Year Ended December 31, 1997
General. Southern Financial's net income for the year ended December
31, 1998 was $2.7 million, an increase of 20.5% over net income of $2.2 million
for the year ended December 31, 1997. The increase in net income was primarily
due to an increase in net interest income of 7.1% and an increase of 35.8% in
other income. Diluted earnings per share for the year ended December 31, 1998
was $1.55 as compared to $1.33 for the year ended December 31, 1997. The
weighted average number of diluted shares of common stock outstanding were
1,713,815 for the year ended December 31, 1998 and 1,657,706 for the year ended
December 31, 1997.
Net interest income. Net interest income before provision for loan
losses was $8.5 million for the year ended December 31, 1998, an increase of
7.1% over $8.0 million for the year ended December 31, 1997. This increase was
due to the growth in the average level of earning assets from $202.7 million to
$233.7 million. The interest rate spread decreased from 3.63% to 3.37% during
the year ended December 31, 1998, and the interest margin went from 3.92% to
3.66% during the same period.
Total interest income. Total interest income was $18.7 million for the
year ended December 31, 1998, an increase of 10.2% over $17.0 million for the
year ended December 31, 1997. This increase resulted from growth in
interest-earning assets. Average loans receivable increased by $9.8 million and
average investment securities increased by $21.2 million over 1997.
The yield on total interest-earning assets was 8.02% for the year ended
December 31, 1998, which decreased from 8.39% for 1997. For the year ended
December 31, 1998, the yield on average loans receivable was 9.61%, down from
9.74% for the year ended December 31, 1997, while the yield on average
investment securities decreased from 6.48% during 1997 to 6.06% for the year
ended December 31, 1998.
Total interest expense. Total interest expense for the year ended
December 31, 1998 was $10.2 million, an increase of 12.8% over $9.0 million for
the year ended December 31, 1997. This increase was due primarily to growth in
the average balance of deposits, which were $214.4 million for the year ended
December 31, 1998 compared to $184.3 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.65% for the year ended
December 31, 1998, a decrease of 11 basis points from 4.76% for the year ended
December 31, 1997.
Provision for loan losses. The provision for loan losses amounted to
$975 thousand for the year ended December 31, 1998, an increase over the
provision of $880 thousand for the year ended December 31, 1997. The provision
for loan losses is a current charge to earnings to increase the allowance for
loan losses. Southern Financial 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, 1998,
Southern Financial'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. Southern Financial's opinion is that the
allowance for loan losses at December 31, 1998 remains adequate. Although
Southern Financial 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 Southern Financial's results of
operations. The allowance for loan losses at December 31, 1998 was $2.1 million,
or 1.52% of total loans receivable compared to $2.0 million, or 1.55% at
December 31, 1997.
68
<PAGE>
Other income. Other income totaled $2.3 million for the year ended
December 31, 1998, an increase of 35.8%, from $1.7 million for the year ended
December 31, 1997. The increase was attributable to gain on sale of loans, which
increased by $605 thousand to $796 thousand for the year ended December 31, 1998
from $192 thousand for the prior year. This increase was primarily the result of
selling the guaranteed portion of SBA loans.
Other expenses. Other expenses for the year ended December 31, 1998
were $6.2 million, an increase of 10.3% from $5.6 million for the year ended
December 31, 1997.
Employee compensation and benefits increased 15.4% to $2.9 million for
the year ended December 31, 1998 from $2.5 million for the prior year. The
increase reflects the cost of staffing the new branch opened in April 1998 and
normal wage increases for existing personnel.
Expenses for premises and equipment decreased $57 thousand during the
year ended December 31, 1998 compared to the prior year. This reduction of
expenses is primarily the result of moving the Fairfax branch to a location
owned by Southern Financial and eliminating the rent expense.
Advertising expense decreased 13.4% to $185 thousand for the year ended
December 31, 1998 from $214 thousand for the prior year as a result of a changed
marketing strategy.
Other expenses increased 28.8% to $1.1 million for the year ended
December 31, 1998 from $887 thousand for the prior year, reflecting higher
miscellaneous expenses.
Comparison of the Year Ended December 31, 1997
With the Year Ended December 31, 1996
General. 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
69
<PAGE>
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.
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. During the year
ended December 31, 1997, Southern Financial'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
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
Southern Financial'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. Southern
Financial's one-time assessment was $830 thousand.
70
<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 Southern Financial's customer base.
Other expenses remained relatively constant during the year ended
December 31, 1997 compared to the prior year.
Asset/Liability Management
Southern Financial, like most other banks, 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 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, 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.
In late 1998, the Asset/Liability Management Committee elected to
purchase and hold for sale fixed rate investment securities since the yield
spread between fixed rate and adjustable rate securities substantially favored
the former and the risk of substantial rises in interest rates was acceptably
low. At year end, Southern Financial held approximately $11.6 million in 15-year
fixed rate residential mortgage-backed securities, $18.2 million in fixed rate
commercial mortgage-backed securities, $4.2 million in fixed rate municipal and
corporate bonds, $1.5 million in fixed rate collaterized mortgage obligations,
and $3.9 million in FHLMC preferred stock.
During the first quarter of 1999, Southern Financial entered into four
swap agreements, each for a notional amount of $5 million, in which Southern
Financial agreed to pay a rate fixed for the period of the swap and receive 3
month LIBOR for the period of the swap. In addition, in the months of January
and February 1999 Southern Financial purchased $20 million of residential and
commercial CMO's. A sustained shift in interest rates could have an impact on
the market value of these securities. A rise in interest rates would decrease
their market value, and a decline in interest rates would increase their market
value.
As a result of entering into the swap agreements and purchasing the
CMO's, Southern Financial's interest sensitivity as reported in its Form 10K for
the year ended December 31, 1998 has changed. Southern Financial's interest rate
sensitivity is primarily monitored by management through the use of a model
which generates estimates of the change in Southern Financial'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 Southern Financial's interest rate risk as measured by the estimated
change in MVPE resulting from instantaneous
71
<PAGE>
and sustained parallel shifts in the yield curve (plus or minus 300 basis
points, measured in 100 basis point increments) as of March 31, 1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
<TABLE>
<CAPTION>
Market Value of Market Value of
Portfolio Equity Portfolio Equity as a % of
-------------------------------------- -----------------------------
Change in
Interest Rates
In Basis Points $ Change % Change Total Portfolio Equity
(Rate Shock) Amount From Base From Base Assets Book Value
------------ ------ --------- --------- ------ ----------
<S> <C> <C> <C> <C> <C>
Up 300 $22,287 (4,567) -17.01% 8.26% 103.01%
Up 200 24,191 (2,663) -9.92% 8.97% 111.80%
Up 100 25,565 (1,289) -4.80% 9.48% 118.15%
Base 26,854 - 0.00% 9.96% 124.11%
Down 100 27,356 502 1.87% 10.14% 126.43%
Down 200 27,442 588 2.19% 10.17% 126.83%
Down 300 28,103 1,249 4.65% 10.42% 129.88%
</TABLE>
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 Southern Financial. Net interest
income represents the difference between income on interest-earning assets and
expense on interest-bearing liabilities including the effect of the interest
rate swaps. Net interest income also depends upon the relative amounts of
interest-earning assets and interest-bearing liabilities and the interest rate
earned or paid on them. In this regard, the model assumes that the composition
of Southern Financial's interest sensitive assets and liabilities existing at
the beginning of a period remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities.
Sensitivity of Net Interest Income
(amounts in thousands)
Change in Adjusted Net
Interest Rates Interest Income Net Interest Margin
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
Up 300 $9,330 -1.76% 3.46% -0.06%
Up 200 9,595 1.03% 3.56% 0.04%
Up 100 9,600 1.08% 3.56% 0.04%
Base 9,497 0.00% 3.52% 0.00%
Down 100 9,390 -1.13% 3.48% -0.04%
Down 200 9,474 -0.24% 3.51% -0.01%
Down 300 9,753 2.70% 3.62% 0.10%
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 certain
72
<PAGE>
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
Southern Financial'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 Southern Financial's worth and
net interest income.
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, Federal Home Loan Bank
advances, other borrowings and retained income.
At March 31, 1999, Southern Financial had $8 million of unfunded lines
of credit and undisbursed construction loan funds of $6.8 million. Approved loan
commitments were $12.6 million at March 31, 1999, and Southern Financial had
commitments from investors to purchase loans in the amount of $2 million. At
December 31, 1998, Southern Financial had $6.5 million of undisbursed loan funds
and $11.8 million of approved loan commitments. The amount of certificate of
deposit accounts maturing in calendar year 1999 is $136.5 million. In addition,
the $3.5 million of Federal Home Loan Bank advances are scheduled to mature in
calendar year 1999. 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 March 31, 1999, Southern Financial exceeded all regulatory capital standards,
which were as follows:
<TABLE>
<CAPTION>
Actual Capital Required Capital Excess Capital
Amount Ratio Amount Ratio Amount Ratio
--------------------------- -------------------------- -------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Leverage capital $ 21,154 8.00% $ 10,577 4.00% $ 10,577 4.00%
Tier 1 capital 21,154 12.99% 6,515 4.00% 14,639 8.99%
Tier 1 and Tier 2 capital 23,191 14.24% 13,030 8.00% 10,161 6.24%
</TABLE>
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 Southern
Financial'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.
73
<PAGE>
Special Note Regarding Forward-Looking Information
Certain statements under the caption "Management's Discussion and
Analysis" and elsewhere in this joint proxy statement/prospectus constitute
"forward-looking statements" within the meaning of the United States Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of Southern Financial, or
industry results, to be materially different from any future results,
performance, or achievements expressed or implied by such forward-looking
statements. Such factors include, among others, the following: general economic
and business conditions in Southern Financial's market area, inflation,
fluctuations in interest rates, changes in government regulations and
competition, which will, among other things, impact demand for loans and banking
services; the ability of Southern Financial to implement its business strategy;
and changes in, or the failure to comply with, government regulations.
Forward-looking statements are intended to apply only at the time they
are made. Moreover, whether or not stated in connection with a forward-looking
statement, Southern Financial undertakes no obligation to correct or update a
forward-looking statement should Southern Financial later become aware that it
is not likely to be achieved. If Southern Financial were to update or correct a
forward-looking statement, investors and others should not conclude that
Southern Financial will make additional updates or corrections thereafter.
74
<PAGE>
CHAPTER IV
DESCRIPTION OF HORIZON
BUSINESS
General
Horizon received its original certificate of incorporation from the
Virginia State Corporation Commission, under the name of "The Guaranty Bank of
Virginia" effective August 31, 1989. On February 15, 1990 Horizon's board of
directors unanimously voted to change the name of the corporation to "The
Horizon Bank of Virginia." Shareholder action was not necessary since the
corporation was in the process of organizing a bank and shareholders had not, as
of the amendment date, fully subscribed to their shares. A Certificate of
Amendment changing the corporation name to "The Horizon Bank of Virginia" was
issued by the Virginia State Corporation Commission effective February 22, 1990.
Headquartered in Merrifield (Fairfax County), Virginia, Horizon serves
the retail and commercial financial market as a deposit and loan specialist from
four full service offices located in Merrifield, Vienna (which includes portions
of Oakton, McLean, and the Tysons Corner corridor), Fairfax City, and Annandale,
Virginia. Horizon's defined market area encompasses Fairfax County.
There is a significant number of major corporate headquarters and high
tech firms located within Horizon's primary market area. A key benefit to
Horizon's branch locations is convenient access to Washington, D.C. and suburban
locations. A majority of Horizon's branches are located in high density business
and commercial areas which are served by several interstate, primary and
secondary roads, including Interstate 495, Interstate 66, Route 50, Route 29,
and Route 123. The branch locations situate Horizon to take full advantage of
the rapid economic growth of the communities in which they serve.
The principal business of Horizon is the acquisition of deposits from
the general public through its administrative and branch offices and use of
these deposits to fund its loan and investment portfolios. Horizon seeks to be a
distinctive customer-oriented full service community bank which provides a wide
variety of financial services to satisfy the demands of the local market and the
needs of the business, professional, and residential communities in the rapidly
growing service area of Horizon. Horizon contributes to the economic and social
well-being of the communities Horizon serves and constantly strives to enhance
shareholder values. Horizon's promotional activities stress the advantages of
engaging in business with a locally owned and operated institution that is
oriented to the particular needs of the community. Horizon is an active
commercial lender that occasionally lends in conjunction with the SBA 7(a) and
504 loan programs. In addition, Horizon is an active residential lender and
offers its retail clients a full menu of permanent residential mortgage loan
alternatives. Horizon also invests funds in treasury securities and securities
issued by agencies of the Federal Government.
The principal sources of funds for Horizon's lending and investment
activities are deposits, amortization and repayment of loans, proceeds from the
sales of mortgage loans, and repayments of maturing investment securities.
Principal sources of revenue are interest and fees on loans and
investment securities, as well as fee income derived from the maintenance of
deposit accounts. Horizon's principal expenses include interest paid on deposits
and operating expenses.
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<PAGE>
Lending Activities
The principal lending activity of Horizon is the origination of
conventional fixed and adjustable rate real estate loans to enable borrowers to
purchase or refinance one-to-four-family, owner-occupied and non-owner occupied
residential properties. In addition, Horizon makes loans on commercial real
estate for the purpose of purchase or refinance of non-residential properties.
Horizon also makes residential construction loans secured by first liens on the
properties to which they relate. At December 31, 1998, approximately 68% of
Horizon's total loan portfolio, or $50.8 million, consisted of loans secured by
real estate. Horizon also makes commercial business and secured and unsecured
consumer loans.
Residential Lending
Horizon provides fixed and adjustable rate, first mortgage loans with
terms up to 40 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 1% to 3% above the prevailing rate for
fixed rate and adjustable rate first mortgages at the time of origination.
Horizon provides construction loans and permanent loans on individual single
family residences and on other residential properties. The majority of these
loans are sold in the secondary market on a servicing released basis.
Construction loans generally have interest rates of prime plus one to two
percent and fees of one to three points, loan-to-value ratios of 80% or less
based on current appraisals and terms of generally twelve months or less. In the
case of conventional loans, Horizon typically lends up to 80% of the appraised
value of single-family residences. Horizon requires private mortgage insurance
for loans exceeding 89% of the appraised value.
Residential mortgage loans are secured by single-family homes. At
December 31, 1998, loans secured by residential property, both permanent and
construction, totaled $30.4 million, which represented approximately 40% of
total loans receivable. Approximately 38% of the total loans receivable
consisted of loans secured by mini-perm and permanent mortgages on one-to-four
family residential property.
Commercial Real Estate Lending
Commercial Permanent Lending. Horizon offers an array of commercial
real estate loans. These loans are serving both the investor and owner occupied
facility market. At December 31, 1998, 100% ($20.2 million) of Horizon's
non-residential mortgages are investor and owner-occupied real estate loans.
These loans are secured by real estate with collateral loan-to-values averaging
less than 75%.
Commercial Construction Lending. Horizon is involved in financing the
construction phase of small business projects. At December 31, 1998,
approximately .3% of Horizon's loan portfolio consisted of nonresidential
construction loans.
Commercial Business Lending
In general, commercial business loans involve somewhat more credit risk
than do residential mortgage loans and real estate backed commercial loans and,
therefore, usually yield a higher return to Horizon. The increased credit risk
for commercial business 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. At December 31, 1998, Horizon had $15.9 million in
commercial business loans, which represent 21% of Horizon's total loans
receivable. Of Horizon's $15.9
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<PAGE>
million in non-mortgage business loans, 5% ($817 thousand) are SBA loans backed
by a guaranty of 80% to 90%. The SBA loan programs are economic development
programs of the SBA. The SBA, in cooperation with banks and other lending
institutions, finances the expansion of small businesses.
Consumer Lending
Horizon offers various types of secured and unsecured consumer loans.
These loans are offered for a variety of purposes such as debt consolidation,
personal lines of credit, overdraft protection, automobile loans and VISA
classic and gold credit cards. At December 31, 1998, Horizon had $9.3 million in
consumer loans which represents 12% of the total loans receivable.
Income From Lending Activities
Interest on loans, gains on sale of loans, and loan fees and service
charges amounted to approximately 76% of Horizon's total revenue for the year
ended December 31, 1998. 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.
Loan Portfolio Composition
The following table sets forth the composition of Horizon's loan
portfolio at the dates indicated:
<TABLE>
<CAPTION>
At March 31,
1999 1998
Amount Percent Amount Percent
------ ------- ------ -------
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 25,939 36% $ 32,642 42%
Nonresidential 21,087 29% 18,226 23%
Construction:
Residential 1,702 2% 1,431 2%
Nonresidential 176 0% 1,019 1%
----------- -----------
Total Mortgage 48,904 67% 53,318 68%
----------- -----------
Nonmortgage:
Business 15,726 22% 15,413 20%
Consumer 8,380 11% 9,471 12%
----------- -----------
Total Nonmortgage 24,106 33% 24,884 32%
----------- -----------
Gross Loans 73,010 100% 78,202 100%
----------- -----------
Less:
Deferred Fees 193 224
Allowance for Loan Losses 1,057 766
----------- -----------
Total Loans Receivable, Net $ 71,760 $ 77,212
=========== ===========
</TABLE>
77
<PAGE>
<TABLE>
<CAPTION>
At December 31,
1998 1997 1996 1995 1994
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage:
Residential $28,776 38% $30,907 40% $24,953 35% $16,417 27% $ 3,302 25%
Nonresidential 20,234 27% 16,944 22% 18,299 26% 17,954 29% 14,342 28%
Construction:
Residential 1,574 2% 2,232 3% 2,421 3% 732 1% 2,012 4%
Nonresidential 190 0% 704 1% 580 1% - -% 585 1%
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total Mortgage 50,774 67% 50,787 66% 46,253 65% 35,103 57% 30,241 58%
Nonmortgage
Business 15,850 21% 15,325 20% 15,596 22% 16,381 26% 11,722 22%
Consumer 9,326 12% 10,431 14% 9,261 13% 10,459 17% 10,578 20%
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total Nonmortgage 25,176 33% 25,756 34% 24,857 35% 26,840 43% 22,300 42%
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Gross Loans 75,950 100% 76,543 100% 71,110 100% 61,943 100% 52,541 100%
Less:
Deferred Fees 228 234 262 165 144
Allowance for Loan Losses 1,011 707 873 851 1,003
------- ------- ------- ------- -------
Total Loans
Receivable, Net $74,709 $75,602 $69,975 $60,927 $51,394
======= ======= ======= ======= =======
</TABLE>
The following table sets forth the scheduled maturity or repricing
frequency of loans as of December 31, 1998 (excluding those in nonaccrual
status):
<TABLE>
<CAPTION>
Three Months Over 3 Months Over 1 Year Over 3 Years Over 5 Years
or Less through 1 Year through 3 Years through 5 Years through 15 Years Over 15 Years
------------ -------------- --------------- --------------- ---------------- -------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Closed-end loans secured by 1st liens
On 1-4 family residential $ 2,216 $ 332 $ 5,970 $ 5,205 $ 7,736 $ 1,182
properties
All loans excluding closed-end loans
Secured by 1st liens on 1-4 family
Residential properties 24,065 4,591 9,861 12,107 1,734 28
------------ -------------- --------------- --------------- ---------------- -------------
Total $ 26,281 $ 4,923 $ 15,831 $ 7,312 $ 9,470 $ 1,210
============ ============== =============== =============== ================ =============
</TABLE>
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<PAGE>
Loan Underwriting Policies
Because future loan losses are so closely intertwined with its
associated underwriting policy, Horizon 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 Horizon'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 the economic environment in which the loan would be
granted will provide acceptable profitability to Horizon.
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 reviewed by the Vice President of the Mortgage Division
and/or the Senior Vice President/Loan Administrator who reports their findings
to Horizon's Executive Committee.
It is Horizon'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 Horizon makes
disbursements for items such as real estate taxes, private mortgage insurance
(required when the loan to value ratio exceeds 89%) and hazard insurance.
Under the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989 ("FIRREA"), the aggregate amount of loans that Horizon may make to one
borrower is limited to 15% of Horizon's unimpaired capital and surplus. The
maximum amount of loans that Horizon could have made to one borrower as of
December 31, 1998 was approximately $1.5 million based on 15% of its unimpaired
capital and surplus. As of December 31, 1998, the largest aggregate amount of
such loans by Horizon to any one borrower was $1.5 million.
When analyzing a potential loan, 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 Horizon 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 Executive Committee, consists of the Chairman of the Board, the
Vice-Chairman of the Board, the President & Chief Executive Officer, the
Secretary of the board and two outside members of the board of directors. This
committee is responsible for the qualitative review of the loan portfolio, for
approving all loans exceeding lending officers' authorities ($150,000 on secured
loans and $100,000 on unsecured 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 Executive Committee are
reported to the full board of directors at its next regularly scheduled meeting.
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<PAGE>
Specific loan authority is granted by the board of directors to
individual officers on a secured and unsecured basis, based upon the individual
officer's technical ability and experience. All authorities are reviewed at
least annually by the full board of directors.
When a borrower fails to make a required payment, Horizon attempts to
cause the deficiency to be cured by contacting the borrower. After 10 days, a
reminder notice is sent indicating that a late charge has been levied. After 20
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, Horizon 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 Horizon may participate as a bidder. If Horizon is the successful bidder,
the acquired real estate property is then included in its real estate owned
account until it is sold. Such assets are carried at the lower of cost or fair
value net of estimated selling costs. To the extent there is a decline in value,
that amount is charged to operating expense.
Past Due Loans and Nonperforming Assets
The following table sets forth information regarding past due loans and
nonperforming assets as of the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended
March 31, Year Ended December 31,
1999 1998 1998 1997 1996 1995 1994
------ ------ ------ ------ ------ ------ ------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Accruing Loans 90 Days
or More Delinquent
Real Estate $ - $ - $ 372 $ - $ 166 $ - $ -
Installment 74 16 220 5 - - -
Credit cards and related plans - 1 - 1 2 - -
Commercial 187 155 58 70 11 - -
------ ------ ------ ------ ------ ------ ------
Total 261 172 650 76 179 - -
====== ====== ====== ====== ====== ====== ======
Nonperforming Loans
Real Estate - - - - - - -
Installment 4 38 6 74 525 35 45
Credit cards and related plans - - - - - - -
Commercial 541 1,214 917 889 672 605 625
------ ------ ------ ------ ------ ------ ------
Subtotal 545 1,252 923 963 1,197 640 670
------ ------ ------ ------ ------ ------ ------
Real Estate Owned
(foreclosed properties) 426 516 426 546 967 1,025 849
------ ------ ------ ------ ------ ------ ------
Total Nonperforming Assets $ 971 $ 1,768 $ 1,349 $1,509 $2,164 $1,665 $1,519
====== ====== ====== ====== ====== ====== ======
Nonperforming Assets
to Total Assets 0.75% 1.52% 0.93% 1.18% 1.81% 1.58% 1.82%
====== ====== ====== ====== ====== ====== ======
</TABLE>
80
<PAGE>
Horizon's loss and delinquency experience on its residential real
estate loan portfolio has been limited by a number of factors, including
Horizon's underwriting standards. Whether Horizon'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, Horizon'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.
At December 31, 1998, loans totaling $1.3 million were classified as
potential problem loans that are not reported in the table above. The loans are
subject to management attention and their classification is reviewed on a
monthly basis. At December 31, 1998, all of the potential problem loans were
adequately secured in the opinion of management.
Allowance for Loan Losses
Management evaluates the adequacy of the allowance at least monthly. As
a result of that process, loans are categorized as to doubtful, substandard
and/or special mention. Each month the board of directors considers a review of
the classified loans in Horizon'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 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 judgment of the
allowance necessary is approximate. The allowance is also subject to regulatory
examinations and determination as to the adequacy of the allowance in comparison
to peer institutions identified by the regulatory agencies.
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<PAGE>
The following table summarizes activity in Horizon's allowance for loan
losses during the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended
March 31, Year Ended December 31,
------------------- ---------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
-------- --------- -------- ---------- --------- ---------- ----------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Allowance at Beginning of Period $1,011 $707 $707 $873 $851 $1,003 $883
Provision for Losses 66 64 326 386 211 178 431
Charge-offs:
Real Estate - - - - - - -
Installment (16) (3) (6) (379) (36) (169) (163)
Credit Card and related plans (5) - - (7) - (6) -
Commercial - (3) (22) (179) (167) (201) (150)
-------- --------- --------- ---------- --------- ---------- ----------
Total Charge-offs (21) (6) (28) (565) (203) (376) (313)
-------- --------- --------- ---------- --------- ---------- ----------
Recoveries:
Real Estate - - - - - - -
Installment 1 1 6 1 6 46 2
Credit Card and related plans - - - - - -
Commercial - - - 12 8 - -
-------- --------- --------- ---------- --------- ---------- ----------
Total Recoveries 1 1 6 13 14 46 2
-------- --------- --------- ---------- --------- ---------- ----------
Net Charge-offs (20) (5) (22) (552) (189) (330) (311)
-------- --------- --------- ---------- --------- ---------- ----------
Allowance at End of Period $ 1,057 $766 $1,011 $707 $873 $851 $1,003
======== ========= ========= ========== ========= ========== ==========
Loans at End of Period $73,010 $78,202 $75,950 $76,543 $71,110 $61,943 $52,541
Ratio of Allowance to Loans 1.45% .98% 1.33% .92% 1.23% 1.37% 1.91%
</TABLE>
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<PAGE>
The following table summarizes the composition of the Allowance for
Loan Losses.
<TABLE>
<CAPTION>
At March 31,
1999 1998
Amount Percent Amount Percent
--------------- ---------------- ---------------- ---------------
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 285 27% $ 280 36%
Nonresidential 190 18% 154 20%
Construction:
Residential - -% 28 4%
Nonresidential - -% - -%
Nonmortgage:
Business 181 17% 90 12%
Consumer 117 11% 61 8%
Unallocated 284 27% 153 20%
--------------- ---------------- ---------------- ---------------
Allowance for Loan Losses $ 1,057 100% $ 766 100%
=============== ================ ================ ===============
</TABLE>
<TABLE>
<CAPTION>
At December 31, At June 30,
1998 1997 1996 1995 1995
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------------------------------------------------------------------------------------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage:
Residential $ 293 29% $ 59 8% $ 225 26% $ 75 9% $ 72 7%
Nonresidential 162 16% 154 22% 202 23% 76 9% 173 17%
Construction:
Residential - -% 28 4% 48 5% 15 2% 46 5%
Nonresidential - -% - -% - -% - -% - -%
Nonmortgage:
Business 65 7% 86 12% 60 7% 88 10% 122 12%
Consumer 113 11% 34 5% 207 24% 267 31% 417 42%
Unallocated 378 37% 346 49% 131 15% 330 39% 173 17%
--------- -------- -------- ------- -------- -------- --------- ------- -------- ---------
Allowance for Loan Losses $ 1,011 100% $ 707 100% $ 873 100% $ 851 100% $ 1,003 100%
========= ======== ======== ======= ======== ======== ========= ======= ======== =========
</TABLE>
Horizon has allocated the allowance according to the amount deemed to
be reasonably necessary to provide for the inherent losses within each of the
above classifications 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.
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<PAGE>
Investment Activities
The following table sets forth Horizon's investment portfolio as of the
periods indicated:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998 1998 1997 1996
-------------- -------------- --------------- ------------ -------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Available-for-sale securities:
FRB stock $ 219 $ 204 $ 205 $ 205 $ 205
FHLB stock 436 - 382 - -
Virginia Bankers Bank stock 54 54 54 54 54
U.S. Treasury Securities 904 1,807 1,207 3,002 3,194
U.S. Government agency obligations 8,982 8,867 7,789 8,756 5,910
-------------- -------------- --------------- ------------ -------------
$ 10,595 $ 10,932 $ 9,637 $12,017 $ 9,363
============== ============== =============== ============ =============
Held-to-maturity securities:
U.S. Treasury Securities $ 6,382 $ 3,297 $ 6,928 $ 3,894 3,590
U.S. Government agency obligations 14,355 6,006 12,604 4,205 6,504
-------------- -------------- --------------- ------------ -------------
$20,737 $ 9,303 $19,532 $ 8,099 $10,094
============== ============== =============== ============ =============
</TABLE>
Source of Funds
Deposits
Deposit accounts have been the primary source of Horizon's funds for
use in lending, making other investments, and for other general business
purposes. In addition to deposits, Horizon obtains funds from loan repayments,
maturing investments, mortgage loan sales, cash flows generated from operations.
Borrowings may be used as an alternative source of lower costing funds or to
fund the origination of certain assets.
The following table shows the average balances and rates (presented on
a monthly average basis) for Horizon's deposits for the periods indicated:
Three Months Ended March 31,
1999 1998
Average Average Average Average
Balance Rate Balance Rate
-------- ------- ------- -------
(amounts in thousands)
Demand $ 24,797 0.00% $ 19,495 0.00%
Interest checking 20,157 2.98% 18,015 3.44%
Money market and savings 23,237 2.87% 22,675 3.28%
Certificates of deposit 51,992 5.44% 42,085 5.67%
-------- ------- ------- -------
$120,183 $102,270
Weighted average rate 3.41% 3.67%
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<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
(amounts in thousands)
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------- ----------- ------------ ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Demand $ 24,126 0.00% $ 1,353 0.00% $16,792 0.00%
Interest checking 17,486 3.50% 12,963 3.16% 8,290 2.76%
Money market and savings 21,514 3.21% 24,718 3.24% 25,452 3.40%
Certificates of deposit 45,694 5.94% 39,916 5.89% 41,151 5.99%
------------- ----------- ------------ ----------- ----------- ----------
$108,820 $98,950 $91,685
Weighted average rate 3.69% 3.60% 3.88%
</TABLE>
The following table sets forth by time remaining until maturity
Horizon's certificates of deposit of $100,000 or more at March 31, 1999:
Time Deposits of
Maturity Period $100,000 or More
-----------------------------
(amounts in thousands)
Three months or less $ 6,179
Over three months through twelve months 7,470
Over twelve months 10,224
-----------------------------
Total $ 23,873
=============================
Competition
Horizon experiences substantial competition in attracting and retaining
deposits and in lending funds. The primary factors in competing for deposits are
convenient office locations and rates offered. Direct competition for deposits
comes from other commercial banks and thrift institutions. Additional
significant competition for 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, 1998, Horizon employed 54 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
Information systems are often complex and have been developed over many
years through a variety of computer languages and hardware platforms. Until
recently, a multitude of companies had operating computer applications which
were designed and developed with only two digits to identify a
85
<PAGE>
year in the date field. If these date fields were not corrected, computer
applications and operating systems could fail or create a magnitude of erroneous
results in the Year 2000.
The Year 2000 problem presents corporate-wide challenges for financial
institutions and their vendors, business partners, counter parties, and
customers. In order to effectively address the Year 2000 concerns, Horizon's
board of directors approved a Year 2000 Compliance Plan and Readiness Disclosure
to mitigate the risks associated with the Year 2000.
The plan, which is managed as outlined by the FFIEC addresses the
primary five phases: Awareness, Assessment, Renovation, Validation and
Implementation.
The Awareness and Assessment phases of the plan were completed in 1998.
Horizon has ensured that customers received statement stuffers educating them on
the Year 2000 issues, as well as informing them of Horizon's strong commitment
to ensuring Year 2000 compliance in order to avoid any significant service
disruptions. Horizon continues to keep an open line of communication to it's
customers by keeping the staff informed and educated on Horizon's progress.
Horizon contacted its material business partners to determine their state of
readiness by sending letters to them requesting updates on their own Year 2000
readiness. Through these endeavors Horizon was able to determine which
applications were required to be removed, replaced, or upgraded and tested to
ensure Year 2000 readiness.
In 1998 Horizon completed several upgrades to applications in
preparation for live Year 2000 testing with NCR Corporation ("NCR"), Horizon's
service provider located in Virginia Beach, Virginia. In August 1998, Horizon
successfully completed end-to-end testing with NCR-related systems. Through
in-house systems testing, proxy testing, and open customer live testing, NCR's
processing software has been deemed Year 2000 compliant. Since NCR is
responsible for the majority of Horizon's mission-critical systems referred to
in the Plan, Horizon will continue to work closely with and monitor NCR's
on-going due diligence throughout 1999. In addition, Horizon will continue to
review all documentation from suppliers and test, when available, all vendor
products and services to ensure Year 2000 compliance is substantially complete
by June 30, 1999. Throughout 1999, Horizon will continue to develop contingency
plans to ensure prompt recovery from major Year 2000 induced system or utility
failures.
The total costs associated with becoming Year 2000 compliant are
estimated to be $175,000 incurred to date. The costs of the project are based on
management's best estimates. There can be no assurance that these estimates will
be achieved and actual results could differ from the plans.
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<PAGE>
Offices and Other Material Properties
At December 31, 1998, Horizon conducted its business from its
administrative office in Vienna, Virginia and four branch offices. The following
table sets forth certain information with respect to the offices of Horizon as
of December 31, 1998:
=============================== ============ ================== ===============
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
=============================== ============ ================== ===============
Administrative Office:
140 Park Street, S.E. Leased June September
Vienna, VA 2004 1992
Branch Offices:
8414 Lee Highway Owned N/A October
Fairfax, VA 1990
527-B Maple Avenue, East Leased January March
Vienna, VA 2005 1985
9720 Lee Highway Leased June July
Fairfax, VA 2006 1996
7857-F Heritage Drive Leased May May
Annandale, VA 2008 1998
=============================== ============ ================== ===============
Legal Proceedings
Horizon is not party to, nor is any of its property the subject of any
material pending legal proceedings incidental to the business of Horizon 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
Horizon.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview
Horizon's net income was $189 thousand for the three months ended March
31, 1999, compared to $188 thousand for the three months ended March 31, 1998,
an increase of $7 thousand, or .53%. Diluted earnings per share were $0.11 and
$0.12 for the three months ended March 31, 1998 and 1997, respectively. The
weighted average number of diluted shares of common stock outstanding were
1,665,170 and 1,598,309 for the same periods in 1999 and 1998, respectively.
Net income for the year ended December 31, 1998, was $694 thousand
($.42 diluted earnings per share), an increase of 15% over earnings of $602
thousand ($.38 diluted earnings per share) for the year ended December 31, 1997.
Total assets increased 14% to $145.4 million at December 31, 1998, from $127.4
million at December 31, 1997. Total loans outstanding decreased to $75.9 million
from $76.5 million at December 31, 1997. Investment securities rose from $20.1
million at December 31, 1997, to $29.2 million at December 31, 1998, an increase
of 77%. Deposits increased 14%, rising to $135.0 million at December 31, 1998,
from $118.2 million at December 31, 1997.
BALANCE SHEET. Total assets of Horizon at March 31, 1999 were $129.3
million, a decrease of $16.1 million, or 12.5%, from total assets of $145.4
million at December 31, 1998. Total liabilities decreased by $16.9 million, or
12.4%, to $119.4 million at March 31, 1999 from $135.7 million at December 31,
1998. The reduction in total assets and liabilities resulted primarily from a
decrease of $12 million in investment securities and deposits from December 31,
1998 to March 31, 1999.
Total assets were $145.4 million at December 31, 1998, an increase of
$18.0 million, or 14.1%, from $127.4 million at December 31, 1997. This growth
was due to an increase in investment securities of $22.0 million, or 77.0%, to
$50.4 million at December 31, 1998 from $28.4 million at December 31, 1997.
Total liabilities increased $17.2 million, or 15%, to $135.7 million at December
31,1998 from $118.5 million at December 31, 1997.
LOANS. Total loans receivable decreased by $2.9 million to $71.8
million at March 31, 1999 from $74.7 million at December 31, 1998.
Non-residential mortgage loans (permanent and construction) increased by $1.6
million, or 7.8%, to $22.8 million at March 31, 1999, from $20.2 million at
December 31, 1998. Residential mortgage loans (permanent and construction)
decreased $2.8 million, from $28.7 million at December 31, 1998, to $25.9
million at March 31, 1999. This change in the loan portfolio mix during the
quarter reflects Horizon's continuing shift in emphasis from residential
mortgage lending to non-residential lending.
Loans receivable, net of deferred fees and allowance for losses, were
$74.7 million at December 31, 1998, a decrease of $.9 million, or 1.0%, from
$75.6 million at December 31, 1997. Installment loans decreased from $12.2
million at December 31, 1997 to $10.8 million at December 31, 1998, a decrease
of $1.4 million. The weighted average interest rate on total loans receivable
decreased to 8.74% at December 31, 1998 from 8.80% at December 31, 1997.
INVESTMENT SECURITIES. Total investment securities increased from $19.5
million at December 31, 1998, to $20.7 million at March 31, 1999. Investment
securities held-to-maturity increased by $1.2 million, or 5.8% to $20.7 million
at March 31, 1999 from $19.5 million at December 31, 1998.
The portfolio of investment securities at December 31, 1998 consisted
of $19.5 million in securities classified as held-to-maturity and $9.6 million
classified as available-for-sale. The portfolio of
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securities held-to-maturity and securities available-for-sale consisted of
obligations of government and government-sponsored agencies.
LIABILITIES. The decrease in total assets was a result of a decrease in
customer deposits of $16.2 million, or 12.0%, to $118.8 million at March 31,
1999 from $135.0 million at December 31, 1998. The repayment of customer
deposits was funded by overnight deposits (Federal Funds) which decreased from
$30.8 million at December 31, 1998 to $13.7 million at March 31, 1999.
The increase in assets in 1998 was funded primarily by an increase in
customer deposits. Deposits at December 31, 1998 were $135.0 million, an
increase of $17.2 million, or 14.5%, over deposits of $118.4 million at December
31, 1997. The weighted average interest rate for all accounts increased to 4.67%
at December 31, 1998 from 4.18% at December 31, 1997. The increase in deposits
reflects the April 1998 opening of a new branch in Annandale, as well as growth
in Horizon's customer base at all branches.
Results of Operations
The operating results of Horizon 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 non-interest income, 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 periods indicated, average balances
of and weighted average yields on interest-earning assets and average balances
and weighted average effective interest paid on interest-bearing liabilities.
Calculations have been made utilizing month-end balances for loans and
investment securities and daily average balances for borrowings and deposits.
Loan balances do not include non-accrual loans.
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<PAGE>
<TABLE>
<CAPTION>
Average Balances, Yields and Rates
(amounts in thousands)
Three Months Ended March 31,
1999 1998
-------------------------------------- -----------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
<S> <C> <C> <C> <C>
Interest-earning assets
Loans receivable $ 73,777 8.66% $ 75,351 8.70%
Securities and Federal Funds 48,561 5.22 28,574 6.19
--------- ---------
Total interest-earning assets 122,338 7.29 103,925 8.01
Interest-bearing liabilities
Deposits 96,606 4.44 83,237 4.05
--------- ---------
Total interest-bearing liabilities 96,606 4.44 83,237 4.05
Average dollar difference between $ 25,732 $ 20,688
Interest-earning assets and
Interest-bearing liabilities
Interest rate spread 2.85 3.96
Interest margin 3.81% 4.33%
</TABLE>
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31 December 31 December 31
1998 1997 1996
------------------------- -------------------------- -------------------------
Average Average Average Average Average Average
Balance Yield/Rate Balance Yield/Rate Balance Yield/Rate
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets
Loans receivable $ 76,606 8.74% $ 74,285 8.80% $ 64,068 9.19%
Investments 32,674 5.95 25,498 5.96 27,693 5.67
-------- -------- --------
Total interest-earning assets 109,280 8.35 99,783 8.55 91,761 8.13
Interest-bearing liabilities
Deposits 85,865 4.67 78,573 4.56 75,191 4.61
-------- -------- --------
Total interest-bearing liabilities 85,865 4.67 78,573 4.56 75,191 4.61
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 23,415 21,210 16,570
Interest rate spread 3.51 3.99 3.52
Interest margin 3.78 4.47 3.89
</TABLE>
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<PAGE>
The following 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) have been
allocated between rate and volume variances based on the percentage relationship
of such variances to each other.
Rate /Volume Analysis
(amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999
Compared to Three Months Ended
March 31, 1998
-----------------------------------------------------------
Volume Rate Total
------ ---- -----
<S> <C> <C> <C>
Interest income
Loans receivable $ (10) $ (30) $ (40)
Securities and Federal Funds 260 (71) 189
----- ----- -----
Total interest income 250 (101) 149
Interest expense
Deposits 47 43 90
----- ----- -----
Total interest expense 47 43 90
----- ----- -----
Net interest income $ 203 $(144) $ 59
===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1998 compared Year ended December 31, 1997 compared
to year ended December 31, 1997 to year ended December 31,1996
----------------------------------- ----------------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
<S> <C> <C> <C> <C> <C> <C>
Interest income
Loans Receivable $ 212 $ (45) $ 167 $ 482 $ 411 $ 893
Investments 430 (2) 428 39 (9) 30
----- ----- ----- ----- ----- -----
Total interest income 642 (47) 595 521 402 923
Interest expense
Deposits 47 385 432 215 (198) 17
----- ----- ----- ----- ----- -----
Total interest expense 47 385 432 215 (198) 17
----- ----- ----- ----- ----- -----
Net interest income 595 (432) 163 306 600 906
===== ===== ===== ===== ===== =====
</TABLE>
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<PAGE>
Comparison of the Three Months Ended March 31, 1999
With the Three Months Ended March 31, 1998
Horizon's net income was $189 thousand for the three months ended March
31, 1999, compared to $188 thousand for the three months ended March 31, 1998,
an increase of $7 thousand, or .53%. Diluted earnings per share were $0.11 and
$0.12 for the three months ended March 31, 1998 and 1997, respectively. The
weighted average number of diluted shares of common stock outstanding were
1,665,170 and 1,598,309 for the same periods in 1999 and 1998, respectively.
NET INTEREST INCOME. Net interest income before provision for loan
losses for the three months ended March 31, 1999 was $1.2 million, a decrease of
$79 thousand, or 6.4% compared to the three months ended March 31, 1998. The
decrease resulted primarily from a decrease in interest margin. Total
interest-earning assets in the three months ended March 31, 1999 averaged $122.3
million as compared to $103.9 million for the same period in 1998. For the three
months ended March 31, 1999, the interest rate spread was 3.19%, a decrease of 9
basis points from 3.28% for the three months ended March 31, 1998. The yield on
interest-earning assets decreased by 72 basis points from 8.01% for the three
months ended March 31, 1998 to 7.29% for the three months ended March 31, 1999.
The cost of interest-bearing liabilities increased by 39 basis points to 4.44%
for the three months ended March 31, 1999 from 4.05% for the three months ended
March 31, 1998.
TOTAL INTEREST INCOME. Total interest income increased by $150
thousand, or 7.2%, to $2.2 million for the three months ended March 31, 1999
from $2.0 million for the three months ended March 31, 1998. This increase was
primarily due to an increase of $11 million in securities and federal funds to
$31.3 million for the three months ended March 31, 1999 from $20.2 million for
the three months ended March 31, 1998. Average loans receivable decreased by
$1.5 million from $75.3 million in the three months ended March 31, 1998 to
$73.8 million in the three months ended March 31, 1998. The average yield on
loans decreased from 9.28 to 9.27 for the same periods.
The yield on average investment securities for the three months ended
March 31, 1999 was 5.22%, a decrease of 97 basis points from 6.19% for the three
months ended March 31, 1998.
TOTAL INTEREST EXPENSE. Total interest expense increased by $230
thousand, or 27.1%, to $1 million for the three months ended March 31, 1999 from
$840 thousand for the three months ended March 31, 1998. Customer deposits
averaged $96.6 million for the three months ended March 31, 1999, up $13.4
million from $83.2 million for the three months ended March 31, 1998. The
average effective rate paid on deposits decreased by 19 basis points to 4.48% in
the 1999 period from 4.67% in the 1998 period.
PROVISIONS FOR LOAN LOSSES. The provision for loan losses for the three
months ended March 31, 1999 was $66 thousand, as compared to $63 thousand for
the three months ended March 31, 1998. The provision for loan losses is a
current charge to earnings to increase the allowance for loan losses. Horizon
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. It is the opinion of Horizon that the allowance for loan losses at
March 31, 1999 remains adequate. Although Horizon 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 Horizon's results
of operations. The allowance for loan losses at March 31, 1999 was $1.05
million, or 1.4% of total loans receivable and $1.01 million at December 31,
1998, which was 1.3% of total loans receivable.
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<PAGE>
During the three months ended March 31, 1999, charge-offs amounted to
$22 thousand compared to $6 thousand during the same period last year. These
charge-offs were related primarily to one non-mortgage business loan. Recoveries
amounted to $14 thousand during the three months ended March 31, 1999, most of
which were recoveries on consumer charge-offs.
OTHER INCOME. Other income for the three months ended March 31, 1999
was $334 thousand as compared to $264 thousand for the three months ended March
31, 1998, an increase of $70 thousand, or 26.5%. Most of the growth in other
income resulted from increases in fee income from servicing and overdraft charge
fees.
OPERATING EXPENSES. Other expense decreased by $59 thousand, or 15%, to
$334 thousand for the three months ended March 31, 1999 from $392 thousand for
the three months ended March 31, 1998 due to a general reduction in occupancy
related expenses. Employee compensation and benefits increased by $24 thousand,
or 5%, reflecting normal wage increases for existing personnel and the cost of
increased staffing levels to accommodate growth in Horizon's customer base.
Expenses for premises and equipment increased by $19 thousand, or 8%, primarily
because of new lease agreements for office space and a new branch opened in
Annandale, May, 1998.
Comparison of the Year Ended December 31, 1998
With the Year Ended December 31, 1997
Horizon's net income for the year ended December 31, 1998 was $694
thousand, an increase of 15.2% over net income of $602 thousand for the year
ended December 31, 1997. The increase in net income was primarily due to an
increase in net interest income of 3.3% and an increase of 50.7% in other
income. Diluted earnings per share for the year ended December 31, 1998 was $.42
as compared to $.38 for the year ended December 31, 1997. The weighted average
number of diluted shares of common stock outstanding were 1,620,817 for the year
ended December 31, 1998 and 1,557,744 for the year ended December 31, 1997.
NET INTEREST INCOME. Net interest income before provision for loan
losses was $5.1 million for the year ended December 31, 1998, an increase of
3.3% over $4.9 million for the year ended December 31, 1997. This increase was
due to the growth in the average level of earning assets from $99.8 million to
$109.3 million. The interest rate spread decreased from 3.89% to 3.51% during
the year ended December 31, 1998, and the interest margin went from 4.47% to
3.78% during the same period.
TOTAL INTEREST INCOME. Total interest income was $9.1 million for the
year ended December 31, 1998, an increase of 7.0% over $8.5 million for the year
ended December 31, 1997. This increase resulted from growth in interest-earning
assets. Average loans receivable increased by $2.3 million and average
investment securities increased by $7.2 million over 1997.
The yield on total interest-earning assets was 8.18% for the year ended
December 31, 1998, which increased from 8.07% for 1997. For the year ended
December 31, 1998, the yield on average loans receivable was 8.74%, down from
8.80% for the year ended December 31, 1997, while the yield on average
investment securities decreased from 5.96% during 1997 to 5.95% for the year
ended December 31, 1998.
TOTAL INTEREST EXPENSE. Total interest expense for the year ended
December 31, 1998 was $4.0 million, an increase of 12.0% over $3.6 million for
the year ended December 31, 1997. This increase was due primarily to growth in
the average balance of deposits, which were $214.4 million for the year ended
December 31, 1998 compared to $184.3 million for the prior year. The average
effective
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<PAGE>
rate paid on interest-bearing liabilities was 4.67% for the year ended December
31, 1998, a decrease of 49 basis points from 4.18% for the year ended December
31, 1997.
PROVISION FOR LOAN LOSSES. The provision for loan losses amounted to
$326 thousand for the year ended December 31, 1998, an decrease over the
provision of $385 thousand for the year ended December 31, 1997. The provision
for loan losses is a current charge to earnings to increase the allowance for
loan losses. Horizon 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. The decrease in the provision for loan losses reflects the
improvement in the portfolio as well as the change in the type of loans.
Horizon's opinion is that the allowance for loan losses at December 31, 1998
remains adequate. Although Horizon 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 Horizon's results of
operations. The allowance for loan losses at December 31, 1998 was $1.0 million,
or 1.34% of total loans receivable compared to $.7 million, or .93% at December
31, 1997.
OTHER INCOME. Other income totaled $798 thousand for the year ended
December 31, 1998, an increase of 50.7%, from $529 thousand for the year ended
December 31, 1997. The increase was attributable to loan origination fees on new
mortgage loans sold, which increased by $243 thousand to $320 thousand for the
year ended December 31, 1998 from $77 thousand for the prior year.
OPERATING EXPENSES. Other expenses for the year ended December 31, 1998
were $4.5 million, an increase of 8.4% from $4.2 million for the year ended
December 31, 1997.
Employee compensation and benefits increased 3.8% to $2.1 million for
the year ended December 31, 1998 from $2.0 million for the prior year. The
increase reflects the cost of staffing the new branch and normal wage increases
for existing personnel.
Expenses for premises and equipment increased $20 thousand during the
year ended December 31, 1998 compared to the prior year. This increase of
expenses is primarily the result of an additional branch and normal rent
increases.
Other expenses increased 20.3% to $1.5 million for the year ended
December 31, 1998 from $1.2 million for the prior year, reflecting increased
mortgage origination costs and increases in other miscellaneous expenses.
Comparison of the Year Ended December 31, 1997
With the Year Ended December 31, 1996
Horizon's net income for the year ended December 31, 1997 was $602
thousand an increase of 48.3% over net income of $406,000 thousand for the year
ended December 31, 1996. The increase in net income was primarily due to an
increase in net interest income of 20.3%, and an increase of 30.2% in other
income. Diluted earnings per share for the year ended December 31, 1997 were
$.38 as compared to $0.26 for the year ended December 31, 1996. The weighted
average number of diluted shares of common stock outstanding were 1,557,744 for
the year ended December 31, 1997 and 1,551,890 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 $4.9 million for the year ended December 31, 1997, an increase of
20.3% over $4.1 million for the year ended December 31, 1996. This increase was
due to the growth in the average level of earning assets from
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<PAGE>
$91.8 million to $99.8 million. The interest rate spread increased from 3.52% to
3.89% during the year ended December 31, 1997, and the interest margin went from
3.89% to 4.47% during the same period.
TOTAL INTEREST INCOME. Total interest income was $8.5 million for the
year ended December 31, 1997, an increase of 10.4% over $7.7 million for the
year ended December 31, 1996. This increase resulted from growth in
interest-earning assets. Average loans receivable increased by $10.2 million,
which off-set a small decrease in average investment securities of $2.2 million
from 1996.
The yield on total interest-earning assets was 8.07% for the year ended
December 31, 1997, which reflected a small decrease compared to 1996. For the
year ended December 31, 1997, the yield on average loans receivable was 8.80%,
down from 9.19% for the year ended December 31, 1996, while the yield on average
investment securities increased from 5.67% during 1996 to 5.96% for the year
ended December 31, 1997. The general decrease in the yield of loans receivable
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 $3.6 million, an increase of .47% over $3.5 million for
the year ended December 31, 1996. This increase was due primarily to growth in
the average balance of deposits, which were $78.6 million for the year ended
December 31, 1997 compared to $75.1 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 5.96% for the year ended
December 31, 1997, an increase of 29 basis points from 5.67% for the year ended
December 31, 1996.
PROVISION FOR LOAN LOSSES. The provision for loan losses amounted to
$385 thousand for the year ended December 31, 1997, an increase over the
provision of $211 thousand for the year ended December 31, 1996. During the year
ended December 31, 1997 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
allowance for loan losses at December 31, 1997 was $706 thousand, or 1.00% of
total loans receivable compared to $873 thousand, or 1.23% at December 31, 1996.
OTHER INCOME. Other income totaled $529 thousand for the year ended
December 31, 1997, an increase of 29.9%, from $407 thousand for the year ended
December 31, 1996. The increase was attributable primarily to fee income, which
increased by 39.1% to $282 thousand for the year ended December 31, 1997 from
$173 thousand for the prior year. Fee income, consisting primarily of
transaction and processing fees on deposit accounts.
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 13.9% to $1.2 million for
the year ended December 31, 1997 from $1.1 million for the prior year. The
increase reflects the cost of staffing the new branch for a full year, as well
as increased staffing levels to accommodate growth in Horizon's customer base
and normal wage increases for existing personnel.
Expenses for premises and equipment increased 24.4% to $918 thousand
for the year ended December 31, 1997 from $738 thousand for the year ended
December 31, 1996. This increase is primarily the result of operating a new
branch for a full year and the cost associated with planning and starting new
expansion in the market area during 1997.
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<PAGE>
Other expenses remained relatively constant during the year ended
December 31, 1997 compared to the prior year.
Asset/Liability Management
Horizon, is engaged primarily in the business of investing funds
obtained from deposits and borrowings into interest-bearing loans and
investments. Consequently, Horizon'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. Horizon, to the extent that its interest-bearing liabilities do not
re-price 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
Horizon'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 Horizon's residential mortgage loan portfolio, it is
Horizon'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, Horizon'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 Horizon's exposure to
rising interest rates.
Horizon's interest rate sensitivity is primarily monitored by
management through the use of a model which generates estimates of the change in
Horizon's MVPE over a range of interest rate scenarios. MVPE is the present
value of expected cash flows from assets, liabilities, and off-balance sheet
contracts using standard industry assumptions about estimated loan prepayment
rates, reinvestment rates, and deposit decay rates. The following table sets
forth an analysis of Horizon'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 March 31, 1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
<TABLE>
<CAPTION>
Market Value of Portfolio Equity Market Value of Portfolio Equity
as a % of Total Portfolio
--------------------------------------- -----------------------------------
Change in Amount $ Change %Change Assets Equity
Interest Rate From Base From Base Book Value
In Basis Points
(Rate Shock)
------------------------- -------------- ------------ ------------ --------------- -------------------
<S> <C> <C> <C> <C> <C>
Up 400 $7,630 $2,286 -23.05% 5.90% 76.95%
Up 300 8,174 1,742 -17.57% 6.32% 82.76%
Up 200 8,748 1,168 -11.78% 6.76% 88.57%
Up 100 9,335 581 -5.96% 7.22% 94.51%
Base 9,916 - 0.00% 7.67% 100.39%
Down 100 10,383 (467) 4.71% 8.03% 105.12%
Down 200 10,750 (834) 8.41% 8.31% 108.84%
Down 300 11,110 (1,194) 12.04% 8.59% 112.48%
Down 400 11,508 (1,592) 13.83% 8.90% 116.51%
</TABLE>
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<PAGE>
Horizon'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. 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 Horizon'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 re-pricing of specific assets and
liabilities.
Sensitivity of Net Interest Income
(amounts in thousands)
<TABLE>
<CAPTION>
Adjusted Net Interest Income Net Interest Margin
--------------------------------------- -----------------------------------------------
Change in Amount $ Change %Change %Change %Change
Interest Rate From Base From Base From Base From Base
In Basis Points
(Rate Shock)
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Up 400 $5,417 $456 9.19% 4.59% 9.29%
Up 300 5,308 347 6.99% 4.49% 6.90%
Up 200 5,198 237 4.78% 4.40% 4.76%
Up 100 5,084 123 2.48% 4.30% 2.38%
Base 4,961 - 0.00% 4.20% 0.00%
Down 100 4,805 (156) -3.14% 4.07% 3.09%
Down 200 4,620 (341) -6.87% 3.91% 6.90%
Down 300 4,427 (534) -10.76% 3.75% 10.71%
Down 400 4,238 (723) -14.57% 3.59% 14.52%
</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 Horizon'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 Horizon's worth and net interest income.
Liquidity and Capital Resources
Horizon's primary sources of funds are deposits, loan repayments,
proceeds from the sale of loans and from investment securities, and repayments
and maturities of investment securities.
At March 31, 1999, Horizon had $18 million of unfunded lines of credit
and undisbursed construction loan funds and home equity lines of $4.2 million.
Approved loan commitments were $4.6 million at March 31, 1999.
At December 31, 1998, Horizon had $24.4 million of unfunded loan
commitments. The amount of certificate of deposit accounts maturing in calendar
year 1999 is $136.5 million. It is anticipated that
97
<PAGE>
funding requirements for these commitments can be met from the normal sources of
funds previously described.
Horizon 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,
1998, Horizon's capital ratios were 8% leverage capital; 12.21% tier I capital;
and 13.46% 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 Horizon'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.
Special Note Regarding Forward-Looking Information
Certain statements under the caption "Management's Discussion and
Analysis" and elsewhere in this joint proxy statement/prospectus 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 Horizon, 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
Horizon'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 Horizon 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, Horizon undertakes no obligation to correct or update a
forward-looking statement should Horizon later become aware that it is not
likely to be achieved. If Horizon were to update or correct a forward-looking
statement, investors and others should not conclude that Horizon will make
additional updates or corrections thereafter.
98
<PAGE>
CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors
The Southern Financial board of directors currently is comprised of
nine members. The board of directors is divided into three classes, each of
which consists of three members. These directors serve, and will continue to
serve following the merger, for the terms of their respective classes, which
expire in 2000, 2001 and 2002.
The merger agreement requires that Southern Financial increase the size
of the board to 12 members and appoint three current directors of Horizon to
become directors of Southern Financial. At the meeting of Southern Financial's
shareholders, Southern Financial will ask its shareholders to elect these three
directors to specific classes and, following their election, the directors will
serve for the remaining terms of their respective classes. In particular,
Southern Financial will ask its shareholders to elect John C. Belotti to Class
II for a term expiring in 2000, Richard L. Hall to Class III for a term expiring
in 2001, and Robert P. Warhurst to Class I for a term expiring in 2002.
The following table sets forth the composition of the board of
directors following the merger.
<TABLE>
<CAPTION>
Class I Class II Class III
(Term Expiring in 2002) (Term Expiring in 2000) (Term Expiring in 2001)
<S> <C> <C> <C>
Alfonso G. Finocchiaro John C. Belotti * Fred L. Bollerer
Virginia Jenkins Neil J. Call Georgia S. Derrico
Michael P. Rucker David de Give Richard L. Hall *
Robert P. Warhurst * R. Roderick Porter John L. Marcellus, Jr.
</TABLE>
____________________
* Horizon director
The following paragraphs set forth certain information, as of May 1,
1999, for the 12 individuals who are expected to serve as directors of Southern
Financial following the consummation of the merger. Unless otherwise indicated,
each director has held his or her current position for more than five years.
Class I
(Term Expiring in 2002)
Alfonso G. Finocchiaro, 66, was Executive Vice President, Regional
General Manager and CEO (Americas) of Banco Portugues do Atlantico from 1978 to
until his retirement in 1997. Mr. Finocchiaro has served as a director of
Southern Financial since April 1999.
Virginia Jenkins, 51, is the owner of V. Jenkins Interiors and Antiques
in Middleburg, Virginia. Ms. Jenkins has served as a director of Southern
Financial since 1988.
Michael P. Rucker, 58, is an executive with Caterpillar, Inc., a
manufacturing company in Peoria, Illinois and serves as Chairman of the Board of
George H. Rucker Realty Corp., a real estate development company in Fairfax,
Virginia. Mr. Rucker has served as a director of Southern Financial since 1991.
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<PAGE>
Robert P. Warhurst, 60, is President and co-owner of Merrifield Garden
Center in Merrifield and Fairfax, Virginia. Mr. Warhurst has served as a
director of Horizon since its organization in 1989.
Class II
(Term Expiring in 2000)
John C. Belotti, 62, is President and co-owner of Bee & H Electric
Company in Fairfax, Virginia. Mr. Belotti has served as a director of Horizon
since its organization in 1989.
Neil J. Call, 65, has been Executive Vice President of MacKenzie
Partners, Inc., a New York financial consulting company, since 1990. Mr. Call
has served as a director of Southern Financial since 1986.
David de Give, 56, has been Senior Vice President of Southern Financial
since 1992. Mr. de Give has served as a director of Southern Financial since
1986.
R. Roderick Porter, 54, has been President and Chief Operating Officer
of Southern Financial since April 1998. From 1994 to 1998, he was President of
FX Concepts, Ltd., an international money management firm in New York, New York.
Mr. Porter has served as a director of Southern Financial since 1986.
Class III
(Term Expiring in 2001)
Fred L. Bollerer, 56, has been President and Chief Executive Officer of
the Potomac Knowledge Way Project, a not for profit leadership organization
company in Herndon, Virginia, since January 1998. From 1993 to 1997, he was
President and Chief Executive Officer of Riggs Bank N.A. in Washington, D.C. Mr.
Bollerer has served as a director of Southern Financial since April 1999.
Georgia S. Derrico, 54, has been Chairman of the Board and Chief
Executive Officer of Southern Financial since 1986. Ms. Derrico has also served
as a director of Southern Financial since 1986.
Richard L. Hall, 51, is the President and Chief Executive Officer and
the co-founder of Horizon. Mr. Hall has served as a director of Horizon since
its organization in 1989.
John L. Marcellus, Jr., 76, is the retired President and Chairman of
the Board of Oneida, Ltd., a silverware manufacturing company in Oneida, New
York. Mr. Marcellus has served as a director of Southern Financial since 1986.
Board Committees
The Asset/Liability Management Committee has authority for policy
formulation and administration of Southern Financial's asset/liability
management policies. The Asset/Liability Management Committee, which consists of
Ms. Derrico and Messrs. Porter (Chairman), Call and de Give, reports monthly to
the board on the interest sensitivity of Southern Financial, including an
analysis of the duration of Southern Financial's assets, liabilities and
contingent liabilities as well as the mortgage pipeline and a calculation of the
duration of Southern Financial's equity. The Asset/Liability Management
Committee met eight times during 1998. The Asset/Liability Management Committee
frequently discusses policy issues by teleconference.
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<PAGE>
The Credit Committee has authority and responsibility to oversee the
prudent operation of Southern Financial's lending function, including the
ongoing qualitative review of the loan portfolio. The Credit Committee, which
consists of Ms. Derrico and Messrs. Call (Chairman) and Rucker, is responsible
for reviewing all loans and approving loans above a certain minimum amount, and
for insuring the development and maintenance of sound credit policies and
procedures. The Credit Committee met in person five times during 1998. The
Credit Committee frequently discusses credit issues by teleconference.
The Audit Committee assists the board in fulfilling its fiduciary
responsibilities relating to corporate accounting and reporting practices of
Southern Financial. The Audit Committee consists of Messrs. Call (Chairman) and
Marcellus and Ms. Jenkins and met two times during 1998.
The Compensation Committee reviews the performance of, and establishes
the compensation for, the executive officers of Southern Financial. Southern
Financial's executive compensation programs are designed to retain and reward
executives based upon (i) their individual performance and ability to lead
Southern Financial to achieving its goals and (ii) Southern Financial's
performance. The Compensation Committee consists of Messrs. Call and Marcellus
(Chairman) and Ms. Jenkins and met three times during 1998.
Executive Officers Who Are Not Directors
William H. Lagos, 48, joined Southern Financial 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, 46, joined Southern Financial 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, 41, joined Southern Financial in 1989. In 1995, she
was promoted to Vice President/Branch Development; in 1997, she was promoted to
Senior Vice President/Branch Development.
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<PAGE>
Security Ownership of Management
The following table sets forth, based on information as of May 1, 1999,
the beneficial ownership of Southern Financial common stock, the beneficial
ownership of Horizon common stock and the anticipated beneficial ownership,
after giving effect to the merger, of Southern Financial common stock by each
director of Southern Financial and Horizon and by each person named in the
"Summary Compensation Table" on page 106.
<TABLE>
<CAPTION>
Ownership Before Ownership After
the Merger the Merger
---------- ----------
Southern Financial
Common Stock
------------
Southern Financial Horizon Number Percent
Common Stock (1) Common Stock of Shares of Class (%)
---------------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Southern Financial Directors:
Fred L. Bollerer * 2,000 - 2,000 **
Neil J. Call * 41,291 (2) - 41,291 (2) 1.5
David de Give * 78,589 - 78,589 2.9
Georgia S. Derrico * 207,992 (3) - 207,992 (3) 7.5
Alfonso G. Finocchiaro * 3,188 - 3,188 **
William H. Lagos 38,824 - 38,824 1.4
Virginia Jenkins * 2,263 - 2,263 **
John L. Marcellus, Jr. * 15,808 (4) - 15,808 (4) **
R. Roderick Porter * 207,992 (3) - 207,992 (3) 7.5
Michael P. Rucker * 80,396 (5) - 80,396 (5) 3.0
All current Southern Financial
Directors and Executive Officers
as a group (12 Persons) 501,896 - 501,896 16.9
Horizon Directors:
John C. Belotti * - 41,580 26,195 **
G. Thomas Collins, Jr. - 2,407 1,516 **
Richard L. Hall * - 22,740 14,326 **
Harry E. Jagoda - 31,185 19,646 **
W. Bruce Jennings - 11,550 7,276 **
Arthur V. Meyers - 12,705 8,004 **
Michael A. Miranda - 21,251 13,388 **
Richard E. Smith - 45,992 28,974 1.1
William Gary Sullivan - 5,151 3,295 **
Robert P. Warhurst * - 22,550 14,206 **
All current Horizon Directors and
Executive Officers as a group (12
Persons) - 218,818 137,851 5.1
All post-merger Southern Financial
Directors and Executive Officers as
a group (15 persons) 556,623 18.7
</TABLE>
_______________
102
<PAGE>
* Director of Southern Financial following the consummation of the merger.
** Percentage of ownership will be less than one percent of the outstanding
shares of Southern Financial common stock.
(1) The amounts in this column include shares of Southern Financial common
stock with respect to which certain persons have the right to acquire
beneficial ownership within sixty days after December 31, 1998, pursuant
to Southern Financial's 1993 Stock Option and Incentive Plan, as amended:
Mr. de Give: 43,403 shares; Ms. Derrico: 92,016 shares; Mr. Lagos: 21,802
shares; Mr. Porter: 10,000; and the directors and officers as a group:
196,236 shares.
(2) Includes 33,331 shares of Southern Financial common stock and 7,009 shares
of Southern Financial convertible preferred stock.
(3) Includes (a) 78,533 shares owned individually by Ms. Derrico over which
she has sole voting and investment power and 92,016 shares that Ms.
Derrico may acquire pursuant to the exercise of stock options; and (b)
23,404 shares of Southern Financial common stock and 4,039 shares of
Southern Financial convertible preferred stock owned individually by Mr.
Porter over which he has sole investment power. Mr. Porter holds an option
to acquire 10,000 shares of common stock. Ms. Derrico and Mr. Porter
disclaim beneficial ownership of each other's shares.
(4) Includes 13,427 shares of Southern Financial common stock and 2,221 shares
of Southern Financial convertible preferred stock.
(5) Includes 11,627 shares of Southern Financial common stock and 991 shares
of Southern Financial convertible preferred stock owned by Michael Rucker,
5,973 shares of Southern Financial common stock and 2,402 shares of
convertible preferred stock owned by Derek Rucker, 8,378 shares of
Southern Financial common stock owned by Lucy Jones, 5,025 shares of
Southern Financial common stock owned by Susan Jones Cooper, 4,832 shares
of Southern Financial common stock owned by David Dodrill and 37,755
shares of Southern Financial common stock owned by Rucker Realty Corp. and
persons associated with Rucker Realty Corp. Southern Financial makes no
representation as to whether any of these persons, individually or in any
combination, share voting or investment power with any other or with
Rucker Realty with respect to their shares.
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<PAGE>
Security Ownership of Certain Beneficial Owners
The following table sets forth, to the knowledge of Southern Financial
and Horizon and based on information as of May 1, 1999, (i) the beneficial
ownership of each person who owns more than five percent of the outstanding
shares of Southern Financial common stock or Horizon common stock and (ii) the
anticipated beneficial ownership of each person expected to own more than five
percent of the outstanding shares of Southern Financial common stock after
giving effect to the merger. No person is known to be the beneficial owner of
more than five percent of the outstanding shares of either Southern Financial
common stock or Horizon common stock.
<TABLE>
<CAPTION>
Ownership of Ownership of
Southern Financial Southern Financial
Common Stock Common Stock
Before the Merger After the Merger
----------------- ----------------
Number Percent Number Percent
of Shares (1) Of Class (%) of Shares of Class (%)
------------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Georgia S. Derrico (2) 207,992 (3) 12.97 207,992 7.48
R. Roderick Porter
2954 Burrland Lane
The Plains, Virginia 20171
Hovde Capital, L.L.C. 145,800 (4) 9.15 145,800 5.44
Financial Institution Partners II, L.P.
1629 Colonial Parkway
Inverness, Illinois 60067
Max C. Chapman 127,122 7.98 127,122 4.75
Nomura Holding America
2 World Financial Center
Building B
New York, New York 10281-1198
Salem Investment Counselors, Inc. 126,372 (5) 7.93 126,372 4.72
P. O. Box 25427
Winston-Salem, North Carolina 27114-5427
Value Partners, Ltd. 117,289 (6) 7.36 117,289 4.38
Fisher Ewing Partners
Richard W. Fisher
Timothy G. Ewing
2200 Ross Avenue, Suite 4600
West Dallas, Texas 75201
David G. Booth (7) 95,635 (8) 5.94 94,607 3.53
Jane Marvel Garnett
24 Monroe Place #9A
Brooklyn, New York 11201
Michael P. Rucker 80,396 (9) 5.04 80,396 3.00
1003 W. Centennial Drive
Peoria, Illinois 61614-5976
</TABLE>
___________________
104
<PAGE>
(1) Except as otherwise indicated, includes shares held directly, as well as
shares held in retirement accounts or by certain family members or
corporations over which the named individuals may be deemed to have voting
or investment power.
(2) Georgia S. Derrico and R. Roderick Porter are married to each other.
(3) Includes (a) 78,533 shares owned individually by Ms. Derrico over which
she has sole voting and investment power and 92,016 shares that Ms.
Derrico may acquire pursuant to the exercise of stock options; and (b)
23,404 shares of Southern Financial common stock and 4,039 shares of
Southern Financial convertible preferred stock owned individually by Mr.
Porter over which he has sole investment power. Mr. Porter holds an option
to acquire 10,000 shares of Southern Financial common stock. Ms. Derrico
and Mr. Porter disclaim beneficial ownership of each other's shares.
(4) Hovde Capital, L.L.C. is the General Partner of Financial Institution
Partners II, L.P., which beneficially owns 145,800 shares. Hovde Capital,
L.L.C. and Financial Institution Partners II, L.P. may be deemed to have
shared voting and investment powers over all such shares.
(5) Salem Investment Counselors, Inc. beneficially owns 126,372 shares and may
be deemed to have sole voting and investment power over all such shares.
(6) Value Partners, Ltd., as managed by Fisher Capital Management,
beneficially owns 117,289 shares. Fisher Ewing Partners may be deemed to
have sole voting and investment power over all such shares.
(7) David G. Booth and Jane Marvel Garnett are married to each other.
(8) Includes 1,028 shares owned by Mr. Booth and 94,607 shares owned by Ms.
Garnett. Southern Financial makes no representation as to whether Mr.
Booth and Ms. Garnett share voting or investment power with respect to
their shares.
(9) Includes 11,627 shares of Southern Financial common stock and 991 shares
of Southern Financial convertible preferred stock owned by Michael Rucker,
5,973 shares of Southern Financial common stock and 2,402 shares of
convertible preferred stock owned by Derek Rucker, 8,378 shares of
Southern Financial common stock owned by Lucy Jones, 5,025 shares of
Southern Financial common stock owned by Susan Jones Cooper, 4,832 shares
of Southern Financial common stock owned by David Dodrill and 37,755
shares of Southern Financial common stock owned by Rucker Realty Corp. and
persons associated with Rucker Realty Corp. Southern Financial makes no
representation as to whether any of these persons, individually or in any
combination, share voting or investment power with any other or with
Rucker Realty with respect to their shares.
Director Compensation
Each member of the board who was not an employee of Southern Financial
or any of its subsidiaries is paid (i) $500 for attendance at each board meeting
and (ii) $150 for attendance at each meeting of a committee of the board of
which he or she is a member. Directors are not compensated for meetings
conducted by teleconference. In addition, each director is paid an annual fee of
$4,000. Employee members of the board are not paid separately for their service
on the board or its committees.
105
<PAGE>
Executive Officer Compensation
The following table presents information concerning the compensation of
Ms. Derrico and Messrs. Porter, Lagos and Hall. This table presents compensation
for services rendered in all capacities to Southern Financial by Ms. Derrico and
Messrs. Porter and Lagos and to Horizon by Mr. Hall in 1998, 1997 and 1996.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------- ----------------------
Securities
Underlying
Name and Other Annual Options All Other
Principal Position Year Salary Bonus Compensation(1) (#) Compensation(2)
- ------------------ ---- ------ ----- --------------- --- ---------------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 1998 $193,226 $200,000 -- 10,000 $4,800
Chairman of the Board 1997 175,000 175,000 -- 10,000 4,500
and Chief Executive 1996 175,000 132,500 -- 22,003 4,500
Officer
R. Roderick Porter 1998 (3) $100,000 -- -- 10,000 $2,505
President and Chief
Operating Officer
William H. Lagos 1998 $ 91,589 $ 25,000 -- 5,000 $1,200
Senior Vice President 1997 87,125 12,500 -- 8,000 2,913
and Controller 1996 (4) 51,875 25,000 -- 8,802 500
Richard L. Hall 1998 $128,500 $ 15,000 -- -- $2,657
President of Horizon 1997 123,673 7,800 -- -- 2,657
1996 121,852 5,635 -- -- 2,265
</TABLE>
____________________
(1) None of the named executive officers received Other Annual Compensation in
excess of the lesser of $50,000 or 10% of combined salary and bonus for
the years indicated.
(2) The amounts set forth in this column constitute contributions to Southern
Financial's 401k Plan.
(3) Mr. Porter joined Southern Financial on April 1, 1998.
(4) Mr. Lagos did not work for Southern Financial from June 1, 1996 through
November 30, 1996.
106
<PAGE>
Option Grants in Last Fiscal Year
The following table sets forth for the year ended December 31, 1998,
the grants of stock options to the executive officers named in the "Summary
Compensation Table."
Option Grants in Year Ended December 31, 1998
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation for
Option Term
Individual Grants(1) -----------
--------------------------------------------------------------------
Percent of
Number of Total Options
Securities Granted to
Underlying Employees in Exercise or
Options Fiscal Year Base Price Expiration
Name Granted (#) (%)(2) ($/Share) Date 5% ($) 10% ($)
- ---- ----------- ------ --------- ---- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 10,000 19.61 21.25 1/22/08 346,140 551,170
R. Roderick Porter 10,000 19.61 26.00 4/23/08 423,513 674,373
William H. Lagos 5,000 9.80 21.25 1/22/08 173,070 275,585
Richard L. Hall -- -- -- -- -- --
</TABLE>
________________________
(1) Stock options were awarded at the fair market value of the shares of
Southern Financial common stock at the date of award and are exercisable
after January 22, 1999 and April 23, 1999.
(2) Options to purchase 34,000 shares of Southern Financial common stock were
granted to Southern Financial's employees during the year ended December
31, 1998.
107
<PAGE>
Option Exercises in Last Fiscal Year
Set forth in the table below is information concerning each exercise of
stock option during the fiscal year ended December 31, 1998 by each of the named
executive officers and the year end value of unexercised options.
Aggregated Option Exercises in Year Ended December 31, 1998
and Fiscal Year End Option Values
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options In-The-Money Options
at December 31, 1998 (#)(1) at December 31, 1998 ($)(2)
--------------------------- ---------------------------
Shares
Acquired on Value
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 4,840 58,128 86,856 10,000 917,690 -- (3)
R. Roderick Porter -- -- -- 10,000 -- -- (3)
William H. Lagos -- -- 16,802 5,000 128,335 -- (3)
Richard L. Hall 1,950 13,572 -- -- -- --
</TABLE>
___________________
(1) Each of these Options relates to Southern Financial common stock.
(2) These values are based on $21.00, the closing price of Southern Financial
common stock on December 31, 1998.
(3) None of unexercisable options held by the named executive officers were
in-the-money as of December 31, 1998.
Employment Agreements
Southern Financial entered into an employment agreement with Ms.
Derrico in 1996 for a term of three years with automatic one-year extensions.
If, during the term of the employment agreement, there is a change in control of
Southern Financial and within 12 months thereafter Ms. Derrico's employment is
terminated for good reason (as provided in the employment agreement) or on
account of disability (as provided in the employment agreement), Ms. Derrico
shall be entitled to receive severance pay equal to three times the sum of her
annual base salary at its highest rate during the preceding 12 months and her
highest annual bonus during the three preceding calendar years. The term "change
in control" as used in Ms. Derrico's agreement shall refer generally to (i) the
acquisition of 25% or more of the voting securities of Southern Financial by any
"person" (within the definition of Section 13(d) of the Securities Exchange Act
of 1934, as amended), (ii) the acquisition of 10% or more of the voting
securities of Southern Financial by any such person if the board has made a
determination that such acquisition constitutes or will constitute control of
Southern Financial, (iii) the approval by Southern Financial's shareholders of
an agreement to merge or consolidate with another corporation if the directors
who constitute the board six months prior to such approval cease to constitute a
majority during the period therefrom and ending two years after such approval,
and (iv) the sale by Southern Financial of 80% or more of its assets to any such
person.
Southern Financial entered into an employment agreement with Mr. Lagos
in 1997 for a term of 18 months with automatic one-year extensions. If, during
the term of the employment agreement, Mr.
108
<PAGE>
Lagos' employment is terminated in connection with or subsequent to a change of
control of Southern Financial by (i) Southern Financial other than for cause or
as a result of Mr. Lagos' death, disability or retirement, or (ii) Mr. Lagos for
good reason (as provided in the employment agreement), Mr. Lagos shall be
entitled to receive severance pay equal to 150% of the total cash compensation
paid to him during the previous 12 months. The term "change in control" as used
in his agreement shall refer generally to (i) the acquisition of 40% or more of
the voting securities of Southern Financial by any "person" or "group" (within
the definition of Section 13(d) and 14(d) of the Securities Exchange Act of
1934, as amended), (ii) a change in the composition of the board to less than a
majority of incumbent directors (as defined in the agreement), or (iii) the
approval by Southern Financial's shareholders of either a business combination
with any other person or group, other than a merger or consolidation that would
result in the Southern Financial common stock outstanding immediately prior
thereto representing at least 50% of the Southern Financial common stock of the
surviving entity outstanding immediately thereafter, or a plan of liquidation or
sale or disposition of all or substantially all of Southern Financial's assets.
Certain Relationships and Related Transactions
Georgia S. Derrico, Chairman of the Board and Chief Executive Officer
and a director of Southern Financial, and R. Roderick Porter, President and
Chief Operating Officer and a director of Southern Financial, are married to
each other.
109
<PAGE>
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF SOUTHERN FINANCIAL CAPITAL STOCK
Common Stock
Voting Rights. Each share of Southern Financial common stock entitles
the holder thereof to one vote on all matters voted on by shareholders. The
shares of Southern Financial common stock do not have cumulative voting rights,
which means that the holders of more than 50% of the shares of Southern
Financial common stock voting for the election of directors can elect all of the
directors, in which event the holders of the remaining shares of Southern
Financial common stock will not be able to elect any of the directors.
Dividend Rights. Holders of Southern Financial common stock are
entitled to receive dividends when, as and if declared by the board of directors
out of funds legally available for the payment of dividends.
Liquidation Rights. Subject to the rights of holders of Southern
Financial preferred stock, upon any liquidation, dissolution or winding up of
the affairs of the Southern Financial, holders of Southern Financial common
stock are entitled to receive pro rata all of the assets of the Southern
Financial for distribution to shareholders.
Assessment and Redemption. Shares of Southern Financial common stock
presently outstanding are validly issued, fully paid and nonassessable. There is
no provision for any voluntary redemption of the Southern Financial common
stock.
Other. Holders of Southern Financial common stock have no subscription,
sinking fund, conversion or preemptive rights.
Preferred Stock
Each share of Southern Financial preferred stock has a liquidation
preference over junior shares of Southern Financial stock, including the
Southern Financial common stock, of $14.50 plus any accrued and unpaid dividends
and bears an annual dividend at the rate of six percent. Dividends are
cumulative and payable quarterly if, as and when declared by the board of
directors from funds legally available therefore. Southern Financial preferred
stock is convertible, at the option of the holder, into 1.466 shares of Southern
Financial common stock, subject to adjustment in certain events.
Except as indicated below or as provided by applicable law, the holders
of the Southern Financial preferred stock are not entitled to vote. Such holders
do have the right as a class to elect two directors whenever dividends payable
on the Southern Financial preferred stock are in arrears in an aggregate amount
equal to six quarterly dividends. Currently, there are no preferred stock
dividends in arrears. Such right continues until such time as the dividends
accumulated on the preferred stock have been paid in full, at which time such
right terminates (subject to renewal and divestment from time to time upon the
same terms and conditions), and the directors so elected by the holders of the
preferred stock shall cease to be directors. In addition, Southern Financial may
not, directly or indirectly or through merger or consolidation with any other
corporation, without the consent of the holders of at least two-thirds of the
holders of preferred stock then outstanding (voting separately as a class) (i)
create any class of stock
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ranking prior to the preferred stock in rights and preferences or (ii) amend,
alter or repeal any of the specific terms of the Southern Financial preferred
stock so as to materially and adversely affect such specific terms.
COMPARATIVE RIGHTS OF SHAREHOLDERS
General
Southern Financial and Horizon are corporations subject to the
provisions of the Virginia Stock Corporation Act. Rights as a shareholder of
Horizon are governed by Horizon's articles of incorporation and bylaws and by
the Virginia Stock Corporation Act. Upon consummation of the merger, Horizon
shareholders will become shareholders of Southern Financial, and as such
shareholder rights will then be governed by the articles of incorporation and
bylaws of Southern Financial and by the Virginia Stock Corporation Act.
The following is a summary of the material differences in the rights of
shareholders of Horizon and Southern Financial. This summary is qualified in its
entirety by reference to the articles of incorporation and bylaws of Southern
Financial and Horizon and to the Virginia Stock Corporation Act.
Authorized Capital
Horizon. Horizon's articles of incorporation authorize the issuance of
up to 2,000,000 shares of Horizon common stock, par value $2.50 per share, of
which 1,659,894 shares were issued and outstanding as of July 22, 1999. Horizon
is not authorized to issue shares of preferred stock.
Southern Financial. Southern Financial's articles of incorporation
authorize the issuance of up to 5,000,000 shares of Southern Financial common
stock, par value $0.01 per share, of which 1,633,094 shares were issued and
outstanding as of July 22, 1999, and 500,000 shares of preferred stock, $0.01
par value, of which 13,621 shares were issued and outstanding as of July 22,
1999. Southern Financial's articles of incorporation authorize the Southern
Financial board, without shareholder approval, to fix the preferences,
limitations and relative rights of the preferred stock and to establish series
of such preferred stock and determine the variations between each series. If any
additional shares of preferred stock are issued, the rights of holders of
Southern Financial common stock would be subject to the rights and preferences
conferred to holders of such preferred stock.
The authority to create and issue separate classes and series of
preferred stock allows a corporation greater flexibility in structuring
financings and acquisitions. While such issuances could, under certain
circumstances, be considered to have the effect of making a change in control
more difficult, any issuance of such stock would be subject to applicable law,
including, without limitation, the duty of the board of directors of Southern
Financial to exercise its good faith business judgment in the best interests of
Southern Financial and its shareholders. Under Southern Financial's articles of
incorporation, the board of directors of Southern Financial would be authorized
to issue a series of preferred stock with more than one vote, less than one
vote, no vote or one vote per share.
Southern Financial's ability to pay dividends is limited by
restrictions imposed by the Virginia Stock Corporation Act on Virginia
corporations. In general, dividends paid by a Virginia corporation may be paid
only if, after giving effect to the distribution, (i) the corporation is still
able to pay its debts as they become due in the usual course of business, or
(ii) the corporation's total assets are greater than or equal to the sum of its
total liabilities plus (unless the corporation's articles of incorporation
permit
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otherwise) the amount that would be needed, if the corporation were to be
dissolved at the time of the distribution, to satisfy the preferential rights,
upon the dissolution, of shareholders whose preferential rights are superior to
those receiving the distribution.
Dividends on the Southern Financial preferred stock are cumulative,
which means that no dividends may be declared or paid on the common stock unless
all dividends accrued on the preferred stock have been paid, or declared and a
sum sufficient for the payment thereof set apart for such payment. In 1998,
Southern Financial paid $12,725.98 in preferred stock dividends.
Amendment of Articles of Incorporation or Bylaws
The Virginia Stock Corporation Act provides that an amendment to a
corporation's articles of incorporation must be approved by each voting group
entitled to vote on the proposed amendment. Under Virginia law, an amendment to
the corporation's articles of incorporation must be approved by more than
two-thirds of all votes entitled to be cast by that voting group. However, the
corporation's articles of incorporation may require a greater vote or a lesser
vote, which may not be not less than a majority, by each voting group entitled
to vote on the transaction. A corporation's board of directors may require a
greater vote.
Horizon. Under Horizon's articles of incorporation, any action
requiring shareholder approval shall be authorized by a majority of the votes
cast by shareholders entitled to vote at the meeting in which the action is
taken. Accordingly, amendments to Horizon's articles of incorporation must be
approved by a majority of the votes cast by shareholders entitled to vote at the
meeting in which any such action is taken. In addition, under Virginia law, the
bylaws may be amended by action of the majority of the shareholders.
Southern Financial. As noted above, amendments to the articles of
incorporation of Virginia corporations, such as Southern Financial, can be
submitted to the shareholders for a vote only by the board of directors.
Additionally, Virginia law provides, as a general rule, that an amendment to the
articles of incorporation must be approved by each voting group entitled to vote
on the proposed amendment by more than two-thirds of all votes entitled to be
cast by such voting group. However, Virginia law also permits the articles of
incorporation to provide for a greater or lesser vote. Southern Financial's
articles of incorporation contain such a provision. Southern Financial's
articles of incorporation provide that amendments must be approved by a majority
of the votes entitled to be cast by each voting group entitled to vote and,
unless such action is approved by at least two-thirds of the Continuing
Directors, by holders of at least two-thirds of the issued and outstanding
shares of Southern Financial common stock. The term "Continuing Director" is
defined in Southern Financial's articles of incorporation to mean (i) any
individual who was an initial director of Southern Financial or (ii) who has
been elected to the board of directors of Southern Financial at an annual
meeting of the shareholders of Southern Financial more than one time or (iii)
who has been elected to fill a vacancy on the board of directors of Southern
Financial and received the affirmative vote of a majority of the Continuing
Directors then on the board of directors and thereafter elected to the board of
directors at an annual meeting of shareholders at least one time.
In the past, the board of directors has acted by a consensus of all
directors on matters of importance and it expects to continue to do so. However,
any significant disagreement among the Continuing Directors on a proposed
amendment to the articles of incorporation likely would indicate that there are
substantial arguments to be made both for and against such amendment. For that
reason, the articles of incorporation effectively require that in such a
situation the matter either receives the support of a large majority of the
shares of Southern Financial common stock, or it would not be adopted. Under
Virginia law and the articles of incorporation and Southern Financial's bylaws,
a proposed amendment to
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Southern Financial's articles of incorporation may be submitted to the
shareholders by a vote of a majority of the board of directors. However, if more
than one-third of the Continuing Directors of Southern Financial did not support
a proposed amendment by voting to submit it to the shareholders, the amendment
would fail unless it is approved by a majority of the votes entitled to be cast
by each voting group entitled to be cast by each voting group entitled to vote
and by holders of two-thirds of the issued and outstanding shares of Southern
Financial common stock. At this time all of the directors of Southern Financial,
except Messrs. Bollerer and Finocchiaro, are Continuing Directors.
In the future, a person who is not a director of Southern Financial
today, including each Horizon director who will become a Southern Financial
director, will not become a Continuing Director unless he is elected by the
shareholders at an annual meeting more than one time, or is elected to fill a
vacancy on the board of directors by a majority of the Continuing Directors and
thereafter is elected by the shareholders at an annual meeting at least one
time. Continuing Directors are intended to be those individuals who have been
involved with Southern Financial through the years, and who therefore provide
continuity and an in-depth knowledge of the business affairs of Southern
Financial. In the context of a hostile or unfriendly attempt to acquire or
exercise control over Southern Financial, an individual elected to the board of
directors by a person or persons attempting to acquire control would not become
a Continuing Director until he is elected to the board of directors at least
twice. While directors elected by a person attempting to acquire control of
Southern Financial might be able to submit a proposed amendment to the
shareholders for a vote, unless at least two-thirds of the Continuing Directors
(who could comprise a minority of the entire board of directors) approved the
action, the additional voting requirement assures that the action would not be
taken if it is opposed by a significant percentage (more than one-third) of the
issued and outstanding shares of Southern Financial common stock. See "Security
Ownership of Management" on page 102 for a description of the percentage of the
outstanding shares of the common stock held by directors and executive officers.
The provisions that govern the vote required to amend Southern
Financial's articles of incorporation would make it more difficult for a
shareholder, or group of shareholders, who are dissatisfied with incumbent
management to amend the articles of incorporation and after gaining control of
the board of directors, which could discourage such a shareholder or group from
attempting to gain control of the board.
The voting requirements described above are intended to ensure that
amendments to the articles of incorporation and certain bylaw provisions of
Southern Financial are favored by a majority of the outstanding shares of each
voting group entitled to vote and by either two-thirds of Continuing Directors
or holders of a large majority of the shares of Southern Financial common stock.
Southern Financial's bylaws generally may be amended by either the
board of directors or the shareholders by a majority vote.
Mergers, Consolidations and Sales of Assets
Horizon. Under Horizon's articles of incorporation, any action
requiring shareholder approval shall be authorized by a majority of the votes
cast by shareholders entitled to vote at the meeting in which the action is
taken. Accordingly, the vote required for a merger, a share exchange or a direct
or indirect sale, lease, exchange or other disposition of all or substantially
all of the property of Horizon is a majority of the votes cast by shareholders
entitled to vote at the meeting in which any such action is taken.
Southern Financial. Southern Financial's articles of incorporation
provide that a plan of merger or share exchange or a direct or indirect sale,
lease, exchange or other disposition of all or substantially all of the property
of Southern Financial not in the ordinary course of business may be approved by
the same
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vote that is required in order to amend the articles of incorporation.
Additionally, consistent with Virginia law, the board of directors of Southern
Financial may condition its submission of such plan of merger or share exchange
or such a sale or disposition of assets to the shareholders on any basis,
including the requirement of a greater vote than the required vote described
above. The reasons that Southern Financial's articles of incorporation provide
for an alternative vote on mergers, share exchanges and certain sales, leases,
exchanges or dispositions of assets are the same reasons that the articles of
incorporation provide for an alternative vote to amend the articles of
incorporation. In many situations, the effect of the provisions in the articles
of incorporation that govern amendments to the articles of incorporation,
mergers and share exchanges and certain dispositions of assets, would be to make
it easier for the board of directors to gain shareholder approval of such
actions than would be the case if a favorable vote of two-thirds of the
outstanding shares were required in all cases.
A proposed merger, share exchange or sale of substantially all assets
of Southern Financial that is favored by two-thirds of the Continuing Directors
could be adopted as long as a majority (rather than two-thirds) of the
outstanding shares entitled to vote in each voting group entitled to vote are
voted in favor of the proposed action. In addition to requiring the affirmative
vote of a majority of the shares entitled to vote in each voting group entitled
to vote, Southern Financial's articles of incorporation would require that,
unless a proposed action is approved by at least two-thirds of the Continuing
Directors, holders of at least two-thirds of the issued and outstanding shares
of Southern Financial common stock must vote in favor of the proposed action.
The purpose of such additional requirement is to ensure that if a proposed major
corporate action does not have the support of a board of directors who can
provide continuity to and an in-depth knowledge of the business of Southern
Financial, the action must be supported by a large majority of the holders of
Southern Financial common stock.
As with amendments to the articles of incorporation, however, if at
least two-thirds of the Continuing Directors of Southern Financial do not
approve such corporate action upon which shareholders are voting, the additional
requirement would permit a minority of the holders of Southern Financial common
stock to defeat the proposed action.
Size and Classification of Board of Directors
Horizon. Horizon's bylaws provide that the board of directors shall
consist of not less than five or more than 25 directors, a majority of whom
shall be residents of Virginia. All directors are elected at each annual meeting
of the shareholders and shall hold their offices until their successors are
elected. Horizon's directors currently do not serve staggered terms.
Southern Financial. Southern Financial's bylaws provide that its board
of directors shall consist of a minimum of five and a maximum of 15 individuals.
Southern Financial's bylaws provide further, subject to the rights of holders of
any series of preferred stock, for the division of the directors into three
classes, consisting, as nearly as may be possible, of one-third of the total
number of directors constituting the entire board of directors. At each annual
meeting of shareholders, successors to the class of directors whose term expires
at that annual meeting are elected for a three-year term. If the number of
directors has changed, any increase or decrease shall be apportioned among the
classes so as to maintain the number of directors in each class as nearly equal
as possible, but in no case will a decrease in the number of directors shorten
the term of any incumbent director. A director shall hold office until the
annual meeting for the year in which his term expires and until his successor
shall be elected and shall qualify, subject, however, to prior death,
resignation, retirement, disqualification or removal from office.
A classified board of directors makes it more difficult for
shareholders, including those holding a majority of shares, to force an
immediate change in the composition of a majority of the board of directors,
even when the reason for a proposed removal is poor performance. Since the terms
of only
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approximately one-third of Southern Financial's directors expire each year, it
requires at least two annual elections for the shareholders to change a
majority, whereas a majority of a non-classified board may be changed in one
year.
Vacancies and Removal of Directors
Horizon. Horizon's bylaws provide that any vacancy on the board of
directors may be filled for the unexpired term by the remaining members of the
board. Horizon's articles of incorporation and bylaws do not address the removal
of directors. Because the Virginia Stock Corporation Act provides that a
director may be removed only at a special meeting of the shareholders, Horizon
shareholders could not remove a director unless a special meeting was called for
that purpose.
Southern Financial. Under Southern Financial's articles of
incorporation, newly created directorships resulting from any increase in the
number of directors and any vacancies on the board of directors resulting from
death, resignation, disqualification, removal or other cause, can be filled only
by the affirmative vote of the majority of the remaining directors then in
office, even if that number is less than a quorum of the board of directors.
This provision would enable incumbent directors to fill vacancies on the board
of directors of Southern Financial to the exclusion of Southern Financial's
shareholders, regardless of the reason for the vacancy.
Southern Financial's articles of incorporation allow removal of
director from office, with or without cause, only if at least two-thirds of the
votes cast are cast in favor of removal. Shareholders of Southern Financial may
not call a special meeting for the purpose of removing a director. In the
context of a takeover attempt these provisions likely would require a hostile
party to prevail at two consecutive annual meetings of Southern Financial in
order to acquire control of the board of directors.
The provisions of Southern Financial's articles of incorporation
relating to the removal of directors and the filling of vacancies would preclude
a holder of a majority of the voting stock from removing incumbent directors and
simultaneously gaining control of the board of directors by filling the
vacancies so created with its own nominees. Accordingly, except with the
concurrence of a majority of the directors remaining in office, persons seeking
representation either by enlarging the board of directors or by filling the
newly created directorships with their own nominees. Since only approximately
one-third of Southern Financial's directors are elected at any one annual
meeting, any hostile bidder, in the context of a takeover attempt, would have to
prevail at two consecutive annual meetings in connection with director elections
in order to replace a majority of the directors of Southern Financial.
Director Liability and Indemnification
The Virginia Stock Corporation Act provides that in any proceeding
brought by or in the right of a corporation or brought by or on behalf of
shareholders of the corporation, the damages assessed against an officer or
director arising out of a single transaction, occurrence or course of conduct
may not exceed the lesser of (1) the monetary amount, including the elimination
of liability, specified in the articles of incorporation or, if approved by the
shareholders, in the bylaws as a limitation on or elimination of the liability
of the officer or director; or (2) the greater of (a) $100,000 or (b) the amount
of cash compensation received by the officer or director from the corporation
during the twelve months immediately preceding the act or omission for which
liability was imposed. The liability of an officer or director is not limited
under the Virginia Stock Corporation Act or a corporation's articles of
incorporation and bylaws if the officer or director engaged in willful
misconduct or a knowing violation of the criminal law or of any federal or state
securities law.
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In addition, the Virginia Stock Corporation Act permits a Virginia
corporation to indemnify any director or officer for reasonable expenses
incurred in any legal proceeding in advance of final disposition of the
proceeding, if the director or officer furnishes the corporation a written
statement of his good faith belief that he has conducted himself in good faith
and that he believed that his conduct was in the best interests of the
corporation, and a determination is made by the board of directors that such
standard has been met. In a proceeding by or in the right of the corporation, no
indemnification shall be made in respect of any matter as to which an officer or
director is adjudged to be liable to the corporation, unless the court in which
the proceeding took place determines that, despite such liability, such person
is reasonably entitled to indemnification in view of all the relevant
circumstances. In any other proceeding, no indemnification shall be made if the
director or officer is adjudged liable to the corporation on the basis that
personal benefit was improperly received by him. Corporations are given the
power to make any other or further indemnity, including advancement of expenses,
to any director or officer that may be authorized by the articles of
incorporation or any bylaw made by the shareholders, or by any resolution
adopted, before or after the event, by the shareholders, except an indemnity
against willful misconduct or a knowing violation of the criminal law. Unless
limited by its articles of incorporation, indemnification of a director or
officer is mandatory when he entirely prevails in the defense of any proceeding
to which he is a party because he is or was a director or officer.
Horizon. Horizon's articles of incorporation provide that any director
or officer of Horizon shall be indemnified by Horizon for his actions, unless he
is adjudged liable for willful misconduct or a knowing violation of criminal
law. The rights of indemnification provided in Horizon's articles of
incorporation are not exclusive of any other rights of the officer or director,
including without limitation rights conferred by applicable law and any right
under insurance policies which may be purchased and maintained by Horizon or
others, even as to liabilities against which Horizon would not have the power to
indemnify.
Southern Financial. To the fullest extent permitted by Virginia law,
Southern Financial's articles of incorporation require it to indemnify any
director or officer of Southern Financial who is made a party to any proceeding
because he was or is a director or officer of Southern Financial against any
liability, including reasonable expenses and legal fees, incurred in the
proceeding. Under Southern Financial's articles of incorporation, "proceeding"
is broadly defined to include pending, threatened or completed actions of all
types, including actions by or in the right of Southern Financial. Similarly,
"liability" is defined to include, not only judgments, but also settlements,
penalties, fines and certain excise taxes. Southern Financial's articles of
incorporation also provide that Southern Financial may, but is not obligated to,
indemnify its other employees or agents. The Southern Financial must indemnify
any person who is or was serving at the written request of Southern Financial as
a director, officer, employee or agent or agent of another corporation,
partnership, joint venture, trust or other enterprise, to the full extent
provided by Virginia law. The indemnification provisions also require Southern
Financial to pay reasonable expenses incurred by a director or officer of
Southern Financial in a proceeding in advance of the final disposition of any
such proceeding, provided that the indemnified person undertakes to repay
Southern Financial if it is ultimately determined that such person was not
entitled to indemnification. At this time, Virginia law does not permit
indemnification against willful misconduct or a knowing violation of the
criminal law.
The rights of indemnification provided in Southern Financial's articles
of incorporation are not exclusive of any other rights which may be available
under any insurance or other agreement, by vote of shareholders or disinterested
directors or otherwise. In addition, the articles of incorporation authorize
Southern Financial to maintain insurance on behalf of any person who is or was a
director, officer, employee or agent of Southern Financial, whether or not
Southern Financial would have the power to provide indemnification to such
person. The rights of indemnification provided to directors of Southern
Financial could reduce the likelihood of shareholder derivative actions and may
discourage other third
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party claims against the directors, even if such actions otherwise would be
beneficial to shareholders of Southern Financial.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling Southern
Financial pursuant to the foregoing provisions, Southern Financial has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is therefor
unenforceable.
Special Meetings of Shareholders
Horizon. Horizon's bylaws provide that special meetings of shareholders
may be held on the dates and times fixed by the board of directors. Shareholders
do not have the right to call a special meeting.
Southern Financial. Southern Financial's bylaws provide that special
meetings of shareholders may be held whenever called by the president, chairman
of the board of directors or by the board of directors, itself, which means that
the shareholders of Southern Financial do not have the right to call special
meetings. The inability of shareholders to call a special meeting could affect
changes in control of Southern Financial by delaying the presentation to
shareholders of proposals relating to, or facilitating, such a change in control
until the annual meeting.
Shareholder Nominations and Proposals
Horizon. Horizon's bylaws do not prescribe procedures for directors'
nominations. In addition, Horizon's articles of incorporation and bylaws do not
contain any requirements relating to the timing or content of shareholder
proposals for shareholder vote.
Southern Financial. Under Southern Financial's bylaws, notice of a
proposed nomination or a shareholder proposal meeting certain specified
requirements must be received by Southern Financial not less than 60 nor more
than 90 days prior to any meeting of shareholders called for the election of
directors, provided in each case that if fewer than 70 days' notice of the
meeting is given to shareholders, such written notice shall be received not
later than the close of the tenth day following the day on which notice of the
meeting was mailed to shareholders.
Southern Financial's bylaws require that the shareholder's notice set
forth as to each nominee (i) the name, age, business address and residence
address of such nominee, (ii) the principal occupation or employment of such
nominee, (iii) the class and number of shares of Southern Financial which are
beneficially owned by such nominee, and (iv) any other information relating to
such nominee that is required under federal securities laws to be disclosed in
solicitations of proxies for the election of directors, or is otherwise required
(including, without limitation, such nominee's written consent to being named in
a proxy statement as nominee and to serving as a director if elected). Southern
Financial's bylaws further require that the shareholder's notice set forth as to
the shareholder giving the notice (i) the name and address of such shareholder
and (ii) the class and amount of such shareholder's beneficial ownership of
Southern Financial capital stock. If the information supplied by a shareholder
is deficient in any material aspect or if the foregoing procedure is not
followed, the chairman of the annual meeting may determine that such
shareholder's nomination should not be brought before the annual meeting and
that such nominee shall not be eligible for election as a director of Southern
Financial.
The advance notice procedure of Southern Financial's bylaws affords the
board of directors the opportunity to consider the qualifications of the
proposed nominees and to inform shareholders about such qualifications. Although
such procedure does not give the board of directors of Southern Financial
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any power to approve or disapprove of shareholder nominations for election of
directors, it may have the effect of precluding surprise nominations and a
contest for the election if directors if such procedure established by it is not
followed. Furthermore, such procedure may discourage or deter a third party from
conducting a solicitation of proxies to elect its own slate of directors.
The procedures regarding shareholder proposals and nominations provide
the board of directors of Southern Financial with the information which will be
necessary to evaluate a shareholder proposal or nomination and other relevant
information, such as existing shareholder support, as well as the time necessary
to consider and evaluate such information in advance of the applicable meeting.
The proposed procedures, however, will give incumbent directors advance notice
of a business proposal or nomination. This may make it easier for the incumbent
directors to defeat a shareholder proposal or nomination, even when certain
shareholders view such proposal or nomination as in the best interests of
Southern Financial or its shareholders. Southern Financial's articles of
incorporation and bylaws do not prevent shareholders from making proposals under
the Commission's rules and regulations.
Shareholder Voting Rights in General
The Virginia Stock Corporation Act generally provides that shareholders
do not have cumulative voting rights unless those rights are provided in the
corporation's articles of incorporation. The Virginia Stock Corporation Act also
specifies additional voting requirements for Affiliated Transactions which are
discussed below under "State Anti-Takeover Statutes."
Horizon. Horizon's articles of incorporation do not provide
shareholders cumulative voting rights for the election of directors. Therefore,
the holders of a majority of the shares voted in the election of directors can
elect all of the directors then standing for election. The holders of common
stock are entitled to one vote per share on all matters submitted to a vote of
shareholders.
Southern Financial. Southern Financial's articles of incorporation do
not provide shareholders cumulative rights for the election of directors.
Therefore, the holders of a majority of the shares voted in the election of
directors can elect all of the directors then standing for election. The holders
of Southern Financial common stock are entitled to one vote per share on all
matters submitted to a vote of shareholders. Except to the extent to which the
board of directors shall have specified voting power with respect to any other
class of stock and except as otherwise provided by law, the exclusive voting
power shall be vested in the holders of Southern Financial common stock.
State Anti-Takeover Statutes
The Virginia Stock Corporation Act restricts transactions between a
corporation and its affiliates and potential acquirors. The summary below is
necessarily general and is not intended to be a complete description of all the
features and consequences of those provisions, and is qualified in its entirety
by reference to the statutory provisions contained in the Virginia Stock
Corporation Act. Because both Horizon and Southern Financial are Virginia
corporations, the provisions of the Virginia Stock Corporation Act described
below apply to Horizon and Southern Financial and will continue to apply to
Horizon after the merger.
Affiliated Transactions. The Virginia Stock Corporation Act contains
provisions governing "Affiliated Transactions," found at Sections 13.1-725 -
727.1 of the Virginia Stock Corporation Act. Affiliated Transactions include
certain mergers and share exchanges, certain material dispositions of corporate
assets not in the ordinary course of business, any dissolution of a corporation
proposed by or on behalf of an Interested Shareholder (as defined below), and
reclassifications, including reverse stock splits, recapitalizations or mergers
of a corporation with its subsidiaries, or distributions or other
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transactions which have the effect of increasing the percentage of voting shares
beneficially owned by an Interested Shareholder by more than 5%. For purposes of
the Virginia Stock Corporation Act, an Interested Shareholder is defined as any
beneficial owner of more than 10% of any class of the voting securities of a
Virginia corporation.
Subject to certain exceptions discussed below, the provisions governing
Affiliated Transactions require that, for three years following the date upon
which any shareholder becomes an Interested Shareholder, any Affiliated
Transaction must be approved by the affirmative vote of holders of two-thirds of
the outstanding shares of the corporation entitled to vote, other than the
shares beneficially owned by the Interested Shareholder, and by a majority (but
not less than two) of the Disinterested Directors (as defined below). A
Disinterested Director is defined in the Virginia Stock Corporation Act as a
member of a corporation's board of directors who (i) was a member before the
later of January 1, 1988 or the date on which an Interested Shareholder became
an Interested Shareholder and (ii) was recommended for election by, or was
elected to fill a vacancy and received the affirmative vote of, a majority of
the Disinterested Directors then on the corporation's board of directors. At the
expiration of the three year period after a shareholder becomes an Interested
Shareholder, these provisions require approval of the Affiliated Transaction by
the affirmative vote of the holders of two-thirds of the outstanding shares of
the corporation entitled to vote, other than those beneficially owned by the
Interested Shareholder.
The principal exceptions to the special voting requirement apply to
Affiliated Transactions occurring after the three year period has expired and
require either that the transaction be approved by a majority of the
corporation's Disinterested Directors or that the transaction satisfy certain
fair price requirements of the statute. In general, the fair price requirements
provide that the shareholders must receive the higher of: the highest per share
price for their shares as was paid by the Interested Shareholder for his or its
shares, or the fair market value of the shares. The fair price requirements also
require that, during the three years preceding the announcement of the proposed
Affiliated Transaction, all required dividends have been paid and no special
financial accommodations have been accorded the interested Shareholder, unless
approved by a majority of the Disinterested Directors.
None of the foregoing limitations and special voting requirements
applies to a transaction with an Interested Shareholder who has been an
Interested Shareholder continuously since the effective date of the statute
(January 26, 1988) or who became an Interested Shareholder by gift or
inheritance from such a person or whose acquisition of shares making such person
an Interested Shareholder was approved by a majority of the Disinterested
Directors of the corporation.
These provisions were designed to deter certain takeovers of Virginia
corporations. In addition, the Virginia Stock Corporation Act provides that by
affirmative vote of a majority of the voting shares other than shares owned by
any Interested Shareholder, a corporation may adopt by meeting certain voting
requirements, an amendment to its articles of incorporation or bylaws providing
that the Affiliated Transactions provisions shall not apply to the corporation.
Neither Horizon nor Southern Financial has adopted such an amendment. Currently,
no shareholder of Horizon owns or controls 10% or more of Horizon common stock,
and there are no Interested Shareholders of Horizon or Southern Financial as
defined by the Virginia Stock Corporation Act.
Control Share Acquisitions. The Virginia Control Share Acquisitions
statute, found at Sections 13.1-728 - 728.8 of the Virginia Stock Corporation
Act, also is designed to afford shareholders of a public company incorporated in
Virginia protection against certain types of non-negotiated acquisitions in
which a person, entity or group ("Acquiring Person") seeks to gain voting
control of that corporation. With certain enumerated exceptions, the statute
applies to acquisitions of shares of a corporation which would result in an
Acquiring Person's ownership of the corporation's shares entitled to vote in the
election of directors falling within any one of the following ranges: 20% to
33-1/3%, 33-1/3% to 50% or 50% or
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more (a "Control Share Acquisition"). Shares that are the subject of a Control
Share Acquisition ("Control Shares") will not be entitled to voting rights
unless the holders of a majority of the "Disinterested Shares" vote at an annual
or special meeting of shareholders of the corporation to accord the Control
Shares with voting rights. Disinterested Shares do not include shares owned by
the Acquiring Person or by officers and inside directors of the target company.
Under certain circumstances, the statute permits an Acquiring Person to call a
special shareholders' meeting for the purpose of considering granting voting
rights to the holders of the Control Shares. As a condition to having this
matter considered at either an annual or special meeting, the Acquiring Person
must provide shareholders with detailed disclosures about his identity, the
method and financing of the Control Share Acquisition and any plans to engage in
certain transactions with, or to make fundamental changes to, the corporation,
its management or business. Under certain circumstances, the statute grants
dissenters' rights to shareholders who vote against granting voting rights to
the Control Shares. The Virginia Control Share Acquisitions Statute also enables
a corporation to make provisions for redemption of Control Shares with no voting
rights. A corporation may opt-out of the statute, which Horizon has not done, by
so providing in its articles of incorporation or bylaws. Southern Financial,
however, has opted out of the statute by so providing in its bylaws. Among the
acquisitions specifically excluded from the statute are acquisitions which are a
part of certain negotiated transactions to which the corporation is a party and
which, in the case of mergers or share exchanges, have been approved by the
corporation's shareholders under other provisions of the Virginia Stock
Corporation Act.
REGULATION
Set forth below is a brief description of certain laws and regulations
that relate to the regulation of Southern Financial and Horizon. 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, and Horizon is a state chartered
bank. As such, Southern Financial and Horizon are each supervised by the Board
of Governors of the Federal Reserve System and are each required to file reports
with the Federal Reserve and provide such additional information as the Federal
Reserve may require. Southern Financial and Horizon are also subject to Virginia
laws regarding financial institution holding companies and financial
institutions, respectively, as administered by the Bureau of Financial
Institutions of the State Corporation Commission of Virginia. Southern Financial
and Horizon are also affected by rules and regulations of the Federal Deposit
Insurance Corporation ("FDIC"). Southern Financial and Horizon are members of
the Federal Reserve System and the Federal Home Loan Bank of Atlanta. The
various laws and regulations administered by the regulatory agencies affect
corporate practices, expansion of business, and provisions of services. Also,
monetary and fiscal policies of the United States directly affect bank loans and
deposits and thus may affect Southern Financial's and Horizon's earnings. The
future impact of these policies and of the continuing regulatory changes in the
financial services industry cannot be predicted.
FDIC Regulations
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
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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 Federal Reserve'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 Federal Reserve has adopted regulations implementing the provisions of the
Truth in Savings Act.
In addition, significant provisions of FDICIA required federal banking
regulators to draft standards in a number of other important areas to assure
bank safety and soundness, including internal controls, information systems and
internal audit systems, credit underwriting, asset growth, compensation, loan
documentation and interest rate exposure. FDICIA also required the regulators to
establish maximum ratios of classified assets to capital, and minimum earnings
sufficient to absorb losses without impairing capital. The legislation also
contained other provisions which restricted the activities of state-chartered
banks, amended various consumer banking laws, limited the ability of "under
capitalized" banks to borrow from the Federal Reserve's discount window, and
required federal banking regulators to perform annual onsite bank examinations
and set standards for real estate lending.
Regulatory Capital Requirement
All depository institutions are required to maintain minimum levels of
regulatory capital. The federal bank regulatory agencies have established
substantially similar risked based and leverage capital standards for financial
institutions that they regulate. These regulatory agencies also may impose
capital requirements in excess of these standards on a case-by-case basis for
various reasons, including financial condition or actual or anticipated growth.
Under the risk-based capital requirements of these regulatory agencies, Southern
Financial and its bank subsidiary and Horizon are each required to maintain a
minimum ratio of total capital to risk-weighted assets of at least 8%. At least
half of the total capital is required to be "Tier 1 capital," which consists
principally of common and certain qualifying preferred shareholders' equity,
less certain intangibles and other adjustments. The remainder ("Tier 2 capital")
consists of a limited amount of subordinated and other qualifying debt
(including certain hybrid capital instruments) and a limited amount of the
general loan loss allowance. Based upon the applicable Federal
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Reserve regulations, at March 31, 1999, Southern Financial Bank and Horizon each
is considered to be "well capitalized."
In addition, the federal regulatory agencies have established a minimum
leverage capital ratio (Tier 1 capital to tangible assets). These guidelines
provide for a minimum leverage capital ratio of 3% for banks and their
respective holding companies that meet certain specified criteria, including
that they have the highest regulatory examination rating and are not
contemplating significant growth or expansion. All other institutions are
expected to maintain a leverage ratio of at least 100 to 200 basis points above
that minimum. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Deposit Insurance
The deposits of each of Southern Financial and Horizon 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. Southern Financial'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. Horizon's
deposits are subject to the rates of the Bank Insurance Fund ("BIF"). Based on
their current risk classifications, Southern Financial and Horizon are required
to pay the minimum SAIF assessment and BIF assessment, respectively.
Federal Home Loan Bank System
Southern Financial and Horizon are members of the Federal Home Loan
Bank System, which consists of 12 district Federal Home Loan Banks with each
subject to supervision and regulation by the Federal Housing Finance Board. The
Federal Home Loan Banks provide a central credit facility for member
institutions. Southern Financial and Horizon, as members of the Federal Home
Loan Bank of Atlanta, are each required to acquire and hold shares of capital
stock in that Federal Home Loan Bank in an amount equal to at least 1% of the
aggregate principal amount of their unpaid residential mortgage loans, home
purchase contracts and similar obligations at the beginning of each year, or 5%
of their advances (borrowings) from the Federal Home Loan Bank of Atlanta,
whichever is greater. At December 31, 1998, Southern Financial and Horizon had
an investment of $1.1 million and $382 thousand, respectively, in the stock of
the Federal Home Loan Bank of Atlanta and were in compliance with these
requirements.
Advances from the Federal Home Loan Bank of Atlanta are secured.
Interest rates charged for advances vary depending upon maturity, the cost of
funds to the Federal Home Loan Bank of Atlanta and the purpose of the borrowing.
At December 31, 1998, Southern Financial and Horizon had $3.5 million
outstanding in borrowings from the Federal Home Loan Bank of Atlanta, and
Horizon had no such outstanding borrowings.
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 each of Southern
Financial and Horizon.
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RESALES OF SOUTHERN FINANCIAL COMMON STOCK
Horizon Shareholders. The shares of Southern Financial common stock to
be issued to Horizon shareholders in the merger have been registered under the
Securities Act. These shares may be traded freely and without restriction by
those shareholders not deemed to be "affiliates" of Horizon as that term is
defined under the Securities Act. An affiliate of a corporation, as defined by
the rules promulgated under the Securities Act, is a person who directly or
indirectly, through one or more intermediaries, controls, is controlled by, or
is under common control with, that corporation. Any subsequent transfer by an
affiliate of Horizon must be one permitted by the resale provisions of Rule 145
promulgated under the Securities Act or as otherwise permitted under the
Securities Act.
Affiliates of Southern Financial and Horizon. Commission guidelines
regarding qualifying for the pooling-of-interests method of accounting also
limit sales of shares of the acquiring company and acquired company by
affiliates of either company in a business combination such as the merger. These
guidelines indicate that the pooling-of-interests method of accounting will
generally not be challenged on the basis of sales by such affiliates if these
persons do not dispose of any of the shares of the corporation they own or any
shares of the corporation they receive in connection with a merger during the
period beginning 30 days prior to the merger and ending when financial results
covering at least 30 days of post-merger operations of the combined entity have
been published (the "Pooling Restricted Period").
Horizon has agreed to deliver to Southern Financial not less than 30
days prior to the effective date, for each of its affiliates, an agreement that
such person will not dispose of (i) any Southern Financial common stock in
violation of the Securities Act or (ii) any Horizon common stock or Southern
Financial common stock during the Pooling Restricted Period.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This joint proxy statement/prospectus, including information included
or incorporated by reference herein, contains certain forward-looking statements
with respect to the financial condition, results of operations, plans,
objectives, future performance and businesses of each of Southern Financial and
Horizon. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by such forward-looking statements include, among others, the
following possibilities:
o competitive pressure from banks and other financial service
providers increases significantly;
o changes in the interest rate environment reduce margins;
o general economic conditions, either nationally or regionally,
are less favorable than expected, resulting in, among other
things, a deterioration in credit quality;
o changes occur in the regulatory environment;
o changes occur in business conditions and inflation;
o changes occur in the securities markets; and
o any business disruptions that may result from Year 2000 issues.
EXPERTS
The financial statements of Southern Financial Bancorp, Inc. as of
December 31, 1998 and 1997 and for each of the years then ended have been
included herein and in the registration statement in
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reliance upon the report of KPMG LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
The financial statements of The Horizon Bank of Virginia as of December
31, 1998 and 1997 and for each of the years ended December 31, 1998, 1997 and
1996 have been included herein and in the registration statement in reliance
upon the report of Thompson, Greenspon & Co., P.C., independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
LEGAL OPINIONS
The validity of the shares of Southern Financial common stock offered
hereby is being passed upon for Southern Financial by Williams, Mullen, Clark &
Dobbins, Richmond, Virginia. Williams, Mullen, Clark & Dobbins will deliver an
opinion to Southern Financial and Horizon concerning certain federal income tax
consequences of the merger. See "The Merger - Material Federal Income Tax
Consequences of the Merger" on page 15.
Certain matters relating to the merger will be passed upon for Horizon
by Mays & Valentine, L.L.P., Richmond, Virginia.
WHERE YOU CAN FIND MORE INFORMATION
Southern Financial maintains an Internet site at
www.southernfinancialbank.com, which contains information relating to Southern
Financial and its business.
In addition, Southern Financial files annual, quarterly and current
reports, proxy statements and other information with the Securities and Exchange
Commission. You may read and copy any document that Southern Financial files at
the Commission's public reference room facility located at 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the Commission's regional offices at 7 World
Trade Center, 13th Floor, Suite 1300, New York, New York 10048 and Suite 1400,
Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661. Please call
the Commission at 1-800-SEC-0330 for further information on the public reference
room. The Commission maintains an Internet site at www.sec.gov that contains
reports, proxy and information statements and other information regarding
issuers, including Southern Financial, that file documents with the Commission
electronically through the Commission's electronic data gathering, analysis and
retrieval system known as EDGAR. Southern Financial's reports, proxy and
information statements may also be reviewed at the offices of the National
Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington D.C.
20006.
This joint proxy statement/prospectus is part of a registration
statement filed by Southern Financial with the Commission. Because the rules and
regulations of the Commission allow the omission of certain portions of the
registration statement from this document, this joint proxy statement/prospectus
does not contain all the information contained in the registration statement.
You may review the registration statement and the exhibits filed with the
registration statement for further information regarding Southern Financial. The
registration statement and its exhibits may be inspected at the public reference
facilities of the Commission at the addresses mentioned above.
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Appendix A
AGREEMENT AND PLAN OF REORGANIZATION
BETWEEN
THE HORIZON BANK OF VIRGINIA
AND
SOUTHERN FINANCIAL BANCORP, INC.
AND
SOUTHERN FINANCIAL BANK
May 3, 1999
(as amended)
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ARTICLE 1
The Reorganization and Related Matters
Page
<S> <C>
1.1 The Reorganization.......................................................................... A-6
1.2 Management.................................................................................. A-6
1.3 The Closing and Effective Date.............................................................. A-7
1.4 Definitions................................................................................. A-7
ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of HBV Shares.................................................................... A-8
2.2 Manner of Exchange.......................................................................... A-8
2.3 No Fractional Shares........................................................................ A-8
2.4 Dividends................................................................................... A-8
ARTICLE 3
Representations and Warranties
3.1 Representations and Warranties of HBV....................................................... A-9
(a) Organization, Standing and Power................................................... A-9
(b) Authority.......................................................................... A-9
(c) Capital Structure.................................................................. A-9
(d) No Subsidiaries.................................................................... A-10
(e) Financial Statements............................................................... A-10
(f) Absence of Undisclosed Liabilities................................................. A-10
(g) Legal Proceedings; Compliance with Laws............................................ A-10
(h) Regulatory Approvals............................................................... A-11
(i) Labor Relations.................................................................... A-11
(j) Tax Matters........................................................................ A-11
(k) Property........................................................................... A-11
(l) Reports............................................................................ A-11
(m) Employee Benefit Plans............................................................. A-11
(n) Investment Securities.............................................................. A-12
(o) Certain Contacts................................................................... A-12
(p) Insurance.......................................................................... A-13
(q) Absence of Material Changes and Events............................................. A-13
(r) Loans, OREO and Allowance for Loan Losses.......................................... A-13
(s) Statements True and Correct........................................................ A-14
(t) Brokers and Finders................................................................ A-14
A-2
<PAGE>
(u) Repurchase Agreements.............................................................. A-15
(v) Administration of Trust Accounts................................................... A-15
(w) Environmental Matters.............................................................. A-15
(x) Year 2000.......................................................................... A-17
3.2 Representations and Warranties of SFB....................................................... A-17
(a) Organization, Standing and Power................................................... A-17
(b) Authority.......................................................................... A-18
(c) Capital Structure.................................................................. A-18
(d) Ownership of the SFB Subsidiaries; Capital Structure
of the SFB Subsidiaries; and Organization of the SFB
Subsidiaries....................................................................... A-18
(e) Financial Statements............................................................... A-19
(f) Absence of Undisclosed Liabilities................................................. A-19
(g) Legal Proceedings; Compliance with Laws............................................ A-19
(h) Regulatory Approvals............................................................... A-20
(i) Labor Relations.................................................................... A-20
(j) Tax Matters........................................................................ A-20
(k) Property........................................................................... A-20
(l) Reports............................................................................ A-21
(m) Employee Benefit Plans............................................................. A-21
(n) Investment Securities.............................................................. A-21
(o) Certain Contacts................................................................... A-22
(p) Insurance.......................................................................... A-22
(r) Loans, OREO and Allowance for Loan Losses.......................................... A-22
(q) Absence of Material Changes and Events............................................. A-23
(s) Statements True and Correct........................................................ A-24
(t) Brokers and Finders................................................................ A-24
(u) Repurchase Agreements.............................................................. A-24
(v) Administration of Trust Accounts................................................... A-24
(w) Environmental Matters.............................................................. A-24
(x) Year 2000.......................................................................... A-26
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties............................................................ A-26
4.2 Confidentiality............................................................................. A-26
4.3 Registration Statement, Proxy Statement and Shareholder Approval............................ A-27
4.4 Operation of the Business of HBV and SFB.................................................... A-27
4.5 Dividends................................................................................... A-28
4.6 No Solicitation............................................................................. A-28
4.7 Regulatory Filings.......................................................................... A-29
4.8 Public Announcements........................................................................ A-29
4.9 Notice of Breach............................................................................ A-29
A-3
<PAGE>
4.10 Accounting Treatment........................................................................ A-29
4.11 Reorganization Consummation................................................................. A-29
ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options................................................................. A-30
5.2 Accounting Treatment........................................................................ A-30
5.3 Benefit Plans............................................................................... A-30
5.4 Indemnification............................................................................. A-31
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to the Reorganization............................................................ A-32
(a) Shareholder Approvals.............................................................. A-32
(b) Regulatory Approvals............................................................... A-32
(c) Registration Statement............................................................. A-32
(d) Tax Opinion........................................................................ A-32
(e) Accountants' Letter................................................................ A-33
(f) Opinions of Counsel................................................................ A-33
(g) Legal Proceedings.................................................................. A-33
6.2 Conditions to Obligations of SFB............................................................ A-33
(a) Representations and Warranties..................................................... A-33
(b) Performance of Obligations......................................................... A-33
(c) Affiliate Letters.................................................................. A-33
(d) Investment Banking Letter.......................................................... A-33
(e) Employment Contract Termination.................................................... A-34
6.3 Conditions to Obligations of HBV............................................................ A-34
(a) Representations and Warranties..................................................... A-34
(b) Performance of Obligations......................................................... A-34
(c) Investment Banking Letter.......................................................... A-34
ARTICLE 7
Termination
7.1 Termination................................................................................. A-35
7.2 Effect of Termination....................................................................... A-35
7.3 Non-Survival of Representations, Warranties and Covenants................................... A-35
7.4 Expenses.................................................................................... A-36
7.5 Termination Fee............................................................................. A-36
A-4
<PAGE>
ARTICLE 8
General Provisions
8.1 Entire Agreement............................................................................ A-37
8.2 Waiver and Amendment........................................................................ A-37
8.3 Descriptive Headings........................................................................ A-37
8.4 Governing Law............................................................................... A-37
8.5 Notices..................................................................................... A-37
8.6 Counterparts................................................................................ A-38
8.7 Severability................................................................................ A-38
8.8 Brokers and Finders......................................................................... A-38
8.9 Subsidiaries................................................................................ A-39
</TABLE>
Exhibit A - Plan of Merger between The Horizon Bank of Virginia and Southern
Financial Bank.
Exhibit B - Form of Employment Agreement between Richard L. Hall and Southern
Financial Bancorp, Inc.
Exhibit C - Form of Amendment to Bylaws of Southern Financial Bancorp, Inc.
A-5
<PAGE>
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made and
entered into as of May 3, 1999 by and between The Horizon Bank of Virginia, a
Virginia state bank with its principal office located in Vienna, Virginia
("HBV"), Southern Financial Bancorp, Inc., a Virginia corporation with its
principal office located in Warrenton, Virginia ("SFB"); and Southern Financial
Bank, a Virginia state bank and a wholly owned subsidiary of SFB with its
principal office located in Warrenton, Virginia (the "Bank").
WITNESSETH:
WHEREAS, HBV and SFB desire to combine their respective businesses; and
WHEREAS, HBV and SFB have agreed to the affiliation of their two
companies through a merger of HBV with and into the Bank under Virginia law, as
a result of which the shareholders of HBV would become shareholders of SFB, all
as more specifically provided in this Agreement and the Plan of Merger in the
form attached hereto as Exhibit A (the "Plan"); and
WHEREAS, the respective Boards of Directors of HBV and SFB have
resolved that the transactions described herein are in the best interests of the
parties and their respective shareholders and have authorized and approved the
execution and delivery of this Agreement.
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements set forth herein, the parties hereby agree as follows:
ARTICLE 1
The Reorganization and Related Matters
1.1 The Reorganization. Subject to the terms and conditions of
this Agreement, at the Effective Date as defined in Section 1.3 hereof, HBV will
be merged with and into the Bank pursuant to the Plan (the "Reorganization").
The separate corporate existence of HBV shall thereupon cease, and the Bank will
be the surviving corporation in the merger. From and after the Effective Date,
the Reorganization will have the effect set forth in Section 13.1-721 of the
Virginia Stock Corporation Act ("VSCA").
1.2 Management. On the Effective Date, SFB shall increase the size
of its Board of Directors by three (3) members and Richard L. Hall, John C.
Belotti and Robert P. Warhurst shall be appointed to fill the vacancies so
created. Mr. Hall shall become a member of the class of Directors whose terms
expire in 2001 and Messrs. Belotti and Warhurst shall become members of the
classes of Directors whose terms expire in 2000 and 2002, respectively. Richard
L. Hall shall become an Executive Vice President of the Bank. The Corporation
shall establish an eastern region Advisory Board and each current member of the
HBV Advisory Board and each HBV Director who desires to serve on the eastern
region Advisory Board shall become a member of such Advisory Board. At the
Effective Date, Section 2.3 of the Bylaws of SFB shall be amended to read as set
forth in Exhibit B hereto.
A-6
<PAGE>
1.3 The Closing and Effective Date. The closing of the
transactions contemplated by this Agreement and the Plan of Reorganization shall
take place at the offices of Williams, Mullen, Christian & Dobbins, 1021 East
Cary Street, Richmond, Virginia or at such other place as may be mutually agreed
upon by the parties. The Reorganization shall become effective on the date shown
on the Certificate of Merger issued by the State Corporation Commission of
Virginia effecting the Reorganization (the "Effective Date"). Unless otherwise
agreed upon in writing by the chief executive officers of SFB and HBV, subject
to the conditions to the obligations of the parties to effect the Reorganization
as set forth in Article 6, the parties shall use their best efforts to cause the
Effective Date to occur on the first day of the month following the month in
which the conditions set forth in Sections 6.1(a) and 6.1(b) are satisfied. All
documents required by the terms of this Agreement to be delivered at or prior to
consummation of the Reorganization will be exchanged by the parties at the
closing of the Reorganization (the "Reorganization Closing"), which shall be
held on or before the Effective Date. At or after the Reorganization Closing,
the Bank and HBV shall execute and deliver to the Virginia State Corporation
Commission Articles of Merger containing a Plan of Merger in substantially the
form of Exhibit A hereto.
1.4 Definitions. Any term defined anywhere in this Agreement shall
have the meaning ascribed to it for all purposes of this Agreement (unless
expressly noted to the contrary). In addition:
(a) the term "knowledge" when used with respect to a
party shall mean the knowledge, after due inquiry, of any "Executive Officer" of
such party, as such term is defined in Regulation O, (12 C.F.R. 215);
(b) the term "Material Adverse Effect", when applied to a
party, shall mean an event, occurrence or circumstance (including without
limitation (i) the making of any provisions for possible loan and lease losses,
write-downs or other real estate and taxes and (ii) any breach of a
representation or warranty by such party) which (a) has or is reasonably likely
to have a material adverse effect on the financial position, results of
operations or business of the party and its subsidiaries, taken as a whole, or
(b) would materially impair the party's ability to perform its obligations under
this Agreement or the consummation of the Reorganization and the other
transactions contemplated by this Agreement; provided, however, that solely for
purposes of measuring whether an event, occurrence or circumstance has a
material adverse effect on such party's results of operations, the term "results
of operations" shall mean net interest income plus non-interest income (less
securities gains) less gross expenses (excluding provisions for possible loan
and lease losses, write-downs of other real estate and taxes); and provided
further, that material adverse effect and material impairment shall not be
deemed to include the impact of (i)
changes in banking and similar laws of general applicability or interpretations
thereof by courts or governmental authorities, (ii) changes in generally
accepted accounting principles or regulatory accounting requirements applicable
to banks and bank holding companies generally, and (iii) the Reorganization on
the operating performance of the parties to this Agreement; and
(c) the term "Previously Disclosed" by a party shall mean
information set forth in a written disclosure letter that is delivered by that
party to the other party prior to or contemporaneously with the execution of
this Agreement and specifically designated as information "Previously Disclosed"
pursuant to this Agreement.
A-7
<PAGE>
ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of HBV Stock. At the Effective Date, by virtue of
the Reorganization and without any action on the part of the holders thereof,
each share of common stock, par value $2.50 per share, of HBV ("HBV Common
Stock") issued and outstanding immediately prior to the Effective Date shall
cease to be outstanding and shall be converted into 0.63 shares of common stock,
par value $.01 per share, of SFB ("SFB Common Stock"), plus cash for fractional
shares (the "Exchange Ratio"). Each holder of a certificate representing any
shares of HBV Common Stock shall thereafter cease to have any rights with
respect to such HBV Common Stock, except the right to receive any dividends
previously declared but unpaid as to such stock and the consideration described
in Sections 2.1 and 2.3 upon the surrender of such certificate in accordance
with Section 2.2. In the event SFB changes the number of shares of SFB Common
Stock issued and outstanding prior to the Effective Date as a result of any
stock split, stock dividend, recapitalization or similar transaction with
respect to the outstanding SFB Common Stock and the record date therefor shall
be prior to the Effective Date, the Exchange Ratio shall be proportionately
adjusted.
2.2 Manner of Exchange. As promptly as practicable after the
Effective Date, SFB shall cause Chase Mellon Shareholder Services, acting as the
exchange agent ("Exchange Agent"), to send to each former shareholder of record
of HBV immediately prior to the Effective Date transmittal materials for use in
exchanging such shareholder's certificates of HBV Common Stock for the
consideration set forth in Section 2.1 above and Section 2.3 below. Any
fractional share checks which a HBV shareholder shall be entitled to receive in
exchange for such shareholder's shares of HBV Common Stock, and any dividends
paid on any shares of SFB Common Stock that such shareholder shall be entitled
to receive prior to the delivery to the Exchange Agent of such shareholder's
certificates representing all of such shareholder's shares of HBV Common Stock
will be delivered to such shareholder only upon delivery to the Exchange Agent
of the certificates representing all of such shares (or indemnity satisfactory
to SFB and the Exchange Agent, in their judgement, if any of such certificates
are lost, stolen or destroyed). No interest will be paid on any such fractional
share checks or dividends to which the holder of such shares shall be entitled
to receive upon such delivery.
2.3 No Fractional Shares. No certificates or scrip for fractional
shares of SFB Common Stock will be issued. In lieu thereof, SFB will pay the
value of such fractional shares in cash on the basis of the average of the
closing prices of SFB Common Stock as reported by NASDAQ for trades reported
during the ten (10) trading days immediately preceding the Effective Date.
2.4 Dividends. No dividend or other distribution payable to the
holders of record of SFB Common Stock at or as of any time after the Effective
Date shall be paid to the holder of any certificate representing shares of HBV
Common Stock issued and outstanding at the Effective Date until such holder
physically surrenders such certificate for exchange as provided in Section 2.2
of this Agreement, promptly after which time all such dividends or distributions
shall be paid (without interest).
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ARTICLE 3
Representation and Warranties
3.1 Representations and Warranties of HBV. HBV represents and
warrants to SFB as follows:
(a) Organization, Standing and Power. (1) HBV is a
corporation and a Virginia state bank, duly organized, validly existing and in
good standing under the laws of Virginia, and it has all requisite corporate
power and authority to carry on its business in Virginia as now being conducted
and to own and operate its assets, properties and business. HBV has the
corporate power and authority to execute and deliver this Agreement and perform
the respective terms of this Agreement and the Plan of Merger. HBV is a member
of the Federal Reserve System. Except as Previously Disclosed, HBV is in
compliance in all material respects with all rules and regulations promulgated
by the Board of Governors of the Federal Reserve System (the "Federal Reserve"),
the Virginia State Corporation Commission ("SCC") and any other relevant
regulatory authority, and it has all requisite corporate power and authority to
carry on a commercial banking business as now being conducted and to own and
operate its assets, properties and business.
(2) HBV is an "insured bank" as defined in the Federal
Deposit Insurance Act and applicable regulations thereunder. All of the shares
of capital stock of HBV are fully paid and nonassessable.
(b) Authority. (1) The execution and delivery of this
Agreement, the Plan of Merger and the consummation of the Reorganization, have
been duly and validly authorized by all necessary corporate action on the part
of HBV, except the approval of shareholders. The Agreement represents the legal,
valid, and binding obligations of HBV, enforceable against HBV in accordance
with its terms (except in all such cases as enforceability may be limited by
applicable bankruptcy, insolvency, reorganization, moratorium or similar laws
affecting the enforcement of creditors' rights generally and except that the
availability of the equitable remedy of specific performance or injunctive
relief is subject to the discretion of the court before which any
proceeding may be brought).
(2) Neither the execution and delivery of this Agreement,
the consummation of the transactions contemplated herein, nor compliance by HBV
with any of the provisions hereof will: (i) conflict with or result in a breach
of any provision of HBV's Articles of Incorporation or Bylaws; (ii) except as
Previously Disclosed, constitute or result in the breach of any term, condition
or provision of, or constitute a default under, or give rise to any right of
termination, cancellation or acceleration with respect to, or result in the
creation of any lien, charge or encumbrance upon, any property or assets of HBV
pursuant to (A) any note, bond, mortgage, indenture, or (B) any material
license, agreement, lease, or other instrument or obligation, to which HBV is a
party or by which any of them or any of their properties or assets may be bound,
or (iii) subject to the receipt of the requisite approvals referred to in
Section 4.7, violate any order, writ, injunction, decree, statute, rule or
regulation applicable to HBV or any or its properties or assets.
(c) Capital Structure. The authorized capital stock of
HBV consists of 2,000,000 shares of common stock, par value $2.50 per share, of
which, as of the date hereof,
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1,659,895 shares are issued, outstanding, fully paid and nonassessable, not
subject to shareholder preemptive rights and were not issued in violation of any
agreement to which HBV is a party or otherwise bound, or of any registration or
qualification provisions of any federal or state securities laws. Except as
Previously Disclosed, there are no outstanding options, warrants or other rights
to subscribe for or purchase from HBV any capital stock of HBV or securities
convertible into or exchangeable for capital stock of HBV.
(d) No Subsidiaries. HBV does not own, directly or
indirectly, 5% or more of the outstanding capital stock or other voting
securities of any corporation, bank or other organization.
(e) Financial Statements. HBV has previously furnished to
SFB true and complete copies of its audited balance sheets and related
consolidated statements of income, statements of cash flows, and statements of
stockholders' equity for the three year period ended December 31, 1998 (together
with the notes thereto, the "HBV Financial Statements"). The HBV Financial
Statements have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis during the periods presented, and
present fairly the financial position of HBV as of the respective dates thereof
and the results of its operations for the three year period then ended.
(f) Absence of Undisclosed Liabilities. At December 31,
1998, HBV had no obligation or liability (contingent or otherwise) of any nature
which was not reflected in the HBV Financial Statements, except for those which
in the aggregate are immaterial or have been Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of HBV's management, threatened against HBV,
or against any property, asset, interest or right of HBV, that are reasonably
expected to have, either individually or in the aggregate a material adverse
effect on the financial condition of HBV or that are reasonably expected to
threaten or impede the consummation of the Reorganization. HBV is not a party to
any agreement or instrument or subject to any judgment, order, writ, injunction,
decree or rule that might reasonably be expected to have a material adverse
effect on the condition (financial or otherwise), business or prospects of HBV.
Except as Previously Disclosed, as of the date of this Agreement, neither HBV
nor any of its properties is a party to or is subject to any order, decree,
agreement, memorandum of understanding or similar arrangement with, or a
commitment or similar submission to, any federal or state governmental agency or
authority charged with the supervision or regulation of depository institutions
or mortgage lenders or engaged in the insurance of deposits which restricts or
purports to restrict in any material respect the conduct of its business or its
properties, or in any manner relates to the capital, liquidity, credit policies
or management of it; and except as Previously Disclosed, HBV has not been
advised by any such regulatory authority that such authority is contemplating
issuing or requesting (or is considering the appropriateness of issuing or
requesting) any such order, decree, agreement, memorandum of understanding,
commitment letter or similar submission. To the best knowledge of HBV's
management, HBV has complied in all material respects with all laws, ordinances,
requirements, regulations or orders applicable to its business (including
environmental laws, ordinances, requirements, regulations or orders).
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(h) Regulatory Approvals. HBV knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b).
(i) Labor Relations. HBV is not a party to or bound by
any collective bargaining agreement, contract or other agreement or
understanding with a labor union or labor organization, nor is it the subject of
a proceeding asserting that it has committed an unfair labor practice (within
the meaning of the National Labor Relations Act) or seeking to compel it to
bargain with any labor organization as to wages and conditions of employment,
nor is there any strike or other labor dispute involving it, pending or, to the
best of its knowledge, threatened, nor is it aware of any activity involving its
employees seeking to certify a collective bargaining unit or engaging in any
other organization activity.
(j) Tax Matters. HBV has filed all federal, state and
local tax returns and reports required to be filed, and all taxes shown by such
returns to be due and payable have been paid or are reflected as a liability in
the HBV Financial Statements or are being contested in good faith and have been
Previously Disclosed. Except to the extent that liabilities therefor are
specifically reflected in the HBV Financial Statements, there are no federal,
state or local tax liabilities of HBV other than liabilities that have arisen
since December 31, 1998, all of which have been properly accrued or otherwise
provided for on the books and records of HBV. Except as Previously Disclosed, no
tax return or report of HBV is under examination by any taxing authority or the
subject of any administrative or judicial proceeding, and no unpaid tax
deficiency has been asserted against HBV by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the HBV Financial Statements, HBV has good and marketable title free and clear
of all material liens, encumbrances, charges, defaults or equities of whatever
character to all of the material properties and assets, tangible or intangible,
reflected in the HBV Financial Statements as being owned by HBV as of the dates
thereof. To the best knowledge of HBV, all buildings, and all fixtures,
equipment, and other property and assets which are material to its business on a
consolidated basis, held under leases or subleases by HBV are held under valid
instruments enforceable in accordance with their respective terms, subject to
bankruptcy, insolvency, reorganization, moratorium and similar laws. The
buildings, structures, and appurtenances owned, leased, or occupied by HBV are
in good operating condition and in a state of good maintenance and repair, and
to the best knowledge of HBV (i) comply with applicable zoning and other
municipal laws and regulations, and (ii) there are no latent defects therein.
(l) Reports. Since January 1, 1995, HBV has filed all
reports and statements, together with any amendments required to be made with
respect thereto, that were required to be filed with the SCC, the Federal
Reserve, and to the best knowledge of HBV, any other governmental or regulatory
authority or agency having jurisdiction over its operations.
(m) Employee Benefit Plans. (1) HBV will deliver for
SFB's review, as soon as practicable, true and complete copies of all material
pension, retirement, profit-sharing, deferred compensation, stock option, bonus,
vacation or other material incentive plans or agreements, all material medical,
dental or other health plans, all life insurance plans and all other material
employee benefit plans or fringe benefit plans, including, without limitation,
all "employee benefit plans" as that
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term is defined in Section 3(3) of the Employee Retirement Income Security Act
of 1974, as amended ("ERISA"), currently adopted, maintained by, sponsored in
whole or in part by, or contributed to by HBV for the benefit of employees,
retirees or other beneficiaries eligible to participate (collectively, the "HBV
Benefit Plans"). Any of the HBV Benefit Plans which is an "employee pension
benefit plan," as that term is defined in Section (3(2) of ERISA, is referred to
herein as a "HBV ERISA Plan." No HBV Benefit Plan is or has been a
multi-employer plan within the meaning of Section 3(37) of ERISA.
(2) Except as Previously Disclosed, all HBV Benefit Plans
are in compliance with the applicable terms of ERISA and the Internal Revenue
Code of 1986, as amended (the "IRC") and any other applicable laws, rules and
regulations, the breach or violation of which could result in a material
liability to HBV on a consolidated basis.
(3) No HBV ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which HBV
has sold securities subject to an obligation to repurchase, none of the
investment securities reflected in the HBV Financial Statements is subject to
any restriction, contractual, statutory, or otherwise, which would impair
materially the ability of the holder of such investment to dispose freely of any
such investment at any time. With respect to any agreements pursuant to which
HBV has purchased securities subject to any agreement to resell, it has a valid,
perfected first lien or security interest in the government securities or other
collateral securing such agreement, and the value of such collateral equals or
exceeds the amount of the debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, HBV is not a party to, or is bound by, (i) any material agreement,
arrangement or commitment, (ii) any agreement, indenture or other instrument
relating to the borrowing of money by HBV or the guarantee by HBV of any such
obligation, (iii) any agreement, arrangement or commitment relating to the
employment of a consultant or the employment, election, retention in office or
severance of any present or former director or officer, (iv) any agreement to
make loans or for the provision, purchase or sale of goods, services or property
between HBV and any director of officer of HBV, or any member of the immediate
family or affiliate of any of the foregoing, or (v) any agreement between HBV
and any 5% or more shareholder of HBV; in each case other than agreements
entered into in the ordinary course of the banking business of HBV or any HBV
Subsidiary consistent with past practice.
(2) Neither HBV, nor to the knowledge of HBV, the other
party thereto, is in default under any material agreement, commitment,
arrangement, lease, insurance policy or other instrument whether entered into in
the ordinary course of business or otherwise, nor has there occurred any event
that, with the lapse of time or giving of notice or both, would constitute such
a default, other than defaults of loan agreement by borrowers from HBV in the
ordinary course of its business.
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(3) Since December 31, 1998 HBV has not incurred or paid
any obligation or liability that would be material to HBV, except obligations
incurred or paid in connection with transactions in the ordinary course of
business of HBV consistent with its practice and, except as Previously
Disclosed, from December 31, 1998 to the date hereof, HBV has not taken any
action that, if taken after the date hereof, would breach any of the covenants
contained in Section 4.4 hereof.
(p) Insurance. A complete list of all policies or binders
of fire, liability, product liability, workmen's compensation, vehicular and
other insurance held by or on behalf of HBV has previously been furnished to SFB
and all such policies or binders are valid and enforceable in accordance with
their terms, are in full force and effect, and insure against risks and
liabilities to the extent and in the manner customary for the industry and are
deemed appropriate and sufficient by HBV. HBV is not in default with respect to
any provision contained in any such policy or binder and has not failed to give
any notice or present any claim under any such policy or binder in due and
timely fashion. HBV has not received notice of cancellation or non-renewal of
any such policy or binder. HBV has no knowledge of any inaccuracy in any
application for such policies or binders, any failure to pay premiums when due
or any similar state of facts or the occurrence of any event that is reasonably
likely to form the basis for any material claim against it not fully covered
(except to the extent of any applicable deductible) by the policies or binders
referred to above. HBV has not received notice from any of its insurance
carriers that any insurance premiums will be increased materially in the future
or that any such insurance coverage will not be available in the future on
substantially the same terms as now in effect.
(q) Absence of Material Changes and Events. Since
December 31, 1998, there has not been any material adverse change in the
condition (financial or otherwise), aggregate assets or liabilities, cash flow,
earnings or business of HBV, and HBV has conducted its business only in the
ordinary course consistent with past practice. This representation and warranty
shall not be deemed to be modified by any disclosures made to SFB or information
provided to SFB as "Previously Disclosed" in connection with this Agreement or
obtained by SFB during due diligence or otherwise in connection with this
Agreement, nor shall the receipt of such disclosures or information limit the
right of SFB (i) to rely upon the representations and warranties contained
herein as a condition to its obligations to effect the Reorganization as
provided in Section 6.2 or (ii) to terminate this Agreement under Section
7.1(c).
(r) Loans, OREO and Allowance for Loan Losses. (1) Except
as Previously Disclosed, and except for matters which individually or in the
aggregate do not materially adversely affect the Reorganization or the financial
condition of HBV, to the best knowledge of HBV, each loan reflected as an asset
in the HBV Financial Statements (i) is evidenced by notes, agreements, or other
evidences of indebtedness which are true, genuine and what they purport to be,
(ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
terms, subject to bankruptcy, insolvency and other laws of general applicability
relating to or affecting creditors' rights and to general equity principles. All
loans and extensions of credit which are subject to regulation by the FDIC which
have been made by HBV comply therewith.
(2) The classification on the books and records of HBV of
loans and/or non-performing assets as nonaccrual, troubled debt restructuring,
OREO or other similar classification,
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complies in all material respects with generally accepted accounting principles
and applicable regulatory accounting principles.
(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the HBV Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and HBV has not received any notice
of denial of any such claim.
(4) HBV is in possession of all of the OREO or, if any of
the OREO remains occupied by the mortgagor, eviction or summary proceedings have
been commenced or rental arrangements providing for market rental rates have
been agreed upon and HBV is diligently pursuing such eviction or summary
proceedings or such rental arrangements. Except as Previously Disclosed, no
legal proceeding or quasi-legal proceeding is pending or, to the knowledge of
HBV, threatened concerning any OREO or any servicing activity or omission to
provide a servicing activity with respect to any of the OREO.
(5) Except as Previously Disclosed, all loans made by HBV
to facilitate the disposition of OREO are performing in accordance with their
terms.
(6) The allowance for possible loan losses shown on the
HBV Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of HBV as of dates subsequent to the execution of
this Agreement will be, in each case as of the dates thereof, adequate in all
material respects to provide for possible losses, net of recoveries relating to
loans previously charged off, on loans outstanding (including accrued interest
receivable) of HBV and other extensions of credit (including letters of credit
and commitments to make loans or extend credit) by HBV.
(s) Statements True and Correct. None of the information
supplied or to be supplied by HBV for inclusion in the Registration Statement on
Form S-4 (the "Registration Statement") to be filed by SFB with the Securities
and Exchange Commission (the "SEC"), the Proxy Statement/Prospectus (as defined
in Section 4.3) to be mailed to every HBV shareholder and every SFB shareholder
or any other document to be filed with the SEC, the SCC, the Federal Reserve, or
any other regulatory authority in connection with the transactions contemplated
hereby, will, at the respective time such documents are filed, and, in the case
of the Registration Statement, when it becomes effective and with respect to the
Proxy Statement/Prospectus, when first mailed to HBV shareholders and SFB
shareholders, be false or misleading with respect to any material fact or omit
to state any material fact necessary in order to make the statements therein not
misleading, or, in the case of the Proxy Statement/Prospectus or any supplement
thereto, at the time of the HBV Shareholders' Meeting and the SFB Shareholders'
Meeting (as defined in Section 4.3), be false or misleading with respect to any
material fact or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the solicitation of any
proxy for the HBV Shareholders' Meeting and the SFB Shareholders' Meeting.
(t) Brokers and Finders. Neither HBV, nor any of its
respective officers, directors or employees, has employed any broker, finder or
financial advisor or incurred any liability
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for any fees or commissions in connection with the transactions contemplated
herein, except for McKinnon & Company, Inc..
(u) Repurchase Agreements. With respect to all agreements
pursuant to which HBV has purchased securities subject to an agreement to
resell, if any, HBV has a valid, perfected first lien or security interest in
the government securities or other collateral securing the repurchase agreement,
and the value of such collateral equals or exceeds the amount of the debt
secured thereby.
(v) Administration of Trust Accounts. HBV has properly
administered, in all respects material and which could reasonably be expected to
be material to the business, operations or financial condition of HBV, all
accounts for which it acts as fiduciary including but not limited to accounts
for which it serves as trustee, agent, custodian, personal representative,
guardian, conservator or investment advisor, in accordance with the terms of the
governing documents and applicable state and federal law and regulation and
common law. Neither HBV, nor any director, officer or employee of HBV has
committed any breach of trust with respect to any such fiduciary account which
is material to or could reasonably be expected to be material to the business,
operations or financial condition of HBV, and the accountings for each such
fiduciary account are true and correct in all material respects and accurately
reflect the assets of such fiduciary account in all material respects.
(w) Environmental Matters. (1) Except as Previously
Disclosed, to the best of HBV's knowledge, HBV does not own or lease any
properties affected by toxic waste, radon gas or other hazardous conditions or
constructed in part with the use of asbestos. HBV is in substantial compliance
with all Environmental Laws applicable to real or personal properties in which
it has a direct fee ownership or, with respect to a direct interest as lessee,
applicable to the leasehold premises or, to the best knowledge of HBV, the
premises on which the leasehold is situated. HBV has not received any
Communication alleging that HBV is not in such compliance and, to the best
knowledge of HBV, there are no present circumstances (including Environmental
Laws that have been adopted but are not yet effective) that would prevent or
interfere with the continuation of such compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on HBV of any liability
arising under any Environmental Laws pending or, to the best knowledge of HBV,
threatened against (A) HBV, (B) any person or entity whose liability for any
Environmental Claim HBV has or may have retained or assumed either contractually
or by operation of law, or (C) any real or personal property which HBV owns or
leases, or has been or is judged to have managed or to have supervised or
participated in the management of, which liability might have a material adverse
effect on the business, financial condition or results of operations of HBV. HBV
is not subject to any agreement, order, judgment, decree or memorandum by or
with any court, governmental authority, regulatory agency or third party
imposing any such liability.
(3) To the best knowledge of HBV, there are no legal,
administrative, arbitral or other proceedings, or Environmental Claims or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on HBV of any liability
arising under any Environmental Laws pending or threatened against any real or
personal property in which HBV holds a security interest in connection with a
loan or a loan participation which liability might have a material adverse
effect on the business, financial condition or results of operations
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of HBV. HBV is not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by HBV, other than OREO, HBV has made available to SFB copies of any
environmental audits, analyses and surveys that have been prepared relating to
such properties. With respect to all OREO held by HBV and all real or personal
property which HBV has been or is judged to have managed or to have supervised
or participated in the management of, HBV has made available to SFB the
information relating to such OREO available to HBV. HBV is in compliance in all
material respects with all recommendations contained in any environmental
audits, analyses and surveys relating to any of the properties, real or
personal, described in this subsection (4).
(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern, that could reasonably form the basis of any Environmental Claim or
other claim or action or governmental investigation that could result in the
imposition of any liability arising under any Environmental Laws currently in
effect or adopted but not yet effective against HBV or against any person or
entity whose liability for any Environmental Claim HBV has or may have retained
or assumed either contractually or by operation of law.
(6) For the purpose of this Agreement, the following
terms shall have the following meanings:
(i) "Communication" means a communication which is of a
substantive nature and which is made (A) in writing to HBV on the one hand or to
SFB or any SFB Subsidiary on the other hand, or (B) orally to a senior officer
of HBV or of SFB or any SFB Subsidiary, whether from a governmental authority or
a third party.
(ii) "Environmental Claim" means any Communication from
any governmental authority or third party alleging potential liability
(including, without limitation, potential liability for investigatory costs,
cleanup costs, governmental response costs, natural resources damages, property
damages, personal injuries, or penalties) arising out of, based on or resulting
from the presence, or release into the environment, of any Material of
Environmental Concern.
(iii) "Environmental Laws" means all applicable federal,
state and local laws and regulations, including the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended, that relate to
pollution or protection of human health or the environment (including, without
limitation, ambient air, surface water, ground water, land surface or subsurface
strata). This definition includes, without limitation, laws and regulations
relating to emissions, discharges, releases or threatened releases of Materials
of Environmental Concern, or otherwise relating to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling of
Materials of Environmental Concern.
(iv) "Materials of Environmental Concern" means
pollutants, contaminants, wastes, toxic substances, petroleum and petroleum
products and any other materials regulated under Environmental Laws.
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(x) Year 2000. Except as Previously Disclosed, HBV has reviewed
the areas within its business and operation which could be adversely affected
by, and has developed a program to address and remedy on a timely basis, "Year
2000" issues such as risks that computer applications, vendors, customers,
equipment and operating systems will not be "Year 2000 Compliant") (hereinafter
defined), and has made appropriate related inquiries of its vendors and
customers. "Year 2000 Compliant," with respect to any person, means that the
hardware and software systems and components (including without limitation
imbedded microchips) owned, licensed or used by such person in connection with
its business operations will (without any additional cost or the need for human
intervention) (i) accurately process information involving any and all dates
before, during and/or after January 1, 2000, including without limitation
recognizing and processing input, providing output, storing information and
performing date-related calculations, all without creating any ambiguity as to
the century and without any other material and adverse error or malfunction,
(ii) operate accurately without material and adverse interruption or malfunction
on and in respect of any and all dates before, during and/or after January 1,
2000 and (iii) where applicable, respond to and process two digit year input
without creating any ambiguity as to the century.
3.2 Representations and Warranties of SFB. SFB represents and
warrants to HBV as follows:
(a) Organization, Standing and Power. (1) SFB is a
corporation duly organized, validly existing and in good standing under the laws
of Virginia. It has all requisite corporate power and authority to carry on its
business as now being conducted and to own and operate its assets, properties
and business, and SFB has the corporate power and authority to execute and
deliver this Agreement and perform the respective terms of this Agreement and
Plan of Reorganization. SFB is duly registered as a bank holding company. under
the Bank Holding Company Act of 1956. The Bank, a wholly owned subsidiary of
SFB, is a Virginia corporation and a Virginia state bank, duly organized,
validly existing and in good standing under the laws of Virginia, is in
compliance in all material respects with all rules and regulations promulgated
by any relevant regulatory authority, and it has all requisite corporate power
and authority to carry on a commercial banking business as now being conducted
and to own and operate its assets, properties and business.
(2) SFB has Previously Disclosed its subsidiary
corporations (and the subsidiaries thereof), all of which are duly organized,
validly existing and in good standing in their respective states of
incorporation and which have all requisite corporate power and authority to
carry on their businesses as now being conducted and to own and operate their
assets, properties and business (the "SFB Subsidiaries" and, collectively with
SFB, the "SFB Companies"). Each SFB Subsidiary that is a depository institution
is an "insured bank" as defined in the Federal Deposit Insurance Act and
applicable regulations thereunder. All of the shares of capital stock of the SFB
Subsidiaries held by SFB are duly and validly issued, fully paid and
nonassessable, and all such shares are owned by SFB or a SFB Subsidiary free and
clear of any claim, lien, pledge or encumbrance of any kind, and were not issued
in violation of the preemptive rights of any shareholder or in violation of any
agreement or of any registration or qualification provisions of federal or state
securities laws. Except as Previously Disclosed, none of the SFB Companies owns
any equity securities of any other corporation or entity. Except as Previously
Disclosed, each of the SFB Companies is in good standing as a foreign
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corporation in each jurisdiction where the properties owned, leased or operated,
or the business conducted, by it require such qualification and where failure to
so qualify either singly or in the aggregate would have a material adverse
effect on the financial condition, properties, businesses or results of
operations of the SFB Companies.
(b) Authority. (1) The execution and delivery of this
Agreement and the Plan of Merger and the consummation of the Reorganization have
been duly and validly authorized by all necessary corporate action on the part
of SFB, except the approval of shareholders. The Agreement represents the legal,
valid, and binding obligation of SFB, enforceable against SFB in accordance with
its terms (except in all such cases as enforceability may be limited by
applicable bankruptcy, insolvency, reorganization, moratorium or similar laws
affecting the enforcement of creditors' rights generally and except that the
availability of the equitable remedy of specific performance or injunctive
relief is subject to the discretion of the court before which any proceeding may
be brought).
(2) Neither the execution and delivery of the Agreement,
the consummation of the transactions contemplated therein, nor the compliance by
SFB with any of the provisions thereof will (i) conflict with or result in a
breach of any provision of the Articles of Incorporation or Bylaws of SFB, (ii)
except as Previously Disclosed, constitute or result in the breach of any term,
condition or provision of, or constitute default under, or give rise to any
right of termination, cancellation or acceleration with respect to, or result in
the creation of any lien, charge or encumbrance upon, any property or assets of
the SFB Companies pursuant to (A) any note, bond, mortgage, indenture, or (B)
any material license, agreement, lease or other instrument or obligation, to
which any of the SFB Companies is a party or by which any of them or any of
their properties or assets may be bound, or (iii) subject to the receipt of the
requisite approvals referred to in Section 4.7, violate any order, writ,
injunction, decree, statute, rule or regulation applicable to any of the SFB
Companies or any of their properties or assets.
(c) Capital Structure. The authorized capital stock of
SFB consists of: 5,000,000 shares of common stock, par value $.01 per share
("SFB Common Stock), of which 1,633,094 shares are issued and outstanding, fully
paid and nonassessable, not subject to shareholder preemptive rights, and not
issued in violation of any agreement to which SFB is a party or otherwise bound,
or of any registration or qualification provisions of any federal or state
securities laws; and 500,000 shares of preferred stock, par value $.01 per
share, of which 13,621 are issued and outstanding. The shares of SFB Common
Stock to be issued in exchange for shares of HBV Common Stock upon consummation
of the Reorganization will have been duly authorized and, when issued in
accordance with the terms of this Agreement, will be validly issued, fully paid
and nonassessable and subject to no preemptive rights. Except as Previously
Disclosed, there are no outstanding understandings or commitments of any
character pursuant to which SFB and any of the SFB Companies could be required
or expected to issue shares of capital stock.
(d) Ownership of the SFB Subsidiaries; Capital Structure
of SFB Subsidiaries; and Organization of the SFB Subsidiaries. (1) SFB does not
own, directly or indirectly, 5% or more of the outstanding capital stock or
other voting securities of any corporation, bank or other organization actively
engaged in business except as Previously Disclosed (collectively the "SFB"
Subsidiaries" and each individually a "SFB Subsidiary"). The outstanding shares
of capital stock of each SFB Subsidiary have been duly authorized and are
validly issued, and are fully paid and
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nonassessable and all such shares are directly or indirectly owned by SFB free
and clear of all liens, claims and encumbrances. No Rights are authorized,
issued or outstanding with respect to the capital stock of any SFB Subsidiary
and there are no agreements, understandings or commitments relating to the right
of SFB to vote or to dispose of said shares. None of the shares of capital stock
of any SFB Subsidiary has been issued in violation of the preemptive rights of
any person.
(2) Each SFB Subsidiary is a duly organized corporation,
validly existing and in good standing under applicable laws. Each SFB Subsidiary
(i) has full corporate power and authority to own, lease and operate its
properties and to carry on its business as now conducted except where the
absence of such power or authority would not have a material adverse effect on
the financial condition, results of operations or business of SFB on a
consolidated basis, and (ii) is duly qualified to do business in the states of
the United States and foreign jurisdictions where its ownership or leasing of
property or the conduct of its business requires such qualification and where
failure to do qualify would have a material adverse effect on the financial
condition, results of operations or business of SFB on a consolidated basis.
Each SFB Subsidiary has all federal, state, local and foreign governmental
authorizations and licenses necessary for it to own or lease its properties and
assets and to carry on its business as it is now being conducted, except where
failure to obtain such authorization or license would not have a material
adverse effect on the business of such SFB Subsidiary.
(e) Financial Statements. SFB's Annual Report on Form
10-K for the fiscal year ended December 31, 1998, and all other documents filed
or to be filed subsequent to December 31, 1998 under Sections 13(a), 13(c), 14
or 15(d) of the Securities Exchange Act of 1934, as amended (together with the
rules and regulations thereunder, the "Exchange Act"), in the form filed with
the SEC (in each such case, the "SFB Financial Statements") did not and will not
contain any untrue statement of a material fact or omit to state a material face
required to be stated therein or necessary to make the statements made therein,
in light of the circumstances under which they were made, not misleading; and
each of the balance sheets in or incorporated by reference into the SFB
Financial Statements (including the related notes and schedules thereto) fairly
presents and will fairly present the financial position of the entity or
entities to which it relates as of its date and each of the statements of income
and changes in stockholders' equity and cash flows or equivalent statements in
the SFB Financial Statements (including any related notes and schedules thereto)
fairly presents and will fairly present the results of operations, changes in
stockholders' equity and changes in cash flows, as the case may be, of the
entity or entities to which it relates for the periods set forth therein, in
each case in accordance with generally accepted accounting principles
consistently applied to banks and bank holding companies during the periods
involved, except as may be noted therein, subject to normal and recurring
year-end audit adjustments in the case of unaudited statements.
(f) Absence of Undisclosed Liabilities. At December 31,
1998, none of the SFB Companies had any obligation or liability (contingent or
otherwise) of any nature which were not reflected in the SFB Financial
Statements, except for those which in the aggregate are immaterial or have been
Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of SFB's management, threatened or probable of
assertion against any of the SFB Companies, or against any property, asset,
interest or right of any of them, that are reasonably expected to have, either
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individually or in the aggregate, a material adverse effect on the financial
condition of SFB on a consolidated basis or that are reasonably expected to
threaten or impede the consummation of the transactions contemplated by this
Agreement. None of the SFB Companies is a party to any agreement or instrument
or subject to any judgment, order, writ, injunction, decree or rule that might
reasonably be expected to have a material adverse effect on the condition
(financial or otherwise), business or prospects of SFB on a consolidated basis.
Except as Previously Disclosed, as of the date of this Agreement, none of the
SFB Companies nor any of their properties is a party to or is subject to any
order, decree, agreement, memorandum of understanding or similar arrangement
with, or a commitment letter or similar submission to, any federal or state
governmental agency or authority charged with the supervision or regulation of
depository institutions or mortgage lenders or engaged in the insurance of
deposits which restricts or purports to restrict in any material respect the
conduct of the business of it or any of its subsidiaries or properties, or in
any manner relates to the capital, liquidity, credit policies or management of
it; and except as Previously Disclosed, none of the SFB Companies has been
advised by any such regulatory authority that such authority is contemplating
issuing or requesting (or is considering the appropriateness of issuing or
requesting) any such order, decree, agreement, memorandum of understanding,
commitment letter or similar submission. To the best knowledge of SFB, the SFB
Companies have complied in all material respects with all laws, ordinances,
requirements, regulations or orders applicable to its business (including
environmental laws, ordinances, requirements, regulations or orders).
(h) Regulatory Approvals. SFB knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b).
(i) Labor Relations. None of the SFB Companies is a party
to, or is bound by any collective bargaining agreement, contract or other
agreement or understanding with a labor union or labor organization, nor is it
the subject of a proceeding asserting that is has committed an unfair labor
practice (within the meaning of the National Labor Relations Act) or seeking to
compel it to bargain with any labor organization as to wages and conditions of
employment, nor is there any strike or other labor dispute involving it, pending
or, to the best of its knowledge, threatened, nor is it aware of any activity
involving its employees seeking to certify a collective bargaining unit or
engaging in any other organizational activity.
(j) Tax Matters. The SFB Companies have filed all
federal, state, and local tax returns and reports required to be filed, and all
taxes shown by such returns to be due and payable have been paid or are
reflected as a liability in the SFB Financial Statements or are being contested
in good faith and have been Previously Disclosed. Except to the extent that
liabilities therefor are specifically reflected in the SFB Financial Statements,
there are no federal, state or local tax liabilities of the SFB Companies other
than liabilities that have arisen since December 31, 1998, all of which have
been properly accrued or otherwise provided for on the books and records of the
SFB Companies. Except as Previously Disclosed, no tax return or report of any of
the SFB Companies is under examination by any taxing authority or the subject of
any administrative or judicial proceeding, and no unpaid tax deficiency has been
asserted against any of the SFB Companies by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the SFB Financial Statements, all of the SFB Companies have good and marketable
title free and clear of all material
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liens, encumbrances, charges, defaults or equities of whatever character to all
of the material properties and assets, tangible or intangible, reflected in the
SFB Financial Statements as being owned by the SFB Companies as of the dates
thereof. To the best knowledge of SFB, all buildings, and all fixtures,
equipment, and other property and assets which are material to its business on a
consolidated basis, held under leases or subleases by the SFB Companies are held
under valid instruments enforceable in accordance with their respective terms,
subject to bankruptcy, insolvency, reorganization, moratorium and similar laws.
The buildings, structures, and appurtenances owned, leased, or occupied by the
SFB Companies are, to the best knowledge of SFB, in good operating condition, in
a state of good maintenance and repair and (i) comply with applicable zoning and
other municipal laws and regulations, and (ii) there are no latent defects
therein.
(l) Reports. Since January 1, 1995, the SFB Companies
have filed all reports and statements, together with any amendments required to
be made with respect thereto, that were required to be filed with the SEC, the
Federal Reserve, the SCC, and any other governmental or regulatory authority or
agency having jurisdiction over their operations.
(m) Employee Benefit Plans. (1) SFB will deliver for
HBV's review, as soon as practicable, true and complete copies of all material
pension, retirement, profit-sharing, deferred compensation, stock option, bonus,
vacation or other material incentive plans or agreements, all material medical,
dental or other health plans, all life insurance plans and all other material
employee benefit plans or fringe benefit plans, including, without limitation,
all "employee benefit plans" as that term is defined in Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), currently
adopted, maintained by, sponsored in whole or in part by, or contributed to by
SFB for the benefit of employees, retirees or other beneficiaries eligible to
participate (collectively, the "SFB Benefit Plans"). Any of the SFB Benefit
Plans which is an "employee pension benefit plan," as that term is defined in
Section 3(2) of ERISA, is referred to herein as a "SFB ERISA Plan." No SFB
Benefit Plan is or has been a multi-employer plan within the meaning of Section
3(37) of ERISA.
(2) Except as Previously Disclosed, all SFB Benefit Plans
are in compliance with the applicable terms of ERISA and the Internal Revenue
Code of 1986, as amended (the "IRC") and any other applicable laws, rules and
regulations the breach or violation of which could result in a material
liability to SFB on a consolidated basis.
(3) No SFB ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which any
of the SFB Companies has sold securities subject to an obligation to repurchase,
none of the investment securities reflected in the SFB Financial Statements is
subject to any restriction, contractual, statutory, or otherwise, which would
impair materially the ability of the holder of such investment to dispose freely
of any such investment at any time. With respect to any agreements pursuant to
which any of the SFB Companies has purchased securities subject to any agreement
to resell, it has a valid, perfected first lien or security interest in the
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government securities or other collateral securing such agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, neither SFB nor any SFB subsidiary is a party to, or is bound by, (i)
any material agreement, arrangement or commitment, (ii) any agreement, indenture
or other instrument relating to the borrowing of money by SFB or any SFB
Subsidiary or the guarantee by SFB or any SFB Subsidiary of any such obligation,
(iii) any agreement, arrangement or commitment relating to the employment of a
consultant or the employment, election, retention in office or severance of any
present or former director or officer, (iv) any agreement to make loans or for
the provision, purchase or sale of goods, services or property between SFB or
any SFB Subsidiary and any director or officer of SFB or any SFB Subsidiary, or
any member of the immediate family or affiliate of any of the foregoing, or (v)
any agreement between SFB or any SFB Subsidiary and any 5% or more shareholder
of SFB; in each case other than agreements entered into in the ordinary course
of the banking business of SFB or a SFB Subsidiary consistent with past
practice.
(2) Neither SFB or any SFB Subsidiary, nor to the
knowledge of SFB, the other party thereto, is in default under any material
agreement, commitment, arrangement, lease, insurance policy or other instrument
whether entered into in the ordinary course of business or otherwise, nor has
there occurred any event that, with the lapse of time or giving of notice or
both, would constitute such a default, other than defaults of loan agreements by
borrowers from SFB or a SFB Subsidiary in the ordinary course of its business.
(p) Insurance. A complete list of all policies or binders
of fire, liability, product liability, workmen's compensation, vehicular and
other insurance held by or on behalf of the SFB Companies has previously been
furnished to HBV and all such policies or binders are valid and enforceable in
accordance with their terms, are in full force and effect, and insure against
risks and liabilities to the extent and in the manner customary for the industry
and are deemed appropriate and sufficient by SFB. The SFB Companies are not in
default with respect to any provision contained in any such policy or binder and
have not failed to give any notice or present any claim under any such policy or
binder in due and timely fashion. None of the SFB Companies has received notice
of cancellation or non-renewal of any such policy or binder. None of the SFB
Companies has knowledge of any inaccuracy in any application for such policies
or binders, any failure to pay premiums when due or any similar state of facts
or the occurrence of any event that is reasonably likely to form the basis for
any material claim against it not fully covered (except to the extent of any
applicable deductible) by the policies or binders referred to above. None of the
SFB Companies has received notice from any of its insurance carriers that any
insurance premiums will be increased materially in the future or that any such
insurance coverage will not be available in the future on substantially the same
terms as now in effect.
(q) Loans, OREO, and Allowance for Loan Losses. (1)
Except as Previously Disclosed, and except for matters which individually or in
the aggregate, do not materially adversely affect the Reorganization or the
financial condition of SFB, to SFB's best knowledge each loan reflected as an
asset in the SFB Financial Statements (i) is evidenced by notes, agreements, or
other evidences of indebtedness which are true, genuine and what they purport to
be, (ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
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terms, subject to bankruptcy, insolvency, and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles. All loans and extensions of credit which are subject to regulation
of the Federal Reserve which have been made by SFB and the SFB Subsidiaries
comply therewith.
(2) The classification on the books and records of SFB
and each SFB Subsidiary of loans and/or non-performing assets as nonaccrual,
troubled debt restructuring, OREO or other similar classification, complies in
all material respects with generally accepted accounting principles and
applicable regulatory accounting principles.
(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the SFB Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and neither SFB nor any SFB
Subsidiary has been received any notice of denial of any such claim.
(4) SFB and each SFB Subsidiary are in possession of all
of the OREO or, if any of the OREO remains occupied by the mortgagor, eviction
or summary proceedings have been commenced or rental arrangements providing for
market rental rates have been agreed upon and SFB and/or each SFB Subsidiary are
diligently pursuing such eviction of summary proceedings or such rental
arrangements. Except as Previously Disclosed, no legal proceeding or quasi-legal
proceeding is pending or, to the knowledge of SFB and each SFB Subsidiary,
threatened concerning any OREO or any servicing activity or omission to provide
a servicing activity with respect to any of the OREO.
(5) Except as Previously Disclosed, all loans made by any
of the SFB Companies to facilitate the disposition of OREO are performing in
accordance with their terms.
(6) The allowance for possible loan losses shown on the
SFB Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of SFB as of dates subsequent to the execution of
this Agreement will be, in each case as of the dates thereof, adequate in all
material respects to provide for possible losses, net of recoveries relating to
loans previously charged off, on loans outstanding (including accrued interest
receivable) of the SFB Companies and other extensions of credit (including
letters of credit and commitments to make loans or extend credit) by SFB.
(r) Absence of Material Changes and Events. Since
December 31, 1998, there has not been any material adverse change in the
condition (financial or otherwise), aggregate assets or liabilities, cash flow,
earnings or business or SFB, and SFB has conducted its business only in the
ordinary course consistent with past practice. This representation and warranty
shall not be deemed to be modified by any disclosures made to HBV or information
provided to HBV as "Previously Disclosed" in connection with this Agreement or
obtained by HBV during due diligence or otherwise in connection with this
Agreement, nor shall the receipt of such disclosures or information limit the
right of HBV (i) to rely upon the representations and warranties contained
herein as a condition to its obligations to effect the Reorganization as
provided in Section 6.3 or (ii) to terminate this Agreement under Section
7.1(d).
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(s) Statements True and Correct. None of the information
supplied or to be supplied by SFB for inclusion in the Registration Statement,
the Proxy Statement/Prospectus or any other document to be filed with the SEC or
any other regulatory authority in connection with the transactions contemplated
hereby, will, at the respective time such documents are filed, and, in the case
of the Registration Statement, when it becomes effective and with respect to the
Proxy Statement/Prospectus, when first mailed to HBV shareholders, be false or
misleading with respect to any material fact or omit to state any material fact
necessary in order to make the statements therein not misleading, or, in the
case of the Proxy Statement/Prospectus or any supplement thereto, at the time of
the HBV Shareholders' Meeting, be false or misleading with respect to any
material fact or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the solicitation of any
proxy for the HBV Shareholders' Meeting. All documents that SFB is responsible
for filing with the SEC or any other regulatory authority in connection with the
transactions contemplated, hereby will comply as to form in all material
respects with the provisions of applicable law, including applicable provisions
of federal and state securities law.
(t) Brokers and Finders. Neither SFB nor any SFB
Subsidiary, nor any of their respective officers, directors or employees, has
employed any broker, finder or financial advisor or incurred any liability for
any fees or commissions in connection with the transactions contemplated herein,
except for Tucker Anthony, Inc.
(u) Repurchase Agreements. With respect to all agreements
pursuant to which SFB or any SFB Subsidiary has purchased securities subject to
an agreement to resell, if any, SFB or such SFB Subsidiary, as the case may be,
has a valid, perfected first lien or security interest in the government
securities or other collateral securing the repurchase agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(v) Administration of Trust Accounts. SFB and SFB
Subsidiaries have properly administered, in all respects material and which
could reasonably be expected to be material to the business, operations or
financial condition of SFB and SFB Subsidiaries, taken as a whole, all accounts
for which they act as fiduciaries including but not limited to accounts for
which they serve as trustees, agents, custodians, personal representatives,
guardians, conservators or investment advisors, in accordance with the terms of
the governing documents and applicable state and federal law and regulation and
common law. Neither SFB nor a SFB Subsidiary, nor any director, officer or
employee of SFB or a SFB Subsidiary has committed any breach of trust with
respect to any such fiduciary account which is material to or could reasonably
be expected to be material to the business, operations or financial condition of
SFB, or a SFB Subsidiary, taken as a whole, and the accountings for each such
fiduciary account are true and correct in all material respects and accurately
reflect the assets of such fiduciary account in all material respects.
(w) Environmental Matters. (1) Except as Previously
Disclosed, to the best of SFB's knowledge, neither SFB nor any SFB Subsidiary
owns or leases any properties affected by toxic waste, radon gas or other
hazardous conditions or constructed in part with the use of asbestos. Each of
SFB and the SFB Subsidiaries is in substantial compliance with all Environmental
Laws applicable to real or personal properties in which it has a direct fee
ownership or, with respect to a direct interest as lessee, applicable to the
leasehold premises or, to the best knowledge of SFB and the SFB Subsidiaries,
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the premises on which the leasehold is situated. Neither SFB nor any SFB
Subsidiary has received any Communication alleging that SFB or such SFB
Subsidiary is not in such compliance and, to the best knowledge of SFB and the
SFB Subsidiaries, there are no present circumstances (including Environmental
Laws that have been adopted but are not yet effective) that would prevent or
interfere with the continuation of such compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on SFB and the SFB
Subsidiaries of any liability arising under any Environmental Laws pending or,
to the best knowledge of SFB and the SFB Subsidiaries, threatened against (A)
SFB or any SFB Subsidiary, (B) any person or entity whose liability for any
Environmental Claim, SFB or any SFB Subsidiary has or may have retained or
assumed either contractually or by operation of law, or (C)any real or personal
property which SFB or any SFB Subsidiary owns or leases, or has been or is
judged to have managed or to have supervised or participated in the management
of, which liability might have a material adverse effect on the business,
financial condition or results of operations of SFB. SFB and the SFB
Subsidiaries are not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
(3) To the best knowledge of SFB and the SFB
Subsidiaries, there are no legal, administrative, arbitral or other proceedings,
or Environmental Claims or other claims, causes of action or governmental
investigations of any nature, seeking to impose, or that could result in the
imposition, on SFB or any SFB Subsidiary of any liability arising under any
Environmental Laws pending or threatened against any real or personal property
in which SFB or any SFB Subsidiary holds a security interest in connection with
a loan or a loan participation which liability might have a material adverse
effect on the business, financial condition or results of operations of SFB. SFB
and the SFB Subsidiaries are not subject to any agreement, order, judgment,
decree or memorandum by or with any court, governmental authority, regulatory
agency or third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by SFB or any SFB Subsidiary, other than OREO, SFB has made available
to HBV copies of any environmental audits, analyses and surveys that have been
prepared relating to such properties. With respect to all OREO held by SFB or
any SFB Subsidiary and all real or personal property which SFB or any SFB
Subsidiary has been or is judged to have managed or to have supervised or
participated in the management of, SFB has made available to HBV the information
relating to such OREO available to SFB. SFB and the SFB Subsidiaries are in
compliance in all material respects with all recommendations contained in any
environmental audits, analyses and surveys relating to any of the properties,
real or personal, described in this subsection (4).
(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern, that could reasonably form the basis of any Environmental Claim or
other claim or action or governmental investigation that could result in the
imposition of any liability arising under any Environmental Laws currently in
effect or adopted but not yet effective against SFB or any SFB Subsidiary or
against any person or entity whose liability for any Environmental Claim SFB or
any SFB Subsidiary has or may have retained or assumed either contractually or
by operation of law.
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(x) Year 2000. Except as Previously Disclosed, SFB has reviewed
the areas within its business and operation which could be adversely affected
by, and has developed a program to address and remedy on a timely basis, "Year
2000" issues such as risks that computer applications, vendors, customers,
equipment and operating systems will not be "Year 2000 Compliant") (hereinafter
defined), and has made appropriate related inquiries of its vendors and
customers. "Year 2000 Compliant," with respect to any person, means that the
hardware and software systems and components (including without limitation
imbedded microchips) owned, licensed or used by such person in connection with
its business operations will (without any additional cost or the need for human
intervention) (i) accurately process information involving any and all dates
before, during and/or after January 1, 2000, including without limitation
recognizing and processing input, providing output, storing information and
performing date-related calculations, all without creating any ambiguity as to
the century and without any other material and adverse error or malfunction,
(ii) operate accurately without material and adverse interruption or malfunction
on and in respect of any and all dates before, during and/or after January 1,
2000 and (iii) where applicable, respond to and process two digit year input
without creating any ambiguity as to the century.
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties. HBV will keep SFB, and SFB
will keep HBV advised of all material developments relevant to their respective
businesses prior to consummation of the Reorganization. Prior to the Effective
Date, SFB, on the one hand, and HBV on the other, agree to give to the other
party reasonable access to all the premises and books and records (including tax
returns filed and those in preparation) of it and its subsidiaries and to cause
its officers to furnish the other with such financial and operating data and
other information with respect to the business and properties as the other shall
from time to time request for the purposes of verifying the warranties and
representations set forth herein; provided, however, that any such investigation
shall be conducted in such manner as not to interfere unreasonably with the
operation of the respective business of the other.
4.2 Confidentiality. Between the date of this Agreement and the
Effective Date, SFB and HBV each will maintain in confidence, and cause its
directors, officers, employees, agents and advisors to maintain in confidence,
and not use to the detriment of the other party, any written, oral or other
information obtained in confidence from the other party or a third party in
connection with this Agreement or the transactions contemplated hereby unless
such information is already known to such party or to others not bound by a duty
of confidentiality or unless such information becomes publicly available through
no fault of such party, unless use of such information is necessary or
appropriate in making any filing or obtaining any consent or approval required
for the consummation of the transactions contemplated hereby or unless the
furnishing or use of such information is required by or necessary or appropriate
in connection with legal proceedings. If the Reorganization is not consummated,
each party will return or destroy as much of such written information as may
reasonably be requested.
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4.3 Registration Statement, Proxy Statement and Shareholder
Approval. (a) The Board of Directors of HBV, and the Board of Directors of SFB,
each will duly call and will hold a meeting of their respective shareholders as
soon as practicable for the purpose of approving the Reorganization or, in the
case of SFB, approving the issuance of SFB Common Stock in the Reorganization
(the "HBV Shareholders' Meeting" and the "SFB Shareholders' Meeting",
respectively) and, subject to the fiduciary duties of the Board of Directors of
HBV and of SFB (as advised in writing by its counsel), HBV and SFB each shall
use its best efforts to solicit and obtain votes of the holders of its Common
Stock in favor of the Reorganization and will comply with the provisions in
their respective Articles of Incorporation and Bylaws relating to the call and
holding of a meeting of shareholders for such purpose; each member of the Board
of Directors of HBV and SFB shall vote all shares of HBV Common Stock and SFB
Common Stock under his control (and not held in a fiduciary capacity) in favor
of the Reorganization; and HBV and SFB shall, at the other's request, recess or
adjourn the meeting if such recess or adjournment is deemed by the other to be
necessary or desirable. SFB and HBV will prepare jointly the proxy
statement/prospectus to be used in connection with the HBV Shareholders' Meeting
and the SFB Shareholders' Meeting (the "Joint Proxy Statement"). SFB will
prepare and file with the SEC the Registration Statement, of which such Joint
Proxy Statement shall be a part and will use its best efforts to have the
Registration Statement declared effective as promptly as possible. When the
Registration Statement or any post-effective amendment or supplement thereto
shall become effective, and at all times subsequent to such effectiveness, up to
and including the date of the Meeting, such Registration Statement and all
amendments or supplements thereto, with respect to all information set forth
therein furnished or to be furnished by HBV relating to HBV and by SFB relating
to the SFB Companies, (i) will comply in all material respects with the
provisions of the Securities Act of 1933 and any other applicable statutory or
regulatory requirements, including applicable state blue-sky and securities
laws, and (ii) will not contain any untrue statement of a material fact or omit
to state a material fact required to be stated therein or necessary to make the
statements contained therein not misleading; provided, however, in no event
shall any party hereto be liable for any untrue statement of a material fact or
omission to state a material fact in the Registration Statement made in reliance
upon, and in conformity with, written information concerning another party
furnished by such other party specifically for use in the Registration
Statement.
SFB shall use its reasonable best efforts to cause KPMG Peat Marwick
LLP, its independent public accounting firm to deliver to HBV and HBV shall use
its reasonable best efforts to cause Thompson, Greenspon & Co., P.C., its
independent public accounting firm to deliver to HBV and to its officers and
directors who sign the Registration Statement for the Reorganization, a "comfort
letter" or "agreed upon procedures letter" in form customarily issued by such
accountants at such time in transactions of this type dated (a) the date of the
mailing of the joint proxy statement for the HBV shareholders' meeting and the
date of mailing of the joint proxy statement for the SFB shareholders' meeting,
respectively, and (b) a date not earlier than fourteen (14) days preceding the
date of the Reorganization Closing.
4.4 Operation of the Business of HBV and SFB. (a) HBV and SFB each
agrees that from the date hereof to the Effective Date it will operate its
business substantially as presently operated and only in the ordinary course,
and, consistent with such operation, it will use its best efforts to preserve
intact its relationships with persons having business dealings with it.
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(b) Without limiting the generality of the foregoing, HBV agrees
that it will not, without the prior written consent of SFB:
(1) Make any change in its authorized capital stock, or
issue or sell any additional shares of, securities convertible into or
exchangeable for, or options, warrants or rights to purchase, its capital stock,
nor shall it purchase, redeem or otherwise acquire any of its outstanding shares
of capital stock, provided that HBV may issue shares of common stock pursuant to
options granted or issued prior to the date hereof:
(2) Voluntarily make any changes in the composition of
its officers, directors or other key management personnel;
(3) Make any change in the compensation or title of any
officer, director or key management employee or make any change in the
compensation or title of any other employee, other than consistent with past
practices in the ordinary course of business, any of which changes shall be
reported promptly to SFB;
(4) Enter into any new bonus, incentive compensation,
stock option, deferred compensation, profit sharing, thrift, retirement,
pension, group insurance or other benefit plan or any employment or consulting
agreement;
(5) Incur any obligation or liability (whether absolute
or contingent, excluding suits instituted against it), make any pledge, or
encumber any of its assets, nor dispose of any of its assets in any other
manner, except in the ordinary course of its business and for adequate value;
(6) Except as permitted by Section 4.4(b)(1) hereof,
issue or contract to issue any shares of its Common Stock, options for shares of
its Common Stock, or securities exchangeable for or convertible into such
shares;
(7) Knowingly waive any right to substantial value:
(8) Enter into material transactions otherwise than in
the ordinary course of its business;
(9) Alter, amend or repeal its Bylaws or Articles of
Incorporation; or
(10) Propose or take any other action which would make any
representation or warranty in Section 3.1 or Section 3.2 hereof untrue.
4.5 Dividends. HBV agrees that SFB may declare and pay regular
quarterly cash dividends not exceeding $0.125 per share per quarter from the
date of this Agreement through the Effective Date. HBV shall not declare or pay
any cash dividend prior to the Effective Date.
4.6 No Solicitation. Unless and until this Agreement shall have
been terminated pursuant to its terms, neither HBV nor any of its officers,
directors, representatives or agents shall, directly or indirectly, (i)
encourage, solicit or initiate discussions or negotiations with any person other
than SFB
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concerning any merger, share exchange, sale of substantial assets, tender offer,
sale of shares of capital stock or similar transaction involving HBV, (ii) enter
into any agreement with any third party providing for a business combination
transaction, equity investment or sale of a significant amount of assets, or
(iii) furnish any information to any other person relating to or in support of
such transaction. HBV will promptly communicate to SFB the terms of any proposal
which it may receive in respect to any of the foregoing transactions.
4.7 Regulatory Filings. SFB shall prepare all regulatory filings
required to consummate the transactions contemplated by the Agreement and the
Plan of Merger and submit the filings for approval with the Federal Reserve
Board and the SCC, and any other governing regulatory authority, as soon as
practicable after the date hereof. SFB shall use its best efforts to obtain
approvals of such filings.
4.8 Public Announcements. Each party will consult with the other
before issuing any press release or otherwise making any public statements with
respect to the Reorganization and shall not issue any such press release or make
any such public statement prior to such consultations except as may be required
by law.
4.9 Notice of Breach. SFB and HBV will give written notice to the
other promptly upon becoming aware of the impending or threatened occurrence of
any event which would cause or constitute a breach of any of the
representations, warranties or covenants made to the other party in this
Agreement and will use its best efforts to prevent or promptly remedy the same.
4.10 Accounting Treatment. (a) SFB and HBV shall each use their
best efforts to ensure that the Reorganization qualifies for
pooling-of-interests accounting treatments.
(b) HBV and SFB shall consult and cooperate with each
other with respect to determining the amount and the timing for recognizing for
financial accounting purposes the expenses of the Merger and the restructuring
charges related to or to be incurred in connection with the Merger, provided
that any such accounting shall be in accordance with generally accepted
accounting principles.
(c) At the request of SFB, HBV shall promptly establish
and take such reserves and accruals as SFB shall request in order to conform on
a mutually satisfactory basis, HBV's loan, accrual and reserve policies to SFB's
policies. It is the objective of SFB and HBV that such reserves, accruals and
charges be taken on or before the Effective Date; and provided, further, that
such reserves and accruals shall not constitute a Material Adverse Change, and
HBV shall not be obligated to take any such action pursuant to this Section
4.10(c) unless and until (i) all conditions to the obligations of HBV and SFB to
consummate the Merger set forth in Sections 6.1 through 6.3 have been waived or
satisfied by the appropriate party, and (ii) such reserves, accruals and charges
conform with generally accepted accounting principles, applicable laws,
regulations, and the requirements of Governmental Entities.
4.11 Reorganization Consummation. Subject to the terms and
conditions of this Agreement, each party shall use its best efforts in good
faith to take, or cause to be taken, all actions, and to do or cause to be done
all things necessary, proper or desirable, or advisable under applicable
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laws, as promptly as practicable so as to permit consummation of the
Reorganization at the earliest possible date, consistent with Section 1.3
herein, and to otherwise enable consummation of the transactions contemplated
hereby and shall cooperate fully with the other parties hereto to that end, and
each of HBV and SFB shall use, and shall cause each of their respective
subsidiaries to use, its best efforts to obtain all consents (governmental or
other) necessary or desirable for the consummation of the transactions
contemplated by this Agreement.
ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options. (a) On the Effective Date, all
rights with respect to HBV Common Stock pursuant to stock options ("HBV
Options") granted by HBV under a HBV stock option plan which are outstanding on
the Effective Date, whether or not they are exercisable, shall be converted into
and become rights with respect to SFB Common Stock, and SFB shall assume each
HBV Option in accordance with the terms of the stock option plan under which it
was issued and the stock option agreement by which it is evidenced. From the
Effective Date forward, (i) each HBV Option assumed by SFB may be excised solely
for shares of SFB Common Stock, (ii) the number of shares of SFB Common Stock
subject to each HBV Option shall be equal to the number of shares of HBV Common
Stock subject to such option immediately prior to the Effective Date multiplied
by the Exchange Ratio and (iii) the per share exercise price under each such HBV
Option shall be adjusted by dividing the per share exercise price under each
such option by the Exchange Ratio and rounding down to the nearest cent;
provided, however, that the terms of each HBV Option shall, in accordance with
its terms, be subject to further adjustment as appropriate to reflect any stock
split, stock dividend, recapitalization or other similar transaction after the
Effective Date. It is intended that the foregoing assumption shall be undertaken
in a manner that will not constitute a "modification" as defined in Section 425
of the Code, as to any stock option which is an "incentive stock option."
5.2 Accounting Treatment. This Reorganization shall qualify for
pooling-of-interests accounting treatment.
5.3 Benefit Plans.
(a) After consummation of the Reorganization, HBV
employees shall, at the option of SFB which may be applied on a plan or program
by plan or program basis and/or separately to different groups of employees and
subject to changes required by applicable law, be entitled either to:
(1) participate in employee benefit plans and
programs established, amended or continued (including a continuation of
an HBV plan or program) by SFB that provide coverages and benefits
which are not less favorable than the coverages and benefits provided
by the employee benefit plans and programs of HBV in which such
employees participated immediately prior to the Reorganization, or
(2) participate in SFB's then existing employee
benefit plans and programs on substantially the same basis as similarly
situated employees of SFB (taking
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into account all applicable factors, including but not limited to
position, location of employment, employment classification, age,
length of service, pay, part time or full time status, and the like, as
well as changes made in such plans and programs in the future);
provided, however, that in no event shall the coverages and benefits
offered by SFB to HBV employees be, in the aggregate, less favorable
than the coverages and benefits of HBV's plans and programs in which
they participated immediately prior to the consummation of the
Reorganization, and provided further, that if an HBV employee employed
by HBV on the date of this Agreement would be required to pay more for
individual and/or any level of family health insurance coverage under a
SFB plan than under the HBV health insurance plan, SFB shall either
increase its contribution toward such individual's health insurance
costs or increase such individual's compensation in order that such
individual pays no more on an after-tax basis than he or she paid under
the HBV plan. The requirements of this subsection shall expire on
December 31, 2000, provided, however, that the foregoing provisions
regarding health insurance contributions shall continue thereafter
until such time, if at all, as SFB ceases to grandfather the employee
health insurance contribution amounts for its employees hired before
August 13, 1997.
(b) Subject to restrictions and limitations imposed by applicable
law, SFB agrees to treat an HBV employee's service with HBV or any of its
predecessors or affiliates as service with SFB for each HBV employee who is
employed by SFB immediately after the consummation of the Reorganization for
purposes of all employee benefit plans and programs.
(c) Subject to restrictions and limitations imposed by applicable
law or by insurance companies providing plan benefits or stop loss insurance
with respect to a plan, SFB shall make participation in employee welfare benefit
plans available to an HBV employee without regard to any waiting period,
evidence and requirement of insurability, preexisting condition, actively at
work requirement or exclusion or limitation (except to the extent and in the
manner any such waiting period, evidence and requirement of insurability,
preexisting condition, actively at work requirement or exclusion or limitation
applies immediately prior to the Reorganization Closing).
(d) SFB also shall honor in accordance with their terms as in
effect on the date of this Agreement (or as amended thereafter with the prior
written consent of SFB), (1) all of HBV's obligations for vacation, sick leave,
personal leave and the like accrued and unused through the date of the
consummation of the Reorganization and (2) all employment, severance, consulting
and other compensation contracts and agreements Previously Disclosed by HBV to
SFB and executed in writing by HBV on the one hand and any individual current or
former director, officer or employee thereof on the other hand.
5.4 Indemnification. SFB agrees that following the Effective Date,
it shall indemnify and hold harmless any person who has rights to
indemnification from HBV, to the same extent and on the same conditions as such
person is entitled to indemnification pursuant to Virginia law and HBV's
Articles of Incorporation or Bylaws, as in effect on the date of this Agreement,
to the extent legally permitted to do so, with respect to matters occurring on
or prior to the Effective Date. SFB further agrees that any such person who has
rights to indemnification pursuant to this Section 5.4 is expressly
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made a third party beneficiary of this Section 5.4 and may directly, in such
person's personal capacity, enforce such rights through an action at law or in
equity or through any other manner or means of redress allowable under Virginia
law to the same extent as if such person were a party hereto. Without limiting
the foregoing, in any case in which corporate approval may be required to
effectuate any indemnification, SFB shall direct, at the election of the party
to be indemnified, that the determination of permissibility of indemnification
shall be made by independent counsel mutually agreed upon between SFB and the
indemnified party. SFB shall use its reasonable best efforts to maintain HBV's
existing directors' and officers' liability policy, or some other policy,
including SFB's existing policy, providing at least comparable coverage,
covering persons who are currently covered by such insurance of HBV for a period
of five years after the Effective Date on terms no less favorable than those in
effect on the date hereof.
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to Each Party's Obligations to Effect the
Reorganization. The respective obligations of each of SFB and HBV to effect the
Reorganization and the other transactions contemplated by this Agreement shall
be subject to the fulfillment or waiver at or prior to the Effective Date of the
following conditions:
(a) Shareholder Approvals. Shareholders of HBV shall have
approved all matters relating to this Agreement and the Reorganization required
to be approved by such shareholders in accordance with Virginia law and
shareholders of SFB shall have approved the issuance of shares of SFB Common
Stock in connection with the Reorganization in accordance with Virginia law and
NASDAQ rules.
(b) Regulatory Approvals. This Agreement and the Plan of
Merger shall have been approved by the Federal Reserve, the SCC, and any other
regulatory authority whose approval is required for consummation of the
transactions contemplated hereby, and such approvals shall not have imposed any
condition or requirement which would so materially adversely impact the economic
or business benefits of the transactions contemplated by this Agreement as to
render inadvisable the consummation of the Reorganization in the reasonable
opinion of the Board of Directors of SFB or HBV.
(c) Registration Statement. The Registration Statement
shall have been declared effective and shall not be subject to a stop order or
any threatened stop order.
(d) Tax Opinion. SFB and HBV shall have received an
opinion of Williams, Mullen, Christian & Dobbins, or other counsel reasonably
satisfactory to SFB and HBV, to the effect that the Reorganization will
constitute a reorganization within the meaning of Section 368 of the Internal
Revenue Code and that no gain or loss will be recognized by the shareholders of
HBV to the extent they receive SFB Common Stock solely in exchange for their HBV
Common Stock in the Reorganization.
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(e) Accountants' Letter. SFB and HBV shall have received
a letter, dated as of the Effective Date, from KPMG Peat Marwick LLP,
satisfactory in form and substance to each of SFB and HBV, that the
Reorganization will qualify for pooling-of-interests accounting treatment under
generally accepted accounting principles.
(f) Opinions of Counsel. HBV shall have delivered to SFB
and SFB shall have delivered to HBV opinions of counsel, dated as of the
Effective Date, as to such matters as they may each reasonably request with
respect to the transactions contemplated by this Agreement and in a form
reasonably acceptable to each of them.
(g) Legal Proceedings. Neither SFB nor HBV shall be
subject to any order, decree or injunction of a court or agency of competent
jurisdiction which enjoins or prohibits the consummation of the Reorganization.
6.2 Conditions to Obligations of SFB. The obligations of SFB to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of HBV shall be true and correct
as of the date of this Agreement and upon the Effective Date with the same
effect as though all such representations and warranties had been made on the
Effective Date, except (i) for any such representations and warranties made as
of a specified date, which shall be true and correct as of such date, (ii) as
expressly contemplated by this Agreement, or (iii) for representations and
warranties the inaccuracies of which relate to matters that, individually or in
the aggregate, do not materially adversely affect the condition (financial or
otherwise) of HBV as provided in Section 3.1(q), the Reorganization and the
other transactions contemplated by this Agreement and SFB shall have received a
certificate or certificates signed by the Chief Executive Officer and Chief
Financial Officer of HBV dated the Effective Date, to such effect.
(b) Performance of Obligations. HBV shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective Date, and SFB shall have received a
certificate signed by the Chief Executive Officer of HBV to that effect.
(c) Affiliate Letters. Each shareholder of HBV who may be
deemed by counsel for SFB to be an "affiliate" of HBV within the meaning of Rule
145 under the Securities Act of 1933 shall have executed and delivered a
commitment and undertaking to the effect that (1) such shareholder will dispose
of the shares of SFB Common Stock received by him in connection with the
Reorganization only in accordance with the provisions of paragraph (d) of Rule
145 and in a manner that would not prevent the Reorganization from qualifying
for pooling-of-interests accounting treatment; (2) such shareholders will not
dispose of any such shares until SFB has received an opinion of counsel
acceptable to it that such proposed disposition will not violate the provisions
of any applicable security laws; and (3) the certificates representing said
shares may bear a conspicuous legend referring to the forgoing restrictions.
(d) Investment Banking Letter. SFB shall have received a
written opinion in form and substance satisfactory to SFB from Tucker Anthony,
Inc. addressed to SFB and dated the
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date the Proxy Statement/Prospectus is mailed to shareholders of SFB, to the
effect that the terms of the Reorganization, including the Exchange Ratio, are
fair, from a financial point of view, to the shareholders of SFB. At its option,
SFB may require that such fairness opinion be updated as of the Effective Date
and, in such event, it shall also be a condition to SFB's obligation to
consummate the Reorganization that SFB receive such updated fairness opinion.
(e) Employment Contract Termination. HBV and Richard L.
Hall shall have entered into an agreement in form and substance satisfactory to
SFB providing, contingent on the Reorganization receiving all requisite
approvals and the consummation of the Reorganization, (i) that the Employment
Agreement, dated as of January 1, 1992, as amended, between HBV and Richard L.
Hall will terminate immediately prior to the time that the Reorganization
becomes effective, (ii) that HBV and Richard L. Hall each shall release the
other from all claims and (iii) that HBV will pay $413,114 (or such other amount
to which the parties may agree) to Richard L. Hall immediately before the time
that the Reorganization becomes effective.
6.3 Conditions to Obligations of HBV. The obligations of HBV to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of SFB shall be true and correct
as of the date of this Agreement and upon the Effective Date with the same
effect as though all such representations and warranties had been made on the
Effective date, except (i) for any such representations and warranties made as
of a specified date, which shall be true and correct as of such date, (ii) as
expressly contemplated by this Agreement, or (iii) for representations and
warranties the inaccuracies of which relate to matters that, individually or in
the aggregate, do not materially adversely affect the condition (financial or
otherwise) of SFB as provided in Section 3.2(r), the Reorganization and the
other transactions contemplated by this Agreement and HBV shall have received a
certificate or certificates signed by the Chief Executive Officer and Chief
Financial Officer of SFB dated the Effective Date, to such effect.
(b) Performance of Obligations. SFB shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective Date, and HBV shall have received a
certificate signed by Chief Executive Officer of SFB to that effect.
(c) Investment Banking Letter. HBV shall have received a
written opinion in form and substance satisfactory to HBV from McKinnon &
Company, Inc. addressed to HBV and dated the date the Proxy Statement/Prospectus
is mailed to shareholders of HBV, to the effect that the terms of the
Reorganization, including the Exchange Ratio, are fair, from a financial point
of view, to the shareholders of HBV. At its option, HBV may require that such
fairness opinion be updated as of the Effective Date and, in such event, it
shall also be a condition to HBV's obligation to consummate the Reorganization
that HBV receive such updated fairness opinion.
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ARTICLE 7
Termination
7.1 Termination. Notwithstanding any other provision of this
Agreement, and notwithstanding the approval of this Agreement and the Plan of
Merger by the shareholders of SFB and HBV, this Agreement may be terminated and
the Reorganization abandoned at any time prior to the Effective Date:
(a) By the mutual consent of the Board of Directors of
each of SFB and HBV;
(b) By the respective Boards of Directors of SFB or HBV
if the conditions set forth in Section 6.1 have not been met or waived by SFB
and HBV;
(c) By the Board of Directors of SFB if the conditions
set forth in Section 6.2 have not been met or waived by SFB;
(d) By the Board of Directors of HBV if the conditions
set forth in Section 6.3 have not been met or waived by HBV;
(e) By the respective Boards of Directors SFB or HBV if
the Reorganization is not consummated by February 29, 2000.
(f) By the Board of Directors of SFB if the Board of
Directors of HBV receives an offer from a person other than SFB to acquire HBV
and does not within fourteen (14) days after receipt of such subsequent offer
confirm in writing to SFB that a majority of the Board of Directors of HBV
supports the Reorganization and will recommend to the shareholders of HBV that
they approve the Reorganization.
(g) By the Board of Directors of HBV if, before the
Effective Date, SFB shall enter into any agreement or letter of intent providing
for the direct or indirect acquisition of substantially all of the assets and
liabilities or voting stock of SFB.
7.2 Effect of Termination. In the event of the termination and
abandonment of this agreement and the Reorganization pursuant to Section 7.1,
this Agreement shall become void and have no effect, except that (i) the last
sentence of Section 4.2 and all of Sections 4.8, 7.4 and 7.5 shall survive any
such termination and abandonment and (ii) no party shall be relieved or released
from any liability arising out of an intentional breach of any provision of this
Agreement.
7.3 Non-Survival of Representations, Warranties and Covenants.
Except for Sections 1.2, 1.4, 2.1, 2.2, 2.3, 2.4, 5.3, 5.4 and 7.4 of this
Agreement, none of the respective representations and warranties, obligations,
covenants and agreements of the parties shall survive the Effective Date,
provided that no such representations, warranties, obligations, covenants and
agreements shall be deemed to be terminated or extinguished so as to deprive SFB
or HBV (or any director, officer, or controlling person thereof) of any defense
in law or equity which otherwise would be available against
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the claims of any person, including without limitation any shareholder or former
shareholder of either SFB or HBV.
7.4 Expenses. The parties provide for the payment of expenses as
follows:
(a) Except as provided in Section 7.4(b) (c) or (d)
below, each of the parties shall bear and pay all costs and expenses incurred by
it or on its behalf in connection with the transactions contemplated herein,
including fees and expenses of its own consultants, investment bankers,
accountants and counsel.
(b) Notwithstanding the provisions of Section 7.4(a)
hereof, if for any reason the Reorganization is not approved by the shareholders
of either party as required, that party shall bear and pay 50% of the costs and
expenses incurred by the other party with respect to the fees and expenses of
accountants, counsel, printers and persons involved in the transactions
contemplated by this Agreement, including the preparation of the Registration
Statement and the Joint Proxy Statement.
(c) If this Agreement is terminated by SFB or HBV because
of a willful and material breach by the other of any representation, warranty,
covenant, undertaking or restriction set forth herein, and provided that the
terminating party shall not have been in breach (in any material respect) of any
representation and warranty, covenant, undertaking or restriction contained
herein, then the breaching party shall bear and pay all such costs and expenses
of the other party, including fees and expenses of consultants, investment
bankers, accountants, counsel, printers, and persons involved in the
transactions contemplated by this Agreement, including the preparation of the
Registration Statement and the Joint Proxy Statement.
(d) Any liability to the other incurred by HBV or SFB
pursuant to this Section 7.4 shall not exceed a total of $100,000.
(e) Final settlement with respect to the payment of such
fees and expenses by the parties shall be made within thirty (30) days after the
termination of this Agreement.
7.5 Termination Fee. If this Agreement terminates other than under
Section 7.1(g) and, after the date of this Agreement and prior to the date of
termination:
(a) HBV shall have solicited or encouraged any inquiry,
offer or proposal from a third party to engage in a "Transaction" (as hereafter
defined) or initiated discussions or negotiations with a third party with
respect to a Transaction or HBV receives an inquiry or unsolicited proposal from
a third party to engage in a Transaction; and
(b) within 12 months after this Agreement terminates, the
Board of Directors of HBV determines that a Transaction with such third party is
in the best interests of HBV and its shareholders;
then, HBV shall pay SFB the sum of One Million Dollars ($1,000,000.00);
provided, no payment under this Section 7.5 shall be due if (A) SFB wrongfully
terminates this Agreement or (B) if, at the time this Agreement terminates (y)
HBV is entitled to terminate or to refuse to consummate
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the Reorganization on the grounds that SFB has breached any representation,
warranty or covenant of SFB contained herein or (z) there has been a failure to
satisfy any of the conditions contained in Section 6.1 (other than approval of
the shareholders of HBV), which failure has not been cured or waived by HBV or
SFB or both, as appropriate. Any sum due under this Section 7.5 shall be paid to
SFB on or before the date on which a Transaction with another entity is agreed
to in principle and shall be paid by wire transfer in immediately available
funds.
For purposes of this Section 7.5, a "Transaction" shall mean a merger,
share exchange, sale of assets or other combination or plan of liquidation
involving HBV and any other entity, regardless of which entity is the surviving
entity.
ARTICLE 8
General Provisions
8.1 Entire Agreement. This Agreement contains the entire agreement
among SFB and HBV with respect to the Reorganization and the related
transactions and supersedes all prior arrangements or understandings with
respect thereto.
8.2 Waiver and Amendment. Any term or provision of this Agreement
may be waived in writing at any time by the party which is, or whose
shareholders are, entitled to the benefits thereof, and this Agreement may be
amended or supplemented by written instructions duly executed by the parties
hereto at any time, whether before or after the meetings of HBV and SFB
shareholders referred to in Section 6.1(a) hereof, except statutory requirements
and requisite approvals of shareholders and regulatory authorities.
8.3 Descriptive Headings. Descriptive headings are for convenience
only and shall not control or affect the meaning and construction of any
provisions of this Agreement.
8.4 Governing Law. Except as required otherwise or otherwise
indicated herein, this Agreement shall be construed and enforced according to
the laws of the Commonwealth of Virginia.
8.5 Notices. All notices or other communications which are
required or permitted hereunder shall be in writing and sufficient if delivered
personally or sent by registered or certified mail, postage prepaid, addressed
as follows:
If to SFB:
Georgia S. Derrico
Southern Financial Bancorp, Inc.
37 E. Main Street, Warrenton, VA, 22186
(Tel. (540) 459-4900)
A-37
<PAGE>
Copy to:
Wayne A. Whitham, Jr.
Williams, Mullen, Christian & Dobbins
1021 East Cary Street
P.O. Box 1320
Richmond, Virginia 23210-1320
(Tel. 804-783-6473)
If to HBV:
Richard L. Hall
The Horizon Bank of Virginia
140 Park Street, SE, Vienna, Virginia 22180
(Tel. (703) 255-6000)
Copy to:
Fred W. Palmore, III
Mays & Valentine, LLP
NationsBank Center
1111 E. Main Street
Richmond, Virginia 23219
(Tel. (804) 697-1396)
8.6 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original, but such counterparts together
shall constitute one and the same agreement.
8.7 Severability. In the event any provisions of this Agreement
shall be held invalid or unenforceable by any court of competent jurisdiction,
such holding shall not invalidate or render unenforceable any other provisions
hereof. Any provision of this Agreement held invalid or unenforceable only in
part or degree shall remain in full force and effect to the extent not held
invalid or unenforceable. Further, the parties agree that a court of competent
jurisdiction may reform any provision of this Agreement held invalid or
unenforceable so as to reflect the intended agreement of the parties hereto.
8.8 Brokers and Finders. Except for Tucker Anthony, Inc. as to SFB
and McKinnon & Company, Inc. as to HBV, each of the parties represents and
warrants that neither it nor any of its officers, directors, employees,
affiliates, or subsidiaries has employed any broker or finder or incurred any
liability for any financial advisory fees, investment banker's fees, brokerage
fees, commissions, or finders' fees in connection with this Agreement or the
transactions contemplated hereby. In the event of any claim by any broker or
finder based upon his or its representing or being retained by or allegedly
representing or being retained by either SFB or HBV, SFB or HBV, as the case may
be, agrees to indemnify and hold the other party harmless of and from any such
claim.
A-38
<PAGE>
8.9 Subsidiaries. All representations, warranties, and covenants
herein, where pertinent, include and shall apply to the wholly owned
subsidiaries belonging to the party making such representations, warranties, and
covenants.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed in counterparts by their duly authorized officers and their corporate
seals to be affixed hereto, all as of the dates first written above.
Southern Financial Bancorp, Inc.
By: /s/ Georgia S. Derrico
------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
Southern Financial Bank
By: /s/ Georgia S. Derrico
------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
The Horizon Bank of Virginia
By: /s/ Richard L. Hall
-------------------------------------
Richard L. Hall
President and Chief Executive Officer
By: /s/ Richard E. Smith
-------------------------------------
Richard E. Smith
Chairman of Board of Directors
A-39
<PAGE>
THE HORIZON BANK OF VIRGINIA
BOARD OF DIRECTORS
Each of the undersigned members of the Board of Directors of The
Horizon Bank of Virginia agrees to be bound by his personal obligations as
provided in Section 4.3 and 4.6 of this Agreement.
/s/ Richard E. Smith /s/ Arthur V. Myers
- ------------------------------- -------------------------------
Richard E. Smith Arthur V. Myers
/s/ John C. Belotti /s/ William Gary Sullivan
- ------------------------------- -------------------------------
John C. Belotti William Gary Sullivan
/s/ Richard L. Hall /s/ Robert P. Warhurst
- ------------------------------- -------------------------------
Richard L. Hall Robert P. Warhurst
/s/ Harry E. Jagoda /s/ W. Bruce Jennings
- ------------------------------- -------------------------------
Harry E. Jagoda W. Bruce Jennings
A-40
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
BOARD OF DIRECTORS
Each of the undersigned members of the Board of Directors of Southern
Financial Bancorp, Inc. agrees to be bound by his personal obligations as
provided in Section 4.3 and 4.6 of this Agreement.
/s/ Virginia Jenkins /s/ David deGive
- ------------------------------- -------------------------------
Virginia Jenkins David deGive
/s/ Michael P. Rucker /s/ R. Roderick Porter
- ------------------------------- -------------------------------
Michael P. Rucker R. Roderick Porter
/s/ Neil J. Call /s/ Georgia S. Derrico
- ------------------------------- -------------------------------
Neil J. Call Georgia S. Derrico
/s/ John L. Marcellus, Jr. /s/ Fred L. Bollerer
- ------------------------------- -------------------------------
John L. Marcellus, Jr. Fred L. Bollerer
/s/ Alfonso G. Finocchiaro
- -------------------------------
Alfonso G. Finocchiaro
A-41
<PAGE>
EXHIBIT A
to the
Agreement and Plan
of Reorganization
PLAN OF MERGER
BETWEEN
THE HORIZON BANK OF VIRGINIA
AND
SOUTHERN FINANCIAL BANK
Pursuant to this Plan of Merger ("Plan of Merger"), The Horizon Bank of
Virginia ("HBV"), a Virginia state bank, shall merge with and into Southern
Financial Bank ("SFB"), a Virginia state bank pursuant to a merger under Section
13.1-716 of the Virginia Stock Corporation Act.
ARTICLE 1
Terms of the Share Exchange
1.1 The Merger. Subject to the terms and conditions of the
Agreement and Plan of Reorganization, dated as of May 3, 1999 between HBV,
Southern Financial Bank and Southern Financial Bancorp, Inc., a Virginia
corporation ("SFB"), at the Effective Date, HBV shall merge with and into
Southern Financial Bank. Southern Financial Bank shall be the surviving
corporation. Each outstanding share of common stock of HBV shall be converted
into shares of the common stock of SFB in accordance with Section 2.1 of this
Plan of Merger in a merger under Section 13.1-716 of the Virginia Stock
Corporation Act (the "Merger"). At the Effective Date, the Merger shall have the
effect as provided in Section 13.1-721 of the Virginia Stock Corporation Act.
1.2 Articles of Incorporation and Bylaws. The Articles of
Incorporation and Bylaws of Southern Financial Bank in effect immediately prior
to the consummation of the Merger shall remain in effect following the Effective
Date until otherwise amended or repealed.
ARTICLE 2
Manner of Exchanging Shares
2.1 Conversion of Shares. Upon, and by reason of, the Merger
becoming effective pursuant to the issuance of a Certificate of Merger by the
Virginia State Corporation Commission, no cash, except as set forth in section
2.3 below, shall be allocated to the shareholders of HBV, and stock shall be
issued and allocated as follows:
Each share of common stock, par value $2.50 per share, of HBV
("HBV Common Stock")issued and outstanding immediately prior to the Effective
Date shall be converted into 0.63 shares of SFB Common Stock (the "Exchange
Ratio"). Each holder of a certificate which immediately prior to the Effective
Date represented shares of HBV Common Stock, upon the surrender of his HBV stock
certificates to SFB, duly endorsed for transfer in accordance with Section 2.2
below, will be entitled to receive in exchange therefor a certificate or
certificates representing the number of shares of
A-42
<PAGE>
SFB Common Stock that such HBV stock certificates shall entitle him to pursuant
to the Exchange Ratio. After the Effective Date, each such former holder of HBV
Common Stock shall have the right to receive (i) any dividend or such
distribution payable at or as of any time after the Effective Date to holders of
record of SFB Common Stock at or as of any time after the Effective Date, and
(ii) the consideration described in Sections 2.1 and 2.3 upon the surrender of
such certificate in accordance with Section 2.2. In the event SFB changes the
number of shares of SFB Common Stock issued and outstanding prior to the
Effective Date as a result of any stock split, stock dividend, reclassification,
recapitalization or similar transaction with respect to the outstanding SFB
Common Stock and the record date therefor shall be prior to the Effective Date,
the Exchange Ratio shall be proportionally adjusted.
2.2 Conversion of Stock Options. (a) On the Effective Date, all
rights with respect to HBV Common Stock pursuant to stock options ("HBV
Options") granted by HBV under a HBV stock option plan which are outstanding on
the Effective Date, whether or not then exercisable, shall be converted into and
become rights with respect to SFB Common Stock, and SFB shall assume each HBV
Option in accordance with the terms of the stock option plan under which it was
issued and the stock option agreement by which it is evidenced. From the
Effective Date forward, (i) each HBV Option assumed by SFB may be exercised
solely for shares of SFB Common Stock, (ii) the number of shares of SFB Common
Stock subject to each HBV Option shall be equal to the number of shares of HBV
Common Stock subject to such option immediately prior to the Effective Date
multiplied by the Exchange Ratio and (iii) the per share exercise price under
each such HBV Option shall be adjusted by dividing the per share exercise price
under each such option by the Exchange Ratio and rounding down to the nearest
cent; provided, however, that the terms of each HBV Option shall, in accordance
with its terms, be subject to further adjustment as appropriate to reflect any
stock split, stock dividend, recapitalization or other similar transaction after
the Effective Date. It is intended that the forgoing assumption shall be
undertaken in a manner that will not constitute a "modification" as defined in
Section 425 of the Code, as to any stock option which is an "incentive stock
option."
(b) Pursuant to approval of this Plan of Merger, the SFB
stock option plan shall be amended to increase the number of authorized shares
to cover the conversion of the HBV Options into options to purchase SFB common
stock pursuant to Section 2.2(a) above and to otherwise provide for conversion
of the HBV Options as described herein.
2.3 Manner of Exchange. As promptly as practicable after the
Effective Date, SFB shall cause Chase Mellon Shareholder Services, acting as the
exchange agent ("Exchange Agent") to send to each former shareholder of record
of HBV immediately prior to the Effective Date transmittal materials for use in
exchanging such shareholder's certificates of HBV Common Stock for the
consideration set forth in Section 2.1 above and Section 2.4 below. Any
fractional share checks which a HBV shareholder shall be entitled to receive in
exchange for such shareholder's shares of HBV Common Stock, and any dividends
paid on any shares of SFB Common Stock that such shareholder shall be entitled
to receive prior to the delivery to the Exchange Agent of such shareholder's
certificates representing all of such shareholder's shares of HBV Common Stock
will be delivered to such shareholder only upon delivery to the Exchange Agent
of the certificates representing all of such shares (or indemnity satisfactory
to SFB and the Exchange Agent, in their judgment, if any of such certificates
are lost, stolen or destroyed). No interest will be paid on any such fractional
share checks or dividends to which the holder of such shares shall be entitled
to receive upon such delivery.
A-43
<PAGE>
2.4 Fractional Shares. In lieu of issuing fractional shares, SFB
will pay the value of such fractional shares in cash on the basis of the average
of the closing prices of SFB Common Stock as reported on the National
Association of Securities Dealers Automated Quotation National Market System for
trades reported during the ten (10) trading days immediately preceding the
Effective Date.
2.5 Dividends. No dividend or other distribution payable to the
holders of record of SFB Common Stock at or as of any time after the Effective
Date shall be paid to the holder of any certificate representing shares of HBV
Common Stock issued and outstanding immediately prior to the Effective Date
until such holder physically surrenders such certificate for exchange as
provided in Section 2.3, promptly after which time all such dividends or
distributions shall be paid by SFB (without interest).
ARTICLE 3
Termination
This Plan of Merger may be terminated at any time prior to the
Effective Date by the parties hereto as provided in Article 7 of the Agreement
and Plan of Reorganization, dated May 3, 1999, between the parties.
A-44
<PAGE>
EXHIBIT B
To the Agreement and
Plan of Reorganization
Section 2.3. Election of Directors. The Directors shall be elected at
the annual meeting of shareholders, and shall hold their offices until their
successors are elected in accordance with the Articles of Incorporation.
Nominations for the election of Directors shall be given in the manner provided
in Section 2.5. At the annual meeting of shareholders in 2000, John C. Belotti,
or an individual designated by Directors who formerly were directors of The
Horizon Bank of Virginia, shall be nominated for election to a three year term.
At the annual meeting of shareholders in 2001, Richard L. Hall (provided he
remains a full time employee of the Corporation or a wholly-owned subsidiary of
the Corporation), or an individual designed by Directors who formerly were
directors of The Horizon Bank of Virginia, shall be nominated for election to a
three year term. If the seat held by any of Messrs. Belotti, Hall or Warhurst
becomes vacant, the Board shall appoint a successor chosen by the Directors who
formerly were directors of The Horizon Bank of Virginia. Prior to the annual
meeting of shareholders in 2001, this Section 2.3 may be amended only by the
unanimous vote of the entire Board of Directors.
A-45
<PAGE>
Appendix B
SOUTHERN FINANCIAL BANCORP, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report...................................................................................................B-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1998 and 1997...........................................................B-3
Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996.................................B-4
Consolidated Statements of Comprehensive Income for the years ended December 31,
1998, 1997 and 1996....................................................................................................B-5
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996.......................................................................................B-6
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.............................B-7
Notes to Consolidated Financial Statements..............................................................................B-8 - B-26
Interim Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 1999 and December 31, 1998................................................B-27
Consolidated Statements of Income for the three months ended March 31, 1999 and 1998..................................B-28
Consolidated Statements of Comprehensive Income for the three months ended
March 31, 1999 and 1998...............................................................................................B-29
Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998..............................B-30
Notes to Interim Consolidated Financial Statements (Unaudited).........................................................B-31 - B-34
</TABLE>
B-1
<PAGE>
Independent Auditors' Report
To the Board of Directors and Stockholders of
Southern Financial Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of
Southern Financial Bancorp, Inc. (Bancorp) as of December 31, 1998 and 1997, and
the related consolidated statements of income, comprehensive income, changes in
stockholders' equity and cash flows for the years 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 audits. The
accompanying consolidated financial statements of the Bancorp as of December 31,
1996, were audited by other auditors whose report thereon dated February 4,
1997, expressed an unqualified opinion on those statements.
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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southern
Financial Bancorp, Inc. as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/s/ KPMG LLP
Washington, D.C.,
February 2, 1999
B-2
<PAGE>
Consolidated Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
Assets December 31, 1998 December 31, 1997
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $ 5,374,945 $ 4,559,266
Overnight earning deposits 928,435 545,470
Investment securities, available-for-sale 74,438,682 4,692,758
Investment securities, held-to-maturity (estimated market value
of $37,794,344 and $80,795,929, respectively) 38,151,121 80,468,952
Loans held for sale 602,500 1,414,445
Loans receivable, net 131,645,482 128,958,190
Federal Home Loan Bank stock, at cost 1,082,500 930,500
Premises and equipment, net 2,370,711 2,398,541
Other assets 4,248,673 2,629,813
- --------------------------------------------------------------------------------------------------------------------------
Total assets $ 258,843,049 $ 226,597,935
- --------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits $ 231,925,592 $ 202,200,249
Advances from Federal Home Loan Bank 3,500,000 4,000,000
Other liabilities 2,494,717 1,855,085
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities 237,920,309 208,055,334
- --------------------------------------------------------------------------------------------------------------------------
Commitments
Stockholders' equity:
6%cumulative convertible preferred stock, $.01 par value, 500,000 shares
authorized, 13,621 and 15,634 shares issued
and outstanding, respectively 136 156
Common stock, $.01 par value, 5,000,000 shares authorized,
1,633,094 and 1,603,220 shares issued and outstanding,
respectively 16,331 16,216
Capital in excess of par value 15,648,527 15,556,882
Retained earnings 5,469,135 3,406,501
Accumulated other comprehensive income 259,698 33,933
Treasury stock, at cost (471,087) (471,087)
- --------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 20,922,740 18,542,601
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 258,843,049 $ 226,597,935
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-3
<PAGE>
Consolidated Statements of Income
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $12,365,456 $ 11,567,846 $10,308,273
Investment securities 6,365,474 5,436,986 4,306,296
- --------------------------------------------------------------------------------------------------------------------------
Total interest income 18,730,930 17,004,832 14,614,569
- --------------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 9,934,551 8,709,000 7,433,334
Borrowings 270,099 334,346 342,078
- --------------------------------------------------------------------------------------------------------------------------
Total interest expense 10,204,650 9,043,346 7,775,412
- --------------------------------------------------------------------------------------------------------------------------
Net interest income 8,526,280 7,961,486 6,839,157
Provision for loan losses 975,000 880,000 695,000
- --------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 7,551,280 7,081,486 6,144,157
- --------------------------------------------------------------------------------------------------------------------------
Other income:
Fee income 1,432,924 1,447,545 950,376
Gain on sale of loans 796,283 191,773 209,962
Gain on sale of investment securities 67,817 - -
Other 50,372 89,161 25,924
- --------------------------------------------------------------------------------------------------------------------------
Total other income 2,347,396 1,728,479 1,186,262
- --------------------------------------------------------------------------------------------------------------------------
Other expense:
Employee compensation and benefits 2,920,727 2,531,851 2,147,974
Premises and equipment 1,783,461 1,840,169 1,591,235
Deposit insurance assessments 124,193 109,010 1,085,536
Advertising 185,042 213,763 142,633
Other 1,142,192 887,102 939,729
- --------------------------------------------------------------------------------------------------------------------------
Total other expense 6,155,615 5,581,895 5,907,107
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes 3,743,061 3,228,070 1,423,312
Provision for income taxes 1,084,300 1,021,800 469,600
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 2,658,761 $ 2,206,270 $ 953,712
- --------------------------------------------------------------------------------------------------------------------------
Earnings per common share:
Basic* $ 1.66 $ 1.39 $ 0.61
Diluted* 1.55 1.33 0.59
Weighted average shares outstanding:
Basic* 1,597,815 1,577,243 1,544,338
Diluted* 1,713,815 1,657,706 1,621,958
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
*1996 amounts have been restated to conform with SFAS 128, "Earnings per Share."
The accompanying notes are an integral part of these financial statements.
B-4
<PAGE>
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $ 2,658,761 $ 2,206,270 $ 953,712
Other comprehensive income, net of tax:
Unrealized gain on transfer of held-to-
maturity securities 151,544 - -
Unrealized gain (loss) arising during period 118,980 109,939 (90,691)
Less: Reclassification adjustment for gains
included in net income (44,759) - -
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income 225,765 109,939 (90,691)
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 2,884,526 $ 2,316,209 $ 863,021
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-5
<PAGE>
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Accumulated
Convertible Capital in Other
Preferred Common Excess of Retained Treasury Comprehensive
Stock Stock Par Value Earnings Stock Income
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $ 166 $13,912 $12,796,014 $ 3,050,284 $(99,990) $ 14,685
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) (371,097) -
Change in other comprehensive income - - - - - (90,691)
Net income - - - 953,712 - -
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 156 15,941 15,276,373 1,655,575 (471,087) (76,006)
Dividends on preferred and common stock - - - (455,344) - -
Options exercised - 275 280,509 - - -
Change in other comprehensive income - - - - - 109,939
Net income - - - 2,206,270 - -
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 156 16,216 15,556,882 3,406,501 (471,087) 33,933
Dividends on preferred and common stock - - - (596,127) - -
Conversion of preferred stock to common stock (20) 32 (12) - - -
Options exercised - 83 91,657 - - -
Change in other comprehensive income - - - - - 225,765
Net income - - 2,658,761 - -
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 136 $16,331 $15,648,527 $5,469,135 $(471,087) $ 259,698
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Total
Stockholders'
Equity
- ---------------------------------------------------------------------
Balance, December 31, 1995 $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 (371,541)
Change in other comprehensive income (90,691)
Net income 953,712
- ---------------------------------------------------------------------
Balance, December 31, 1996 16,400,952
Dividends on preferred and common stock (455,344)
Options exercised 280,784
Change in other comprehensive income 109,939
Net income 2,206,270
- ---------------------------------------------------------------------
Balance, December 31, 1997 18,542,601
Dividends on preferred and common stock (596,127)
Conversion of preferred stock to common stock -
Options exercised 91,740
Change in other comprehensive income 225,765
Net income 2,658,761
- ---------------------------------------------------------------------
Balance, December 31, 1998 $20,922,740
- ---------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
B-6
<PAGE>
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,658,761 $ 2,206,270 $ 953,712
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 930,671 566,989 251,249
Provision for loan losses 975,000 880,000 695,000
Provision for deferred income taxes 222,323 (209,383) (13,849)
Gain on sale of loans (796,283) (191,773) (209,962)
Loss on real estate owned - - 17,000
Gain on sale of investment securities, net (67,817) - -
Amortization of deferred loan fees (623,098) (607,286) (431,247)
Net funding of loans held for sale 1,608,228 (778,172) (64,538)
Decrease (increase) in other assets (1,793,183) 492,759 (255,565)
Increase in other liabilities 685,565 491,891 430,522
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,800,167 2,851,295 1,372,322
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Increase in loans receivable (3,049,902) (21,421,747) (4,299,175)
Purchases of investment securities, available-for-sale (79,587,904) - -
Purchases of investment securities, held-to-maturity (1,959,970) (35,017,808) (32,427,276)
Paydowns of investment securities 36,800,004 20,020,684 11,844,529
Sale of investment securities, available-for-sale 16,965,806 - -
Decrease (increase) in overnight earning deposits, net (382,965) 1,850,104 (599,672)
Increase in premises and equipment, net (338,513) (911,095) (592,142)
(Increase) decrease in Federal Home Loan Bank stock (152,000) (62,900) 82,400
- --------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (31,705,444) (35,542,762) (25,991,336)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposits 29,725,343 37,921,144 20,465,419
Increase (decrease) in advances from Federal Home
Loan Bank (500,000) (4,500,000) 4,500,000
Net proceeds from stock options exercised 91,740 280,784 495,372
Repurchase of common stock - - (371,541)
Dividends on preferred and common stock (596,127) (455,344) (360,971)
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 28,720,956 33,246,584 24,728,279
- --------------------------------------------------------------------------------------------------------------------------
Net increase in cash and due from banks 815,679 555,117 109,265
Cash and due from banks, beginning of period 4,559,266 4,004,149 3,894,884
- --------------------------------------------------------------------------------------------------------------------------
Cash and due from banks, end of period $ 5,374,945 $ 4,559,266 $ 4,004,149
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-7
<PAGE>
Southern Financial Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 1998, 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, Bancorp acquired
all of the outstanding shares of the Southern Financial Bank (the "Bank"). The
Bank, formerly Southern Financial Federal Savings Bank, converted from a savings
bank to a state chartered commercial bank effective December 1, 1995.
The 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, which are managed as a single business segment.
The accounting and reporting policies of 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. 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 other comprehensive income in
stockholders' equity on an after-tax basis. Trading securities are reported at
fair value with unrealized gains and losses included in earnings. The specific
identification method is used to determine gains or losses on sales of
investment securities.
B-8
<PAGE>
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.
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.
B-9
<PAGE>
Real Estate Owned
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 dilutive common stock
equivalents outstanding during the periods. Common stock equivalents include the
number of shares issuable on exercise of outstanding options less the number of
shares that could have been purchased with the proceeds from the exercise of the
options based on the average price of common stock during the period plus the
number of shares issuable on conversion of the convertible preferred shares to
common shares.
Financial Instruments with Off-Balance Sheet Risk
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
Effective October 1, 1998, the Bancorp adopted Statement of Financial
Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133). Adoption of SFAS 133 had no cumulative effect on
earnings. Concurrent with this adoption the Bancorp reclassified certain
investment securities, consisting of mortgage-backed securities with original
maturities of 15 and 30 years, from the Held to Maturity category to the
Available for Sale category. These investments had a book value of $18.2 million
and a market value of $18.4 million as of October 1, 1998, which increased
Stockholders' Equity by $151.5 thousand.
B-10
<PAGE>
Effective January 1, 1998, the Bancorp adopted Statement of Financial
Accounting Standard No. 130, "Reporting Comprehensive Income" (SFAS 130). 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 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.
2. Investment Securities:
The portfolio consists of the following securities:
B-11
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale:
FHLMC preferred stock $ 3,807,585 $ 80,939 $ - $ 3,888,524
FHLMC MBS 11,996,172 46,261 36,766 12,005,667
GNMA MBS 3,825,601 - 54,153 3,771,448
FNMA MBS 29,671,448 178,016 35,814 29,813,650
Collateralized mortgage obligations 1,526,527 2,568 - 1,529,095
Commercial MBS 18,043,819 222,332 19,901 18,246,250
Obligations of counties and municipalities 3,234,489 11,602 25,593 3,220,498
Corporate obligations 989,319 2,981 - 992,300
U.S. Government agency obligations 949,066 22,184 - 971,250
- ---------------------------------------------------------------------------------------------------------------------
$ 74,044,026 $ 566,883 $ 172,227 $ 74,438,682
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
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, 1998
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
FHLMC MBS $ 4,091,316 $ 6,484 $ 27,668 $ 4,070,132
GNMA MBS 24,305,052 1,150 301,533 24,004,669
FNMA MBS 6,779,894 5,772 53,996 6,731,670
Collateralized mortgage obligations 1,015,264 - 1,699 1,013,565
Obligations of counties and municipalities 1,959,595 17,813 3,100 1,974,308
- ---------------------------------------------------------------------------------------------------------------------
$ 38,151,121 $ 31,219 $ 387,996 $ 37,794,344
- ---------------------------------------------------------------------------------------------------------------------
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------
Held-to-maturity:
FHLMC MBS $ 6,077,859 $ 69,247 $ 37,836 $ 6,109,270
GNMA MBS 42,471,075 226,020 39,186 42,657,909
FNMA MBS 27,075,234 191,349 80,392 27,186,191
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
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
B-12
<PAGE>
Held-to-maturity securities are carried at cost adjusted for
amortization of premiums and accretion of discounts. Held-to-maturity securities
totaling $36,191,526 have adjustable rates of interest while the remaining
held-to-maturity securities totaling $1,959,595 have fixed interest rates.
Available-for-sale securities are carried at fair value with unrealized
gains and losses reported as a separate component of stockholders' equity, net
of the tax effect. Available-for-sale securities totaling $34,760,501 have fixed
interest rates, and the remaining available-for-sale securities totaling
$39,678,181 have adjustable rates of interest.
Gross gains of $80,958 and gross losses of $13,141 were realized on the
sale of investment securities during the year ended December 31, 1998. There
were no sales of investment securities during the years ended December 31, 1997
and 1996.
As of December 31, 1998 and December 31, 1997, securities having a book
value of $63,569,352 and $71,324,504, 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.
The following table sets forth information regarding maturity and
average yields of the investment portfolio:
<TABLE>
<CAPTION>
December 31, 1998
Available-for-sale Held-to-maturity
Fair Amortized Weighted Fair Amortized Weighted
Value Cost Average Yield Value Cost Average Yield
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
FHLMC preferred stock $ 3,888,524 $ 3,807,585 7.62% $ - $ - - %
Mortgage-backed securities:
Maturing after 10 years 45,590,765 45,493,221 6.30 34,806,471 35,176,262 5.99
Collateralized mortgage obligations:
Maturing after 5 years through 10 years 1,529,095 1,526,527 6.40 - - -
Maturing after 10 years - - - 1,013,565 1,015,264 11.31
Commercial MBS:
Maturing after 5 years through 10 years 8,012,500 7,926,211 6.87 - - -
Maturing after 10 years 10,233,750 10,117,608 6.89 - - -
Obligations of counties and municipalities:
Maturing after 5 years through 10 years 195,000 195,000 8.00 348,880 346,359 4.45
Maturing after 10 years 3,025,498 3,039,489 4.96 1,625,428 1,613,236 4.73
Corporate obligations:
Maturing after 5 years through 10 years 992,300 989,319 6.71 - - -
U.S. Government agency obligations:
Maturing after 10 years 971,250 949,066 6.25 - - -
-------------------------- ---------------------------
$74,438,682 $74,044,026 $37,794,344 $38,151,121
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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.
B-13
<PAGE>
3. Loans Receivable:
Loans receivable consist of the following:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage:
Residential $ 26,046,289 $ 30,421,147
Nonresidential 64,890,406 57,160,286
Construction:
Residential 5,184,844 6,534,271
Nonresidential 11,213,848 13,160,542
Non-Mortgage:
Business 24,773,003 21,252,681
Consumer 2,424,602 3,092,938
- ----------------------------------------------------------------------------------------------------
Total loans receivable 134,532,992 131,621,865
Less:
Deferred loan fees, net 836,898 627,143
Allowance for loan losses 2,050,612 2,036,532
- ----------------------------------------------------------------------------------------------------
Loans receivable, net $ 131,645,482 $ 128,958,190
- ----------------------------------------------------------------------------------------------------
</TABLE>
The following sets forth information regarding the allowance for loan
losses:
<TABLE>
<CAPTION>
December 31,
1998 1997
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Allowance at beginning of period $ 2,036,532 $ 1,500,941
Provision for losses charged to income 975,000 880,000
Charge-offs, net (960,920) (344,409)
Allowance at end of period $ 2,050,612 $ 2,036,532
- --------------------------------------------------------------------------------------------------
</TABLE>
Bancorp's loan portfolio is concentrated in the Northern Virginia area.
At December 31, 1998 and 1997, the average yield on loans receivable was 9.01
percent and 9.37 percent, respectively. The amount of loans being serviced for
others was $8,102,931 and $137,208 at December 31, 1998 and 1997, respectively.
At December 31, 1998, there were 12 loans with balances totaling approximately
$236,101 that had payments ninety days or more past due on which interest was
still accruing. 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.
B-14
<PAGE>
Impaired loans were as follows:
December 31,
1998 1997
- -----------------------------------------------------------------------
Carrying value $ 1,982,938 $ 1,444,861
Allocation of general reserve 297,441 204,313
The average carrying balances and interest income earned on impaired
loans were as follows:
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Average carrying value $ 1,332,091 $ 1,373,997 $ 1,322,450
Income anticipated under
original loan agreements 192,224 165,400 220,461
Income recorded - 5,000 44,700
</TABLE>
4. Premises and Equipment:
Premises and equipment consists of the following:
December 31,
1998 1997
- -------------------------------------------------------------------------------
Land $ 568,500 $ 568,500
Building and improvements 980,848 951,028
Furniture and equipment 2,031,257 1,748,500
Leasehold improvements 1,034,361 1,008,393
- -------------------------------------------------------------------------------
4,614,966 4,276,421
Less: Accumulated depreciation
and amortization (2,244,255) (1,877,880)
- -------------------------------------------------------------------------------
Premises and equipment, net $2,370,711 $2,398,541
- -------------------------------------------------------------------------------
Depreciation and amortization expense aggregated $366,343, $327,340,
and $251,249 for the years ended December 31, 1998, 1997, and 1996,
respectively.
B-15
<PAGE>
5. Deposits:
Deposits consist of the following:
<TABLE>
<CAPTION>
December 31,
1998 1997
Weighted Weighted
Average Average
Interest Rate Amount Interest Rate Amount
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Demand accounts -% $ 21,371,737 -% $ 13,001,697
Interest checking accounts 0.81 19,473,014 1.16 16,570,989
Money market and savings accounts 2.76 27,410,132 3.46 23,443,684
Certificates of deposit 5.36 163,670,709 5.82 149,183,879
- ----------------------------------------------------------------------------------------------------
4.18% $231,925,592 4.79% $202,200,249
- ----------------------------------------------------------------------------------------------------
</TABLE>
As of December 31, 1998, certificates of deposit mature as follows:
1999 $ 138,360,136
2000 14,036,787
2001 6,359,301
2002 4,498,593
Thereafter 415,892
--------------
$ 163,670,709
==============
Deposits with balances greater than $100,000 totaled approximately
$45,947,283 and $33,541,040 at December 31, 1998 and 1997, respectively, of
which $24,060,064 and $17,962,855 represented certificates of deposit at
December 31, 1998 and 1997, respectively.
Interest expense by deposit category follows:
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest checking accounts $ 213,990 $ 185,000 $ 211,746
Money market and savings accounts 774,965 761,000 710,372
Certificates of deposit 8,945,596 7,763,000 6,511,216
- ------------------------------------------------------------------------------------------
$9,934,551 $8,709,000 $7,433,334
- ------------------------------------------------------------------------------------------
</TABLE>
Total cash paid for interest aggregated approximately $3,044,796,
$3,017,413, and $2,628,853 for the years ended December 31, 1998, 1997,and 1996,
respectively.
B-16
<PAGE>
6. Advances from Federal Home Loan Bank:
The Bancorp has a credit availability agreement with FHLB totaling
$45,000,000. The agreement does not have a maturity date and advances are made
at FHLB's discretion. At December 31, 1998 and 1997, advances from FHLB totaled
$3,500,000 and $4,000,000, respectively. The advances at December 31, 1998 were
made at variable interest rates. The weighted average rates of interest were
5.15 percent and 5.95 percent at December 31, 1998 and 1997, respectively.
Advances outstanding at December 31, 1998, mature on October 19, 1999, and are
secured by investment securities having a book value of $59,316,280.
7. Stockholders' Equity:
Each share of the Bancorp's preferred stock is convertible to 1.6
shares of common stock. The preferred stock has an annual dividend rate of six
percent. Dividends are payable quarterly and are cumulative.
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:
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income:
As reported $ 2,658,761 $ 2,206,270 $ 953,712
Pro forma 2,379,101 2,045,266 603,344
- -------------------------------------------------------------------------------------------
Basic earnings per share:
As reported 1.66 1.39 0.61
Pro forma 1.49 1.30 0.39
Diluted earnings per share:
As reported 1.55 1.33 0.59
Pro forma 1.39 1.23 0.37
- -------------------------------------------------------------------------------------------
Weighted-average assumptions:
Expected lives (years) 10 10 10
Risk-free interest rate (%) 4.50% 5.76% 6.06%
Expected volatility (%) 25.07% 23.39% 45.00%
Expected dividends (annual per share) 0.13% 0.13% -
- -------------------------------------------------------------------------------------------
</TABLE>
B-17
<PAGE>
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 option pricing model for each
grant made in 1998,1997 and 1996, using the key assumptions detailed above.
A summary of the status of the Bancorp's stock option plan as of
December 31, 1998, 1997 and 1996, respectively, and changes during the years
ended December 31, 1998, 1997 and 1996 is presented below. Average prices and
shares subject to options have been adjusted to reflect stock dividends.
<TABLE>
<CAPTION>
1998 1997 1996
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period 174,314 $ 11.97 177,327 $11.02 188,792 $ 9.94
Granted 51,000 22.47 31,500 15.79 66,029 13.43
Exercised (8,301) 11.05 (27,431) 10.24 (65,373) 8.18
Expired (3,000) 19.50 (7,082) 11.74 (12,121) 13.04
Outstanding at end of period 214,013 14.40 174,314 11.97 177,327 11.02
- --------------------------------------------------------------------------------------------------------------------
Options exercisable at end of period 165,013 142,814 112,127
- --------------------------------------------------------------------------------------------------------------------
Weighted average fair value of
options granted during the period $ 10.29 $ 7.74 $ 5.92
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
Remaining
Contractual
Exercise Options Options Life
Price Outstanding Exercisable (months)
-----------------------------------------------------
$ 7.49 7,260 7,260 18
8.83 29,039 29,039 66
9.30 6,453 6,453 6
9.61 16,133 16,133 52
11.98 29,039 29,039 79
12.73 9,902 9,902 91
13.64 37,687 37,687 85
13.75 3,000 3,000 97
16.00 26,500 26,500 103
21.25 35,000 - 109
24.00 1,000 - 117
25.25 3,000 - 113
26.00 10,000 - 113
-----------------------------------------------------
214,013 165,013
-----------------------------------------------------
B-18
<PAGE>
There were 18 option holders at December 31, 1998. Options exercised
during 1998 had exercise prices ranging from $8.99 to $16.00. 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. The closing price
of the Bancorp's stock at December 31, 1998 was $22.89 per share.
On May 28. 1996, the Bancorp acquired 9,374 shares of its own stock at
a market price of $16.00 in a stock swap transaction with the Chief Executive
Officer. The shares acquired were accepted as payment to redeem 22,026 options
to purchase common stock. 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.
8. 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, 1998, the most recent notification from the Federal
Reserve Bank categorized the Bancorp as adequately capitalized under the
regulatory framework for prompt corrective action. To be categorized as
adequately capitalized the Bancorp must maintain minimum total risk-based, Tier
I risk-based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The Bancorp's actual capital amounts and ratios are also presented in
the tables below. (All dollar amounts are in thousands.)
B-19
<PAGE>
<TABLE>
<CAPTION>
For To Be Well Capitalized
Captial Adequacy Under Prompt Corrective
Actual Purposes Action Provisions
- -----------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998
Total Capital $ 22,594 14.8 % $ 12,256 8.0 % $ 15,320 10.0 %
(to risk-weighted assets)
Tier I Capital 20,496 13.4 6,128 4.0 9,192 6.0
(to risk-weighted assets)
Tier I Capital 20,496 8.0 10,249 4.0 12,811 5.0
(to average assets)
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)
</TABLE>
During 1996, the Bancorp paid an additional $830,270 one-time SAIF
assessment required by legislation to recapitalize the SAIF.
B-20
<PAGE>
9. Parent Company Activity:
The Bancorp owns all of the outstanding shares of the Bank.
Accordingly, the balance sheets and statements of income for the Bancorp only,
are as follows:
<TABLE>
<CAPTION>
Balance Sheets
December 31,
1998 1997
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Investment in bank $ 20,923,860 $ 18,480,334
Other assets 1,843 65,668
- ---------------------------------------------------------------------------------------------
Total assets $ 20,925,703 $ 18,546,002
- ---------------------------------------------------------------------------------------------
Liabilities:
Other liabilities $ 2,963 $ 3,401
- ---------------------------------------------------------------------------------------------
Stockholders' equity:
Convertible preferred stock 136 156
Common stock 16,331 16,216
Capital in excess of par 15,648,527 15,556,882
Retained earnings 5,469,135 3,406,501
Accumulated other comprehensive income 259,698 33,933
Treasury stock (471,087) (471,087)
- ---------------------------------------------------------------------------------------------
Total stockholders' equity 20,922,740 18,542,601
- ---------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 20,925,703 $ 18,546,002
- ---------------------------------------------------------------------------------------------
Statements of Income
Year Ended Year Ended
December 31, December 31,
1998 1997
- ---------------------------------------------------------------------------------------------
Equity in earnings of Bank $ 2,658,761 $ 2,206,270
- ---------------------------------------------------------------------------------------------
</TABLE>
10. 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, 1998. 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
B-21
<PAGE>
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, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
($ in thousands) December 31, 1998 December 31, 1997
- ----------------------------------------------------------------------------------------------------------------
Carrying Amount Fair Value Carrying Amount Fair Value
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and amounts due from banks $ 5,375 $ 5,375 $ 4,559 $ 4,559
Available-for-sale securities 74,439 74,439 4,693 4,693
Held-to-maturity securities 38,151 37,794 80,469 80,796
Loans receivable, net of allowance 131,645 133,637 128,958 132,597
Loans held for sale 603 612 1,414 1,441
Financial liabilities:
Deposits:
Checking accounts 40,845 37,398 29,573 26,710
Money market and savings accounts 27,410 26,897 23,444 22,859
Certificates of deposit 163,671 164,559 149,184 149,563
</TABLE>
The following methods and assumptions were used to estimate the fair value
amounts at December 31, 1998 and 1997:
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.
B-22
<PAGE>
Deposits
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. 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.
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.
11. 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 $37,700, $24,000, and $20,000 for the
years ended December 31, 1998, 1997, and 1996, respectively.
12. Provision for Income Taxes:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Year Ended
December 31,
1998 1997 1996
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current provision:
Federal $ 861,977 $ 1,231,183 $ 483,449
State - - -
- ----------------------------------------------------------------------------------------------
861,977 1,231,183 483,449
- ----------------------------------------------------------------------------------------------
Deferred (benefit) provision:
Federal 222,323 (209,383) (13,849)
State - - -
- ----------------------------------------------------------------------------------------------
222,323 (209,383) (13,849)
- ----------------------------------------------------------------------------------------------
$ 1,084,300 $ 1,021,800 $ 469,600
- ----------------------------------------------------------------------------------------------
</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
B-23
<PAGE>
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, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Provision for losses on loans and real estate owned $ 269,986 $ 602,857
Valuation of loans and securities 134,183 17,328
Depreciation 131,726 111,006
Other 4,947 4,947
- --------------------------------------------------------------------------------------------
Gross deferred tax assets 540,842 736,138
- --------------------------------------------------------------------------------------------
Liabilities:
Deferred loan fees 213,565 186,538
FHLB dividend 35,771 35,771
- --------------------------------------------------------------------------------------------
Gross deferred tax liabilities 249,336 222,309
- --------------------------------------------------------------------------------------------
Net deferred tax assets $ 291,506 $ 513,829
- --------------------------------------------------------------------------------------------
</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
December 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pretax income 34% 34% 34%
Adjustment for prior year accrual (3%) -- --
Dividends received deduction (2%) (2%) (1%)
- ---------------------------------------------------------------------------------------------------
Effective tax rate 29% 32% 33%
- ---------------------------------------------------------------------------------------------------
</TABLE>
Cash paid for income taxes was $1,175,000, $725,000, and $919,000 for
the years ended December 31, 1998, 1997, and 1996, respectively.
13. Commitments:
The Bank leases its corporate headquarters and branch facilities under
operating lease agreements expiring in fiscal years through 2002. As of December
31, 1998, future minimum lease payments required under these arrangements,
assuming no extension options are exercised, are as follows:
B-24
<PAGE>
Years Ending Minimum Lease
December 31, Payments
------------------ -------------------
1999 $ 527,047
2000 540,265
2001 493,200
2002 372,912
2003 312,326
Thereafter 1,506,520
Rent expense aggregated $485,792, $558,704, and $504,647 for the years
ended December 31, 1998, 1997, and 1996, respectively.
Outstanding loan commitments amounted to $11,842,340 (of which
$3,887,840 had fixed interest rates) and $5,393,550 (of which $413,550 had fixed
interest rates) at December 31, 1998 and 1997, respectively. The Bank had
commitments from investors of $1,171,500 and $1,825,395 to purchase loans from
the Bank at December 31, 1998 and 1997, respectively.
At December 31, 1998, the Bank had commercial letters of credit
outstanding in the amount of approximately $537,078.
At December 31, 1998, the Bank had unfunded lines of credit of
$9,212,327 and undisbursed construction loan funds of $6,491,231.
14. Earnings Per Share
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number of shares
of diluted potential common stock. Potential dilutive common stock has no effect
on income available to common stockholders. Earnings per share amounts for prior
periods have been restated to give effect to the application of SFAS 128 which
was adopted in 1997.
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- -------------------------- --------------------------
Per Per Per
Share Share Share
Shares Amount Shares Amount Shares Amount
------------- ----------- ------------ ----------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS 1,597,815 $ 1.66 1,577,243 $ 1.39 1,544,338 $ 0.61
=========== =========== ===========
Effect of dilutive
Securities:
Stock Options 92,343 55,240 50,960
Convertible Preferred Stock 21,975 25,223 25,223
============= =========== ============ =========== ============ ===========
Diluted EPS 1,712,133 $ 1.55 1,657,706 $ 1.33 1,620,521 $ 0.59
============= =========== ============ =========== ============ ===========
</TABLE>
B-25
<PAGE>
15. Quarterly Financial Information (Unaudited - in thousands, except per share
data):
<TABLE>
<CAPTION>
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
Dec. 31, 1998 Sep. 30, 1998 Jun. 30, 1998 Mar. 31, 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net interest income $ 2,243 $ 2,085 $ 2,120 $ 2,078
Provision for loan losses 300 225 225 225
Total other income 752 667 438 489
Total other expense 1,687 1,571 1,487 1,411
Net income 697 658 674 630
Earnings per share:
Basic 0.43 0.41 0.42 0.39
Diluted 0.41 0.38 0.39 0.37
Weighted average shares
outstanding:
Basic 1,603,220 1,602,066 1,593,260 1,592,548
Diluted 1,707,793 1,717,428 1,720,913 1,709,010
- -------------------------------------------------------------------------------------------------------------
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
Dec. 31, 1997 Sep. 30, 1997 Jun. 30, 1997 Mar. 31, 1997
- -------------------------------------------------------------------------------------------------------------
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>
B-26
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31,
1999 December 31,
(Unaudited) 1998
-------------------- -------------------
<S> <C> <C>
Assets
Cash and due from banks $ 6,306,346 $ 5,374,945
Overnight earning deposits 1,050,376 928,435
Investment securities, available-for-sale 83,676,421 74,438,682
Investment securities, held-to-maturity 33,702,604 38,151,121
Loans held for sale 990,950 602,500
Loans receivable, net 136,352,860 131,645,482
Federal Home Loan Bank stock, at cost 1,253,700 1,082,500
Premises and equipment, net 2,870,329 2,370,711
Other assets 3,540,589 4,248,673
-------------------- -------------------
Total assets $ 269,744,175 $ 258,843,049
==================== ===================
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 242,689,282 $ 231,925,592
Advances from Federal Home Loan Bank 3,000,000 3,500,000
Other liabilities 2,419,688 2,494,717
-------------------- -------------------
Total liabilities 248,108,970 237,920,309
-------------------- -------------------
Commitments
Stockholders' equity:
Preferred stock 136 136
Common stock 16,331 16,331
Capital in excess of par value 15,648,527 15,648,527
Retained earnings 5,987,341 5,469,135
Accumulated other comprehensive income 453,957 259,698
Treasury stock, at cost (471,087) (471,087)
-------------------- -------------------
Total stockholders' equity 21,635,205 20,922,740
-------------------- -------------------
Total liabilities and stockholders' equity $ 269,744,175 $ 258,843,049
==================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-27
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
-------------------- --------------------
<S> <C> <C>
Interest income:
Loans $ 3,108,715 $ 3,106,302
Investment securities 1,804,933 1,456,620
-------------------- --------------------
Total interest income 4,913,648 4,562,922
-------------------- --------------------
Interest expense:
Deposits 2,436,743 2,445,688
Borrowings 102,833 39,567
-------------------- --------------------
Total interest expense 2,539,576 2,485,255
-------------------- --------------------
Net interest income 2,374,072 2,077,667
Provision for loan losses 275,000 225,000
-------------------- --------------------
Net interest income after provision for loan losses 2,099,072 1,852,667
-------------------- --------------------
Other income:
Gain on sale of loans 272,577 137,963
Fee income 403,016 343,928
Other 10,809 7,600
-------------------- --------------------
Total other income 686,402 489,491
-------------------- --------------------
Other expense:
Employee compensation and benefits 896,442 657,285
Premises and equipment 299,484 249,001
Data processing expense 182,628 178,260
Deposit insurance assessments 34,056 30,065
Advertising 75,285 48,089
Other 302,556 248,121
-------------------- --------------------
Total other expense 1,790,451 1,410,821
-------------------- --------------------
Income before income taxes 995,023 931,337
Provision for income taxes 297,500 301,500
-------------------- --------------------
Net income $ 697,523 $ 629,837
==================== ====================
Earnings per common share:
Basic $ 0.43 $ 0.39
Diluted 0.41 0.37
Weighted average shares outstanding:
Basic 1,603,220 1,592,548
Diluted 1,685,143 1,709,010
</TABLE>
The accompanying notes are an integral part of these financial statements
B-28
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
----------------------- ------------------------
<S> <C> <C>
Net income $ 697,523 $ 629,837
Other comprehensive income, net of tax:
Unrealized holding loss on securities (55,409) (18,582)
Unrealized gain on cash flow hedges 249,668 -
----------------------- ------------------------
Other comprehensive income 194,259 (18,582)
Comprehensive income $ 891,782 $ 611,255
======================= ========================
</TABLE>
The accompanying notes are an integral part of these financial statements
B-29
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
-------------------------- ---------------------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 697,523 $ 629,837
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 264,036 198,684
Provision for loan losses 275,000 225,000
Gain on sale of loans (272,577) (137,963)
Amortization of deferred loan fees (148,859) (181,935)
Net change in loans held for sale (115,873) 248,908
(Increase) decrease in other assets 1,011,538 (189,622)
Increase (decrease) in other liabilities (75,029) 475,622
-------------------------- ---------------------------
Net cash provided by operating activities 1,635,759 1,268,531
-------------------------- ---------------------------
Cash flows from investing activities:
(Increase) decrease in loans receivable (4,866,213) 714,777
Purchase of investment securities, available-for-sale (20,072,629) (13,206,693)
Paydowns of investment securities 15,040,602 6,547,487
Increase in overnight earning deposits, net (121,941) (736,322)
Increase in premises and equipment, net (597,350) (38,948)
Increase in Federal Home Loan Bank stock (171,200) (152,000)
-------------------------- ---------------------------
Net cash used in investing activities (10,788,731) (6,871,699)
-------------------------- ---------------------------
Cash flows from financing activities:
Net increase in deposits 10,763,690 9,651,462
Decrease in advances from FHLB (500,000) (4,000,000)
Proceeds from stock options exercised - 15,031
Dividends on preferred and common stock (179,317) (130,823)
-------------------------- ---------------------------
Net cash provided by financing activities 10,084,373 5,535,670
-------------------------- ---------------------------
Net increase (decrease) in cash and due from banks 931,401 (67,498)
Cash and due from banks, beginning of period 5,374,945 4,559,266
-------------------------- ---------------------------
Cash and due from banks, end of period $ 6,306,346 $ 4,491,768
========================== ===========================
</TABLE>
The accompanying notes are an integral part of these statements
B-30
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q, and, therefore, do
not include all information or footnotes necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
generally accepted accounting principles. However, all adjustments which are, in
the opinion of management, necessary for a fair presentation have been included.
All adjustments are of a normal recurring nature. The results of operations for
the three-month period ended March 31, 1999 are not necessarily indicative of
the results of the full year. These consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
included in Southern Financial Bancorp, Inc.'s Annual Report for the year ended
December 31, 1998.
NOTE 2 - HEDGE ACCOUNTING
During the first quarter of 1999, the Bancorp entered into four
interest rate swap agreements that are accounted for as cash flow hedges. In
accordance with SFAS 133, the Bancorp records the change in fair value of the
swaps in comprehensive income. To the extent that the hedge is not completely
effective, the ineffective portion is charged or credited to interest expense.
The amounts recorded in comprehensive income subsequently are reclassified into
interest expense as a yield adjustment in the same period in which the related
interest on the certificates of deposit (CD's) affects earnings.
Each of the four swap agreements has a notional amount of $5 million,
and the Bancorp agreed to pay a rate fixed for the period of the swap and
receive 3 month LIBOR. Three of the swaps are for a period of five years and
have fixed rates ranging from 5.23% to 5.29%; the fourth swap is for a period of
ten years and has a fixed rate of 5.45%. The purpose of all four of these swaps
was to hedge the variability of cash flows resulting from changes in interest
rates in the Bancorp's floating rate liabilities, specifically the Bancorp's
CD's in amounts greater than $90,000, which have maturities of one month to six
months. The Bancorp performed a regression analysis using monthly averages of
both 3 month LIBOR and the Bancorp's hedged CD's and determined that there was a
highly effective correlation. The Bancorp designated CD's that were outstanding
on the inception dates of the swaps as being hedged by the swaps, and as the
hedged CD's mature, the Bancorp has identified other individual CD's to replace
them. During the year ending December 31, 1999, approximately $61,900 of gains
in accumulated other comprehensive income related to the interest rate swaps are
expected to be reclassified into interest expense as a yield adjustment of the
hedged CD's.
B-31
<PAGE>
NOTE 3 - INVESTMENT SECURITIES
The following table sets forth the Bancorp's investment securities
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
---------------- ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Available-for-sale securities:
FHLMC preferred stock $ - $ - $ 3,807,585 $ 3,888,524
FHLMC MBS 9,716,786 9,739,266 11,996,172 12,005,667
GNMA MBS 3,405,838 3,372,653 3,825,601 3,771,448
FNMA MBS 25,570,688 25,806,657 29,671,448 29,813,650
Collaterized mortgage obligations 19,352,320 19,346,575 1,526,527 1,529,095
Commercial MBS 20,137,415 20,115,640 18,043,819 18,246,250
Obligations of counties and municipalities 3,241,278 3,331,000 3,234,489 3,220,498
Corporate obligations 989,797 969,320 989,319 992,300
U.S. Government agency obligations 951,598 995,310 949,066 971,250
---------------- ---------------- --------------- ----------------
$ 83,365,720 $ 83,676,421 $ 74,044,026 $ 74,438,682
================ ================ =============== ================
Held-to-maturity securities:
FHLMC MBS $ 3,662,594 $ 3,673,172 $ 4,091,316 $ 4,070,132
GNMA MBS 21,798,212 21,734,954 24,305,052 24,004,669
FNMA MBS 6,199,807 6,218,010 6,779,894 6,731,670
Collateralized mortgage obligations 82,635 86,556 1,015,264 1,013,565
Obligations of counties and municipalities 1,959,356 1,986,408 1,959,595 1,974,308
---------------- ---------------- --------------- ----------------
$ 3,702,604 $ 3,699,100 $ 38,151,121 $ 37,794,344
================ ================ =============== ================
</TABLE>
B-32
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------------- ----------------
<S> <C> <C>
Mortgage:
Residential $ 26,277,400 $ 26,046,289
Nonresidential 67,763,647 64,890,406
Construction:
Residential 5,732,802 5,184,844
Nonresidential 13,613,438 11,213,848
Non-Mortgage:
Business 23,610,847 24,773,003
Consumer 2,401,071 2,424,602
---------------- ----------------
Total loans receivable 139,399,205 134,532,992
Less:
Deferred loan fees, net 899,225 836,898
Allowance for loan losses 2,147,120 2,050,612
---------------- ----------------
Loans receivable, net $ 136,352,860 $ 131,645,482
================ ================
</TABLE>
The following sets forth information regarding the allowance for loan
losses:
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
3/31/99 3/31/98
---------------- ----------------
<S> <C> <C>
Allowance at beginning of period $ 2,050,612 $ 2,036,532
Provision for losses charged to income 275,000 225,000
Charge-offs (380,368) (111,045)
Recoveries 201,876 346
---------------- ----------------
Allowance at end of period $ 2,147,120 $ 2,150,833
================ ================
</TABLE>
B-33
<PAGE>
NOTE 5 - EARNINGS PER SHARE
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number of shares
of dilutive common stock equivalents.
<TABLE>
<CAPTION>
For the three months ended
March 1999 March 1998
---------------------------------------- ----------------------------------------
Per Per
Share Share
Shares Amount Shares Amount
------------------- ----------------- ------------------- ----------------
<S> <C> <C> <C> <C>
Basic EPS 1,603,220 $ 0.43 1,592,548 $ 0.39
================= ================
Effect of dilutive
Securities:
Stock Options 59,948 91,239
Convertible Preferred Stock 21,975 25,223
------------------- -------------------
Diluted EPS 1,685,143 $ 0.41 1,709,010 $ 0.37
=================== ================= =================== ================
</TABLE>
NOTE 6 - OTHER SIGNIFICANT MATTERS
The Bancorp signed a definitive Merger Agreement providing for a merger
with The Horizon Bank of Virginia. The Bancorp will issue .63 shares of its
common stock in exchange for each share of common stock of The Horizon Bank of
Virginia. Subject to certain conditions including receipt of regulatory approval
and approval of the shareholders of the Bancorp and The Horizon Bank of
Virginia, closing of the merger is anticipated to occur in the third quarter of
1999. The merger will be accounted for under the pooling method.
B-34
<PAGE>
Appendix C
[TUCKER ANTHONY LETTERHEAD]
July 28, 1999
Board of Directors
Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, VA 20186
Members of the Board:
You have requested our opinion as to the fairness, from a financial point of
view, to the holders of Southern Financial Bancorp, Inc. (the "Company") common
stock (the "Company Common Stock"), par value $0.01, of the consideration to be
paid by the Company to the holders of The Horizon Bank of Virginia ("Horizon" or
the "Seller") common stock (the "Seller Common Stock"), par value $2.50 per
share, pursuant to the Agreement and Plan of Reorganization (the "Agreement") by
and between the Company and Seller. At the Effective Time, as defined in the
Agreement, each share of Seller Common Stock held by Horizon's shareholders
shall be converted into the right to receive 0.63 shares of Company Common
Stock.
Tucker Anthony Clear Gull ("Tucker Anthony") as part of its investment banking
business is regularly engaged in the valuation of businesses and their
securities in connection with mergers and acquisitions, negotiated
underwritings, private placements and valuations for corporate and other
purposes. In the ordinary course of our business, we may actively trade the
securities of the Company for our own account and for the accounts of customers
and, accordingly, may at any time hold a long or short position in such
securities. Tucker Anthony previously provided financial advisory services to
the Company in 1998 and received a fee for these services.
In arriving at our opinion, we have among other things:
(i) Reviewed the draft Agreement and Plan of Reorganization dated March 29,
1999;
(ii) Reviewed certain historical financial and other information concerning
the Company for the five fiscal years ended December 31, 1998, and for
the quarter ended March 31, 1999;
(iii) Reviewed certain historical financial and other information concerning
Horizon for the five fiscal years ended December 31, 1998, and for the
quarter ended March 31, 1999;
(iv) Held discussions with the senior management of the Company and Horizon
with respect to their past and current financial performance, financial
condition and future prospects;
(v) Reviewed certain internal financial data, projections and other
information of the Company and Horizon, including financial projections
approved by Company management;
(vi) Analyzed certain publicly available information of other financial
institutions that we deemed comparable or otherwise relevant to our
inquiry, and compared the Company and Horizon from a financial point of
view with certain of these institutions;
(vii) Compared the consideration to be paid by the Company pursuant to the
Agreement with the consideration paid in other acquisitions of
financial institutions that we deemed comparable or otherwise relevant
to our inquiry;
C-1
<PAGE>
(viii) Reviewed publicly available earnings estimates, historical trading
activity and ownership data of the Company's Common Stock and
considered the prospects for dividends and price movement; and
(ix) Considered such other financial studies, analyses and investigations
and reviewed such other information as we deemed appropriate to enable
us to render our opinion. In our review, we have also taken into
account an assessment of general economic, market and financial
conditions and certain industry trends and related matters.
In our review and analysis and in arriving at our opinion we have assumed and
relied upon the accuracy and completeness of all the financial information
publicly available or provided to us by the Company and Horizon and have not
attempted to verify any of such information. We have assumed that (i) the
financial projections of the Company and Horizon provided to us with respect to
the results of operations likely to be achieved by each company have been
prepared on a basis reflecting the best currently available estimates and
judgments of the Company's and Horizon's management as to future financial
performance and results and (ii) that such forecasts and estimates will be
realized in the amounts and in the time periods currently estimated. We have
also assumed, without independent verification, that the current and projected
aggregate reserves for possible loan losses for the Company and Horizon are
adequate to cover such losses. We did not make or obtain any independent
evaluations or appraisals of any assets or liabilities of the Company, Horizon
or any of their respective subsidiaries nor did we verify any of the Company's
or Horizon's books or records or review any individual loan credit files.
Our opinion is necessarily based upon market, economic and other conditions as
they exist and can be evaluated as of the date of this letter.
This opinion is being furnished for the use and benefit of the Board of
Directors of the Company and is not a recommendation to shareholders. The
Company and Tucker Anthony have agreed that they do not believe any person other
than the Board has the legal right to rely on the opinion and, absent any
controlling precedent, would resist any assertion otherwise.
Based upon and subject to the foregoing, it is our opinion that as of the date
hereof the consideration to be paid by the Company pursuant to the Agreement is
fair to the Company's stockholders from a financial point of view.
Very truly yours,
/s/ Tucker Anthony Cleary Gull
C-2
<PAGE>
Appendix D
THE HORIZON BANK OF VIRGINIA
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report....................................................................................D-2
Financial Statements
Balance Sheets as of December 31, 1998 and 1997............................................................D-3
Statements of Income for the years ended December 31, 1998, 1997 and 1996..................................D-4
Statements of Comprehensive Income for the years ended December 31, 1998, 1997 and 1996....................D-5
Statements of Changes in Stockholders' Equity for the years ended December 31, 1998,
1997 and 1996..............................................................................................D-6
Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996........................D-7 - D-8
Notes to Financial Statements............................................................................D-9 - D-23
Interim Financial Statements
Balance Sheets as of March 31, 1999 and December 31, 1998.................................................D-24
Statements of Operations for the three months ended March 31, 1999 and 1998...............................D-25
Statements of Comprehensive Income for the three months ended March 31, 1999 and 1998.....................D-26
Statements of Changes in Stockholders' Equity for the three months ended March 31, 1999
and year ended December 31, 1998..........................................................................D-27
Statements of Cash Flows for the three months ended March 31, 1999 and 1998...............................D-28
Notes to Interim Financial Statements (Unaudited).......................................................D-29 - D-31
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders
The Horizon Bank of Virginia
Merrifield, Virginia
We have audited the accompanying balance sheets of The Horizon Bank of
Virginia as of December 31, 1998 and 1997, and the related statements of
operations, other comprehensive income, changes in stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Corporation'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 the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of The Horizon Bank of
Virginia as of December 31, 1998 and 1997, and the results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles.
/s/ Thompson, Greenspon & Co., P.C.
Fairfax, Virginia
January 29, 1999
D-2
<PAGE>
The Horizon Bank of Virginia
Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
Assets December 31, 1998 December 31, 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $ 5,445,820 $ 6,467,421
Overnight earning deposits 30,846,000 20,308,000
Investment securities, available-for-sale 9,636,855 12,017,486
Investment securities, held to maturity (estimated market
value of $19,553,348 and $8,104,781, respectively) 19,531,871 8,098,909
Loans receivable, net 74,709,594 75,602,129
Premises and equipment, net 3,152,593 3,220,127
Other assets 2,088,334 1,704,091
- ---------------------------------------------------------------------------------------------------------------
Total assets $145,411,067 $127,418,163
===============================================================================================================
Liabilities and Stockholders' Equity
- ---------------------------------------------------------------------------------------------------------------
Liabilities:
Deposits $134,979,742 $118,164,235
Other liabilities 728,198 288,464
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 135,707,940 118,452,699
- ---------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock, $2.50 par value, 2,000,000 authorized,
1,639,729 and 1,557,778 shares issued and
outstanding, respectively 4,099,325 3,894,445
Capital in excess of par value 4,223,773 3,564,319
Retained earnings 1,352,984 1,503,105
Accumulated other comprehensive income 27,045 3,595
- ---------------------------------------------------------------------------------------------------------------
Total stockholders' equity 9,703,127 8,965,464
- ---------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $145,411,067 $127,418,163
===============================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-3
<PAGE>
The Horizon Bank of Virginia
Statements of Income
December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans $ 7,189,034 $ 7,021,964 $ 6,129,444
Investment securities 1,937,583 1,509,402 1,551,055
- ---------------------------------------------------------------------------------------------------------------
Total interest income 9,126,617 8,531,366 7,680,499
- ---------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 4,015,542 3,583,289 3,566,500
- ---------------------------------------------------------------------------------------------------------------
Total interest expense 4,015,542 3,583,289 3,566,500
- ---------------------------------------------------------------------------------------------------------------
Net interest income 5,111,075 4,948,077 4,113,999
Provision for loan losses 325,801 385,314 211,152
- ---------------------------------------------------------------------------------------------------------------
Net interest income after provision for
loan losses 4,785,274 4,562,763 3,902,847
- ---------------------------------------------------------------------------------------------------------------
Other income:
Fee income 785,631 518,167 392,358
Gain on sale of investment securities - 1,464 7,354
Other 12,000 9,828 6,905
- ---------------------------------------------------------------------------------------------------------------
Total other income 797,631 529,459 406,617
- ---------------------------------------------------------------------------------------------------------------
Other expense:
Employee compensation and benefits 1,936,704 2,014,174 1,858,954
Premises and equipment 938,142 917,786 738,029
Advertising 42,282 18,544 51,964
Other 1,614,360 1,229,924 1,043,510
- ---------------------------------------------------------------------------------------------------------------
Total other expense 4,531,488 4,180,428 3,692,457
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes 1,051,417 911,794 617,007
Provision for income taxes 357,775 310,000 210,730
- ---------------------------------------------------------------------------------------------------------------
Net income $ 693,642 $ 601,794 $ 406,277
===============================================================================================================
Earnings per common share:
Basic* $ .43 $ .39 $ .26
Diluted* .42 .38 .26
Weighted average shares outstanding:
Basic* 1,620,817 1,557,744 1,551,890
Diluted* 1,633,548 1,571,446 1,564,956
- ---------------------------------------------------------------------------------------------------------------
*1996 amounts have been restated to conform with SFAS 128, "Earnings per Share."
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-4
<PAGE>
The Horizon Bank of Virginia
Statements of Comprehensive Income
December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $693,642 $601,794 $406,277
Other comprehensive income, net of tax:
Unrealized gain (loss) arising during period 23,450 14,201 (48,021)
- ---------------------------------------------------------------------------------------------------------------
Other comprehensive income 23,450 14,201 (48,021)
Comprehensive income $717,092 $615,995 $358,256
===============================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-5
<PAGE>
The Horizon Bank of Virginia
Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Net Unrealized Gain
Number Retained (Loss) on Securities
of Shares Par Value Surplus Earnings Available for Sales Totals
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 691,600 $3,458,000 $3,458,000 $ 843,954 $ 37,415 $7,797,369
Options exercised 17,850 87,125 87,125 - - 174,250
Stock dividend of 10 percent 69,784 348,920 - (348,920) - -
Stock split - 2 for 1 778,384 - - - - -
Options granted - - 18,794 - - 18,794
Change in other comprehensive
income - - - - (48,021) (48,021)
Net income - - - 406,277 - 406,277
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 1,557,618 3,894,045 3,563,919 901,311 (10,606) 8,348,669
Options exercised 160 400 400 - - 800
Change in other comprehensive
income - - - - 14,201 14,201
Net income - - - 601,794 - 601,794
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 1,557,778 3,894,445 3,564,319 1,503,105 3,595 8,965,464
Options excercised 4,114 10,285 10,285 - - 20,570
Stock dividend of 5 percent 77,837 194,595 649,169 (843,764) - -
Change in other comprehensive
income - - - - 23,450 23,450
Net income - - - 693,643 - 693,643
- ---------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 1,639,729 $4,099,325 $4,223,773 $1,352,984 $ 27,045 $9,703,127
=================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-6
<PAGE>
The Horizon Bank of Virginia
Statements of Cash Flows
For the Years Ended December 31, 1998, 1997, and 1996
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
- ------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income $ 693,642 $ 601,794 $ 406,277
Noncash items included in net income
Depreciation and amortization 291,847 271,477 220,242
Provision for loan losses 325,801 385,314 211,152
Provision for losses on other
real estate owned 120,000 64,513 61,000
Net amortization of premiums on
securities (11,840) (7,605) (5,852)
Stock option compensation - - 18,794
(Increase) Decrease in
Accrued interest receivable (42,861) 41,139 7,507
Other assets (490,930) 279,143` (87,081)
Increase (Decrease) in
Accrued interest payable (2,259) (2,444) (9,535)
Other accrued expenses 441,994 (28,422) 56,530
- ------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating
Activities 1,325,394 1,604,909 879,034
- ------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Net Federal funds sold (10,538,000) (5,423,000) (1,682,000)
Acquisition of bank premises and
equipment (194,765) (360,684) (440,008)
Loans collected (made), net 566,734 (6,026,430) (9,259,523)
Proceeds from the maturities of
investment securities 5,700,000 3,813,750 6,611,031
Purchase of securities available for sale (4,300,000) (8,563,636) (5,642,064)
Purchase of investment securities (17,117,041) (1,811,206) (6,993,917)
Proceeds from the maturities of
securities available for sale 6,700,000 5,924,242 8,285,939
Other real estate owned
Proceeds from sale - 527,376 -
Acquisition of intangible assets - (171,195) (40,500)
Capitalized expenses - - (2,800)
Additions to deposits - - (203,258)
- ------------------------------------------------------------------------------------------------------------
Net Cash Used by Investing
Activities (19,183,072) (12,090,783) (9,367,100)
- ------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-7
<PAGE>
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Financing Activities
Proceeds from sale of common stock 20,570 800 174,747
Net increase in deposits 16,815,507 7,471,842 13,614,467
- ------------------------------------------------------------------------------------------------------------
Net Cash Provided by
Financing Activities 16,836,077 7,472,642 13,789,214
- ------------------------------------------------------------------------------------------------------------
Net Decrease (Increase) in Cash and
Due from Banks (1,021,601) (3,013,232) 5,301,148
Cash and Due from Banks, beginning of year 6,467,421 9,480,653 4,179,505
- ------------------------------------------------------------------------------------------------------------
Cash and Due from Banks, end of year $ 5,445,820 $ 6,467,421 $ 9,480,653
============================================================================================================
Noncash
Unrealized gain on securities available
for sale, net $ 23,450 $ 14,201 $ (48,021)
============================================================================================================
Stock Dividend $ 843,764 $ - $ 348,920
============================================================================================================
</TABLE>
D-8
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Bank follows generally accepted accounting principles and reporting
practices applicable to the banking industry. Significant accounting
policies are summarized below.
Nature of Operations
The Horizon Bank of Virginia is a state member bank of the Federal
Reserve and provides a variety of banking services to its customers. As
a state bank, the Bank is subject to regulations of the Virginia State
Banking Commission and the Federal Reserve. The Bank serves primarily
the Northern Virginia area with services provided at four branch
offices and a mortgage department.
Use of Estimates
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 revenue
and expenses during the reporting period. Actual results could vary
from the estimates that were used.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand and amounts due from banks.
Cash paid for interest amounted to $4,017,801 in 1998, $3,585,733 in
1997, and $3,516,036 in 1996.
Income taxes paid amounted to $287,000 in 1998, $279,040 in 1997, and
$136,717 in 1996.
The Bank is required by regulatory authorities to maintain a specific
portion of its assets in the form of legal cash reserves, computed by
applying prescribed percentages to its various types of deposits. When
the Bank's vault cash reserves and balances maintained at the Federal
Reserve Bank are in excess of that required, it may lend the excess to
other banks on a daily basis. The average balance required to be
maintained at the Federal Reserve Bank for the year ended December 31,
1998 was approximately $1,211,000.
The Bank's available unsecured Federal fund lines of credit with
correspondent banks is based on bank capital. At December 31, 1998, the
lines were approximately $6,330,000. Continued availability of the
lines are reviewed annually by the correspondent bank and the Federal
Reserve. The rate of interest charged fluctuates daily in response to
market conditions. There were no borrowings on these lines at December
31, 1998 and 1997.
D-9
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Investment Securities
Securities are classified as investment securities to be held to
maturity when management has the intent and the Bank has the ability at
the time of purchase to hold them until maturity or on a long-term
basis. These securities are carried at cost adjusted for amortization
of premium and accretion of discount, computed by the straight-line
method over their contractual lives. If the interest method of
accounting for amortization of premiums and accretion of discounts was
used, it would not have a material effect on the financial statements.
Gains and losses on the sale of such securities are determined by the
specific identification method.
Securities to be held for indefinite periods of time and not intended
to be held to maturity or on a long-term basis are classified as
available for sale and accounted for at fair value on an aggregate
basis. These include securities used as part of the Bank's
asset/liability management strategy and may be sold in response to
changes in interest rates, prepayment risk, the need or desire to
increase capital, to satisfy regulatory requirements and other similar
factors. Unrealized gains and losses of securities available for sale
are excluded from earnings and included in stockholders' equity, net of
related income taxes. Realized gains and losses of securities available
for sale are included in net securities gains (losses) based on the
specific identification method.
Loans and Loan Fees
Loans are stated at the principal amount outstanding, net of deferred
loan fees. Interest on loans is generally computed using the simple
interest method. Loan fees and related direct loan origination costs
are deferred and recognized as an adjustment of yield over the life of
the loan or currently upon the sale or repayment of the loans.
Interest on all categories of loans is accrued based upon the principal
amounts outstanding. The accrual of interest income is discontinued on
loans which are past due ninety or more days as to principal or
interest payments, except for certain guaranteed loans and other
limited exceptions. When loans are placed on nonaccrual status,
interest accrued in the current year is charged against interest
income, and interest accrued in prior years is charged to the allowance
for loan losses. Loans may be reinstated to accrual status when all
payments are brought current, and, in the opinion of management,
collection of the remaining balance can reasonably be expected. The
classification of a loan as nonaccrual is not necessarily indicative of
a potential loan loss.
The Bank originates mortgage loans for both sale and for its own
portfolio in order to insure the availability of a broad range of
mortgage products for its customers. The Bank sells originated
mortgages primarily on the secondary market. The Bank retains
negligible risk of principal loss for mortgages sold.
Allowance for Loan Losses
The Bank grants loans to customers located in Northern Virginia.
Although the Bank has a diversified portfolio, a substantial number of
loans are unsecured or collateralized by real estate.
D-10
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for Loan Losses (continued)
The allowance for loan losses is a current estimate of the losses
inherent in the loan portfolio. The allowance is maintained at a level
considered adequate by management to absorb inherent losses based upon
management's evaluation of the portfolio.
The allowance is increased by provisions for loan losses charged to
operating expense and reduced by net chargeoffs. The provisions are
based on management's estimate of net realizable value or fair value of
the collateral, as applicable, considering the current and future
operating or sales conditions. These estimates are susceptible to
changes that could result in a material adjustment to future results of
operations.
Bank Premises and Equipment
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. Leasehold improvements are amortized
over the asset life using the straight-line method. Furniture and
equipment are depreciated over estimated useful lives of five and seven
years using the straight-line method. The bank headquarters building is
depreciated over its estimated useful life of approximately 31.5 years
using the straight-line method.
Other Real Estate Owned
Other real estate owned includes properties acquired through
foreclosure or other proceedings in satisfaction of indebtedness. At
the date of acquisition, such property is recorded at the lower of the
recorded investment in the related receivable or net realizable value.
Write-downs at the date of acquisition are charged to the allowance for
loans losses. Subsequent declines in market value, operating expenses
and gains or losses on disposition of other real estate are reflected
in other expenses.
Stockholders' Equity
The Bank was capitalized through a private offering circular dated
October 2, 1989, for $6,421,000. Capital funds were allocated equally
between capital stock and surplus. The Bank has 2,000,000, $2.50 par
value, common shares authorized. There were 1,639,729 outstanding in
1998, and 1,557,778 in 1997.
In January, 1998, the Bank declared a 5 percent stock dividend for
stockholders of record on February 15, 1998 and payable on March 15,
1998.
State banking laws and regulatory compliance restrict the availability
of earnings for the payment of dividends.
The Bank is also required to maintain minimum amounts of capital to
total "risk weighted" assets, as defined by the banking regulators. At
December 31, 1998, the Bank is required to have minimum Tier 1 and
Total capital ratios of 4.00 percent and 8.00 percent, respectively.
The Bank's actual ratios at that date were 12.21 percent and 13.46
percent, respectively.
D-11
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income Taxes
The Bank utilizes an asset and liability approach to accounting for
income taxes. The objective is to recognize the amount of income taxes
payable or refundable in the current year based on the Bank's income
tax return and the deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized in the
Bank's financial statements or tax returns. The asset and liability
method accounts for deferred income taxes by applying enacted statutory
rates to temporary differences, the difference between financial
statement amounts and tax bases of assets and liabilities. Deferred
income tax liabilities or assets are adjusted to reflect changes in tax
laws or rates in the year of enactment.
The Bank pays state franchise tax in lieu of state income taxes.
Income per Common Share
The Bank has adopted Statement of Financial Accounting Standards
("SFAS") No. 128 which establishes standards for computing and
presenting earnings per share (EPS) for entities with publicly held
common stock. The standard requires presentation of two categories of
earnings per share, basic EPS and diluted EPS. Basic EPS excludes
dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares
outstanding for the year. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the Bank.
The financial statements provide information that considers the effects
of the 10 percent stock dividend.
<TABLE>
<CAPTION>
1998 1997 1997
---------------------------- ---------------------------- ----------------------------
Per - Per - Per -
Share Share Share
Income Shares Amount Income Shares Amount Income Shares Amount
-------- -------- ------ -------- -------- ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available
to common
stockholders $693,642 1,620,817 $0.43 $601,794 1,557,744 $0.39 $406,277 1,551,890 $0.26
===== ===== =====
Effect of Dilutive
Securities
Stock options
unexercised - 12,731 - 13,702 - 13,066
-------- --------- -------- --------- -------- ---------
Dilutive EPS
Income available
to common
stockholders
plus assumed
conversions $693,642 1,633,548 $0.42 $601,794 1,571,446 $0.38 $406,277 1,564,956 $0.26
======== ========= ===== ======== ========= ===== ======== ========= =====
</TABLE>
D-12
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Impaired Loans
Effective January 1, 1995, the Bank adopted Statement of Financial
Accounting Standards ("SFAS") No. 114, as amended by SFAS No. 118. SFAS
No. 114, as amended provided that a loan is impaired when, based on
current information and events, it is probable that the creditor will
be unable to collect all principal and interest amounts due according
to the contractual terms of the loan agreement. SFAS No. 114, as
amended provides guidelines relating to recognition of interest income
on impaired loans and requires that impaired loans be measured based on
the present value of the expected future cash flows, discounted at the
loan's effective interest rate. The effective rate of a loan is defined
as the contractual interest rate adjusted for any deferred loan fees or
costs, premiums or discounts existing at the inception or acquisition
of the loan. If the loan is collateral dependent, as a practical
expedient, impairment can be based on a loan's observable market price
of the fair value of the collateral. The value of the loan is adjusted
through a valuation allowance created through a charge against income.
Residential mortgages, consumer installment obligations and credit
cards are excluded. Loans that were treated as in-substance
foreclosures under previous accounting pronouncements are considered to
be impaired loans and under SFAS No. 114 will remain in the loan
portfolio.
A loan may be placed on non-accrual status and not classified as an
impaired loan when in the opinion of management, based on current
information and events, it is probable that the Bank will eventually
collect all principal and interest amounts due according to the
contractual terms of the loan agreement. Interest income for impaired
loans is generally recognized on an accrual basis unless it is deemed
inappropriate to do so. In cases which the receipt of interest payments
is deemed more uncertain, the cash basis of income recognition is
utilized. Loans are placed on non-accrual status when, in the judgement
of management, the probability of timely collection of interest is
deemed to be insufficient to warrant further accrual. As a matter of
policy, the Bank does not accrue interest on loans past due 90 days or
more except when the estimated value of the collateral and collection
efforts are deemed sufficient to ensure full recovery. When a loan is
placed on non-accrual status, previously accrued but unpaid interest is
deducted from interest income.
Management considered loans impaired amounting to $922,460 at December
31, 1998 and $840,663 at December 31, 1997. The total allowance for
possible loan losses related to impaired loans amounted to $381,802 at
December 31, 1998 and $83,899 at December 31, 1997.
Accounting Pronouncements
SFAS No. 133 - Accounting for Derivative Instruments and Hedging
Activities
This statement standardizes the accounting for derivative instruments,
including certain derivative instruments embedded in other contracts,
by requiring that an entity recognize those items as assets or
liabilities in the statement of financial position and measure them at
fair value. The Bank is evaluating the potential impact of adopting
SFAS No. 133. Management does not expect the adoption of SFAS No. 133
to have a material impact on financial condition or results of
operations. The statement is effective for all fiscal quarters of all
fiscal years beginning after June 15, 1999.
D-13
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
2. INVESTMENT SECURITIES
The portfolio consists of the following:
<TABLE>
<CAPTION>
December 31, 1998
-------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
----------- ---------- ---------- --------------
<S> <C> <C> <C> <C>
Available for sale
U.S. Government Treasury
and agency obligations $ 9,595,877 $47,073 $ 6,095 $ 9,636,855
=========== ======= ======= ===========
December 31, 1997
-------------------------------------------------------------
Available for sale:
U.S. Government Treasury
and agency obligations $12,012,038 $36,484 $31,036 $12,017,486
=========== ======= ======= ===========
December 31, 1998
-------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
----------- ---------- ---------- --------------
Value
Held to maturity:
U.S. Government Treasury
and agency obligations $19,531,871 $59,187 $37,710 $19,553,348
=========== ======= ======= ===========
December 31, 1997
-------------------------------------------------------------
Held to maturity:
U.S. Government Treasury
and agency obligations $ 8,098,909 $19,032 $13,160 $ 8,104,781
=========== ======= ======= ===========
</TABLE>
The scheduled maturities of the portfolio at December 31, 1998 were as
follows:
<TABLE>
<CAPTION>
Held to Maturity Available for Sale
------------------------------ -------------------------------
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less $ 6,029,786 $ 6,022,188 $ 2,699,475 $ 2,708,813
Due from one year to
five years 13,502,085 13,531,160 6,896,402 6,928,042
----------- ----------- ----------- -----------
$19,531,871 $19,553,348 $ 9,595,877 $ 9,636,855
=========== =========== =========== ===========
</TABLE>
Securities with a carrying amount of $16,700,000 and $12,150,000 at
December 31, 1998 and 1997, respectively, were pledged as collateral on
public deposits and for other purposes as required or permitted by law.
D-14
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
3. LOANS RECEIVABLE
Loans receivable at December 31 include the following:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Mortgage:
Residential $28,776,000 $30,907,000
Nonresidential 20,234,000 16,944,000
Construction 1,764,000 2,936,000
Nonmortgage:
Business 16,041,000 15,386,000
Consumer 9,134,586 10,369,771
----------- -----------
Total loans receivable 75,949,586 76,542,771
Less: Deferred loan fees (228,973) (233,804)
Less: Allowance for loan losses (1,011,019) (706,838)
----------- -----------
Loans receivable, net $74,709,594 $75,602,129
=========== ===========
</TABLE>
An analysis of the allowance for loan losses at December 31 is as
follows:
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
Balance beginning of year $ 706,838 $ 873,378
Provision for loan losses 325,801 385,314
Charge-offs, net (21,620) (551,854)
---------- ---------
$1,011,019 $ 706,838
========== =========
</TABLE>
Loans on which the accrual of interest has been discontinued amount to
$922,460 at December 31, 1998 and $962,496 at December 31, 1997. Had
interest been accrued on those loans, such income would have
approximated $104,143 and $46,449 for the years ended December 31, 1998
and 1997, respectively.
The amount of the allowance deducted for Federal income tax purposes in
1998 was $390,000, in 1997 was $646,000, and in 1996 was $199,724.
4. BANK PREMISES AND EQUIPMENT
Bank premises and equipment include the following:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Land $ 1,304,033 $ 1,304,033
Building 494,633 494,633
Automobiles 103,360 103,360
Leasehold improvements 1,085,350 1,014,025
Furniture and equipment 1,638,059 1,514,935
----------- -----------
4,625,435 4,430,986
Less accumulated depreciation (1,472,842) (1,210,859)
----------- -----------
$ 3,152,593 $ 3,220,127
=========== ===========
</TABLE>
Depreciation of bank premises and equipment charged to expense amounted
to $262,299 in 1998, $258,477 in 1997, and $214,842 in 1996.
D-15
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
5. OTHER REAL ESTATE OWNED
Activity related to foreclosed real estate is as follows:
Expenses related to other real estate owned are included in other
operating expenses and amounted to $12,750 in 1998, $3,066 in 1997, and
$3,441 in 1996.
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Balance, January 1 $ 546,177 $ 966,871
Additions - 171,195
Sales - (527,376)
Allowance for losses (120,000) (64,513)
---------- ----------
Balance, December 31 $ 426,177 $ 546,177
========== ==========
</TABLE>
Activity of the allowance for other real estate owned losses is as
follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Balance, January 1 $ 125,513 $ 61,000
Additions 120,000 64,513
---------- ----------
Balance, December 31 $ 245,513 $ 125,513
========== ==========
</TABLE>
6. OTHER ASSETS
In addition to Other Real Estate Owned and Accrued Interest Receivable,
other assets include the following:
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
Goodwill, net of accumulated amortization
of $98,353 in 1998 and $68,805 in 1997 $ 92,552 $ 55,002
Prepaid taxes and expenses 139,032 101,403
Deposits and other 41,716 42,933
Deferred tax asset 368,000 187,000
Covenant not to compete 206,420 -
---------- ---------
$ 847,720 $ 386,338
========== =========
</TABLE>
The goodwill of $190,905 is being amortized over sixty months under the
straight-line method. Amortization charged to expense amounted to
$29,548 in 1998, $13,000 in 1997 and $5,400 in 1996.
7. TIME DEPOSITS
The maturity distribution of time certificates of deposit in
denominations of $100,000 or more was approximately $25,107,867 at
December 31, 1998 and $16,735,561 at December 31, 1997.
At December 31, 1998, the scheduled maturities of time deposits are as
follows:
3 months or less $ 8,294,176
3 to 12 months 21,407,321
1 to 5 years 21,676,063
Over 5 years -
-----------
$51,377,560
===========
D-16
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
8. INCOME TAXES
The provision for income taxes charged to operations was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Current income taxes $ 538,775 $ 286,500 $ 257,230
Deferred tax (benefit) expense (181,000) 23,500 (46,500)
--------- --------- ---------
Total income tax expense $ 357,775 $ 310,000 $ 210,730
========= ========= =========
</TABLE>
Net deferred tax assets are comprised of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Deferred Source
Unearned loan fees $ 68,903 $ 72,841
Organization/start-up costs and other 2,110 2,016
Loan loss and other real estate reserve 277,289 117,337
Net unrealized loss on securities available for sale - 1,852
Non accrued loan interest 28,625 -
Depreciation 5,006 -
--------- ---------
Gross deferred tax assets 381,933 194,046
--------- ---------
Net unrealized gain on securities available for sale 13,933 -
Depreciation - 7,046
--------- ---------
Gross deferred tax liability 13,933 7,046
--------- ---------
Net deferred tax asset $ 368,000 $ 187,000
========= =========
</TABLE>
Net deferred tax assets for 1998 and 1997 are included in Other Assets.
Income taxes payable of $266,000 for 1998 are included in other accrued
expenses.
A reconciliation between the amount of reported income tax expense and
the amount computed by multiplying the applicable statutory Federal
income tax rate is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Income before income taxes $1,051,417 $ 911,794 $ 617,007
Applicable statutory income tax rate 34% 34% 34%
---------- ---------- ----------
Computed "expected" Federal tax expense 357,482 310,010 209,782
Adjustments to Federal income tax
resulting from:
Nondeductible items and other 293 (10) 948
---------- ---------- ----------
Provision for Federal income taxes $ 357,775 $ 310,000 $ 210,730
========== ========== ==========
</TABLE>
D-17
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
9. OPERATING LEASES
In 1998, the Bank entered into two new lease agreements for a new
branch and additional office space. The lease agreement provides for a
term of ten years ending April 30, 2008, with annual lease payments of
$45,000 plus 5 percent annual increases. The office space agreement is
a six year lease beginning February 1, 1999 at $59,598 per year with
three percent increases annually.
In July, 1996, the Bank commenced occupancy in a new branch location in
Fairfax City. The current rent expense being paid by the Bank is
$124,689 per year. The initial ten year lease began with the date of
occupancy and includes four additional five year options to extend the
lease. Additionally, the Bank currently holds a $650,000 first deed of
trust loan on the building and land on which the Fairfax City branch is
located.
The Bank leased office space for its mortgage department at $30,500 per
year, net of a sublease. The lease expired in September 1998.
In January, 1995, the Bank entered into a lease agreement for a new
branch located in Vienna. The agreement provides for a term of ten
years ending in February, 2005 with an automatic ten year renewal
option unless the Bank issues an advance written notice. Total base
annual lease payments are $107,870 adjusted 1.5 percent per annum.
In 1995, the Bank amended its current lease agreement for office space
and signed a new lease for an additional floor of office space. The
agreements call for total annual lease payments of $119,700 per year
plus two thirds of all real estate taxes. The leases are in force for a
term of 5 years, ending on June 30, 1999. The Bank has the option for
five additional terms of five years each and may terminate the leases
after the third year with proper notice.
The following are the future minimum lease payments at December 31,
1998:
Years ending December 31,
-------------------------
1999 $ 437,977
2000 415,145
2001 421,353
2002 427,775
2003 and thereafter 1,291,184
----------
Total $2,993,434
==========
Rent expense amounted to $420,000 in 1998, $401,500 in 1997 and
$319,500 in 1996.
10. INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
In the ordinary course of business, the Bank has granted loans to
directors, executive officers, employees and their associates. These
transactions have been made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons. Directors, officers and
their affiliated companies were indebted to the Bank for loans totaling
$1,622,674 at December 31, 1998 and $1,667,022 at December 31, 1997.
Activity of loans to directors, officers and their affiliated companies
is as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Balance, January 1 $1,667,022 $1,291,000
Advances 255,345 727,772
Repayments (299,693) (351,750)
---------- ----------
Balance, December 31 $1,622,674 $1,667,022
========== ==========
</TABLE>
D-18
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
11. STOCK OPTIONS
Stock Option Plan
On April 9, 1991, the stockholders approved a stock option plan
authorizing options for 160,000 shares of the Bank's common stock, of
which 154,000 shares have been granted to eligible directors. On May
31, 1996, 4,650 options were granted to officers and employees. On
January 1, 1997, 1,350 options were granted to employees. Under the
terms of the plan the purchase price of the stock will be $5.00 per
share. Compensation expense has been recognized for options granted at
less than the market price at the measurement date. All options expire
April 9, 1999.
A summary of activities is as follows:
<TABLE>
<CAPTION>
Amount Price
--------- -----
<S> <C> <C>
Authorized 160,000
=========
Balance outstanding at December 31, 1996 24,800 $5
Granted 1,350 $5
Exercised (160) $5
---------
Balance outstanding at December 31, 1997 25,990 $5
Granted -
Exercised (4,114)
---------
Balance outstanding at December 31, 1998 21,876 $5
=========
</TABLE>
Stock Compensation
In 1996, the Bank adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation and will continue to apply Accounting Principles Board No.
25 and related interpretations in accounting for its plans. SFAS No.
123 establishes standards of financial accounting and reporting for
stock-based employee compensation plans including stock option plans,
stock purchase plans and other arrangements by which employees receive
shares of stock or other equity instruments based on the market price
of an entity's stock.
If the Bank had elected to recognize compensation cost for the plan
based on the fair value at the grant dates for awards under those
plans, consistent with the method prescribed by SFAS No. 123, net
income and earnings per share would have been changed to the pro forma
amounts indicated below;
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, December 31, December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net income As reported $693,643 $601,794 $406,277
Pro forma $693,643 $601,215 $392,939
Earnings per share As reported $ .43 $ .39 $ .26
Pro forma $ .43 $ .39 $ .25
</TABLE>
D-19
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
11. STOCK OPTION PLAN (continued)
Stock Compensation (continued)
The fair value of Horizon Bank stock options used to compute pro forma
net income and earnings per share disclosures is the estimated present
value at grant date using the Minimum Value pricing model with the
following assumptions for 1998: a risk free interest rate of 6.50
percent, an estimated dividend yield of 3 percent and an expected
holding period of four years.
12. EMPLOYEE BENEFIT PLAN
In 1995, the Bank adopted a contributory 401 (k) savings plan covering
substantially all employees. Effective as of January 1, 1996, the plan
allows eligible employees to contribute a fixed percentage of their
compensation with the Bank matching a portion of each employee's
contribution. The Bank's contributions amounted to $22,513 in 1998,
$16,308 in 1997 and $17,378 in 1996.
13. BUSINESS COMBINATIONS
On March 13, 1996, the Bank completed its acquisition of the assets and
assumed certain liabilities of VIP Mortgage Corporation. The excess of
the total acquisition cost over the fair value of the net assets
acquired of $73,902 is being amortized over 5 years on a straight-line
basis. The acquisition has been accounted for as a purchase and results
of operations of VIP Mortgage Corporation since the date of acquisition
are included in the Bank's financial statements. A director of the Bank
was also an owner of the mortgage corporation. Certain contingent
payments relating to the purchase were made to former stockholders in
1998 and 1997.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair value
of each class of financial instrument for which it is practicable to
estimate that value.
Cash and Short-term Investment
For cash, due from banks, Federal funds sold and other short-term
instruments, the carrying amount approximates fair value.
Investment Securities and Securities Available for Sale
Fair values are based on quoted market prices or dealer quotes. If a
quoted market price is not available, fair value is estimated using
quoted market prices for similar securities.
Loans Receivable
For certain homogeneous categories of loans, such as some residential
mortgages and other consumer loans, fair value is estimated using the
quoted market prices for securities backed by similar loans, adjusted
for differences in loan characteristics. The fair value of other types
of loans is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities.
D-20
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
Deposit Liabilities
The fair value of demand deposits, savings account, and certain money
market deposits is the amount payable on demand at the reporting date.
The fair value of fixed-maturity certificates of deposit is estimated
using the rates currently offered for deposits of similar remaining
maturities.
Commitments to Extend Credit, Stand-by Letters of Credit, and Financial
Guarantees Written
The fair value of commitments is estimated using the fees currently
charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present credit worthiness of
the counter parties. For fixed-rate loan commitments, fair value also
considers the difference between current levels of interest rates and
the committed rates. The fair value of guarantees and letters of credit
is based on fees currently charged for similar agreements or on the
estimated cost to terminate them or otherwise settle the obligations
with the counterparties at the reporting date.
Unrecognized financial instrument accrual and deferral fees were not
considered material.
The estimated fair value of the Bank's financial instruments are as
follows:
<TABLE>
<CAPTION>
1998 (In Thousands) 1997 (In Thousands)
------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Financial Assets:
Cash and short-term investments $ 36,292 $ 36,292 $ 26,775 $ 26,775
Securities 29,169 29,190 20,116 20,123
Loans 75,721 75,659 76,309 76,199
Less allowance for loan losses (1,011) - (707) -
Net loans 74,710 75,659 75,602 76,199
--------- --------- --------- ---------
Total financial liabilities $ 140,171 $ 141,141 $ 122,507 $ 123,097
========= ========= ========= =========
Financial Liabilities:
Deposits $ 134,980 $ 135,247 $ 118,164 $ 118,698
========= ========= --------- ---------
Total financial liabilities $ 134,980 $ 135,247 $ 118,164 $ 118,698
========= ========= ========= =========
Unrecognized financial instruments:
Commitments to extend credit $ 24,400 $ 24,400 $ 15,900 $ 15,900
Standby letters $ 1,880 $ 1,880 $ 1,848 $ 1,848
</TABLE>
D-21
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
15. SEGMENT INFORMATION
The Bank adopted SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, in 1998 which changes the way the
Bank reports information about its segments.
The Bank currently considers its banking operations and mortgage
operations as reportable segments.
Banking: This segment consists of all banking services and products
which are not reported under the mortgage operations.
Mortgage: This segment consists of mortgage banking products and
services. The main product of the mortgage department is providing
residential mortgage loans in the Northern Virginia metro area.
<TABLE>
<CAPTION>
Banking Mortgage Total
------- -------- -----
<S> <C> <C> <C>
1998 (In Thousands)
----
Interest Income $ 7,630 $ 1,497 $ 9,127
Interest Expense (2,909) (1,107) (4,016)
------- ------- -------
Net Interest Income 4,721 390 5,111
Provision for Loan Losses (303) (23) (326)
Other Income 454 344 798
Operating Expense (4,182) (349) (4,531)
Income Taxes (235) (123) (358)
------- ------- -------
Net Income $ 455 $ 239 $ 694
======= ======= =======
Banking Mortgage Total
------- -------- -----
1997 (In Thousands)
----
Interest Income $ 7,247 $ 1,284 $ 8,531
Interest Expense (2,993) (590) (3,583)
------- ------- -------
Net Interest Income 4,254 694 4,948
Provision for Loan Losses (343) (42) (385)
Other Income 302 227 529
Operating Expense (3,723) (457) (4,180)
Income Taxes (167) (143) (310)
------- ------- -------
Net Income $ 323 $ 279 $ 602
======= ======= =======
</TABLE>
D-22
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
16. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT
In the normal course of business, the Bank incurs certain contingent
liabilities that are not reflected in the accompanying financial
statements. These contingent liabilities include standby letters of
credit and unfunded commitments. Commitments under standby letters of
credit approximated $1,880,553 in 1998 and $1,848,305 in 1997, and
unfunded commitments approximated $24,413,106 in 1998 and $15,899,877
in 1997. The Bank does not anticipate any material losses as a result
of these commitments.
The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on management's credit evaluation of the
counter-party. Collateral held varies but may include cash, securities,
accounts receivable, inventory, property, plant and equipment and
income-producing commercial properties and residential properties.
All of the Bank's loans, commitments, and commercial and standby
letters of credit have been granted to customers in the Banks market
area. The concentrations of credit by type of loan are set forth in
Note 3. The distribution of commitments to extend credit approximates
the distribution of loans outstanding. Commercial and standby letters
of credit were granted primarily to commercial borrowers. The Bank does
not extend credit to any single borrower or group of related borrowers
in excess of their legal limit. The Bank does not have a payroll
processing customer which may have deposits in excess of ten percent of
total deposits during seasonal peaks.
From time to time, the Bank is party to litigation and claims arising
in the normal course of business. Management, after consultation with
legal counsel, believes that the liabilities, if any, arising from such
litigation and claims will not be material to the financial position.
In connection with the retirement of the former Chief Executive
Officer, the Bank entered into a contract with the former executive
which provided for his continued employment as a consultant through
December 31, 1997. In addition, the Bank received his agreement not to
compete which is effective upon resignation from the Board of Directors
and will remain in effect until April 30, 2000, in return for monthly
payments of $12,350 and continuation of certain benefits during the
agreement period.
D-23
<PAGE>
The Horizon Bank of Virginia
Balance Sheets
March 31, 1999 and December 31, 1998
<TABLE>
<CAPTION>
(Unaudited)
Assets March 31, 1999 December 31, 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and Due from Bank $ 7,324,401 $ 5,445,820
Federal Funds Sold 13,701,000 30,846,000
Investment Securities 20,737,192 19,531,871
Securities Available for Sale 10,595,604 9,636,855
Loans Receivable, net 71,848,847 74,709,594
Bank Premises and Equipment, Net 3,101,152 3,152,593
Accrued Interest Receivable 839,621 814,437
Other Real Estate Owned 425,177 426,177
Other Assets 740,398 847,720
- ---------------------------------------------------------------------------------------------------------------
Total Assets $129,313,392 $145,411,067
===============================================================================================================
Liabilities and Stockholders' Equity
- ---------------------------------------------------------------------------------------------------------------
Liabilities
Deposits $118,818,978 $134,979,742
Other liabilities 617,104 728,198
- ---------------------------------------------------------------------------------------------------------------
Total Liabilities 119,436,082 135,707,940
Stockholders' Equity
Common stock 4,108,075 4,099,325
Capital in excess of par value 4,232,523 4,223,773
Retained earnings 1,542,454 1,352,984
Accumulated other comprehensive income (5,742) 27,045
- ---------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 9,877,310 9,703,127
- ---------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $129,313,392 $145,411,067
===============================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-24
<PAGE>
The Horizon Bank of Virginia
Statements of Operations
Three Months Ended March 31, 1999 and March 31, 1998
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
March 31, 1999 March 31, 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans $ 1,597,590 $ 1,638,505
Investments securities 633,192 442,356
- -------------------------------------------------------------------------------------------------------------------
Total Interest Income 2,230,782 2,080,861
Interest expense:
Deposits 1,072,521 843,667
- -------------------------------------------------------------------------------------------------------------------
Net Interest Income 1,158,261 1,237,194
Provision for Loan Losses 66,036 63,500
- -------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 1,092,225 1,173,694
- -------------------------------------------------------------------------------------------------------------------
Other income:
Fee income 330,457 261,090
Other 3,839 2,775
- -------------------------------------------------------------------------------------------------------------------
Total other income 334,296 263,865
- -------------------------------------------------------------------------------------------------------------------
Other expense:
Employee compensation and benefits 527,104 502,714
Premises and equipment 248,811 229,448
Data processing expense 30,628 30,444
Other 333,583 392,416
- -------------------------------------------------------------------------------------------------------------------
Total other expense 1,140,126 1,155,022
- -------------------------------------------------------------------------------------------------------------------
Income before income taxes 286,395 282,537
Provision for income taxes 96,925 94,200
- -------------------------------------------------------------------------------------------------------------------
Net Income $ 189,470 $ 188,337
===================================================================================================================
Earnings per common share:
Basic $ 0.12 $ 0.12
Diluted $ 0.11 $ 0.12
Weighted average shares outstanding:
Basic 1,640,197 1,572,318
Diluted 1,665,170 1,598,309
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-25
<PAGE>
The Horizon Bank of Virginia
Statements of Comprehensive Income
(Unaudited)
Three Months Ended
March 31,
1999 1998
-------- --------
Net income $189,470 $188,337
Other comprehensive income, net of tax:
Unrealized gain (loss) on securities, net (32,787) 9,499
-------- --------
Other comprehensive income (32,787) 9,499
Comprehensive income $156,683 $197,836
======== ========
The accompanying notes are an integral part of these financial statements
D-26
<PAGE>
The Horizon Bank of Virginia
Statements of Changes in Stockholders' Equity
Three Months Ended March 31, 1999 and Year Ended December 31, 1998
<TABLE>
<CAPTION>
Accumulated
Other
Number Retained Comprehensive
of Shares Par Value Surplus Earnings Income Totals
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance,
December 31, 1997 1,557,778 $3,894,445 $3,564,319 $1,503,105 $ 3,595 $8,965,464
Exercise of stock options 4,114 10,285 10,285 - - 20,570
5 Percent Stock
Dividend 77,837 194,595 649,169 (843,764) - -
Net Change in Unrealized
Gain on Securities
Available for Sale - - - - 23,450 23,450
Net Income for the
Year Ended
December 31, 1998 - - - 693,643 - 693,643
- -------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1998 1,639,729 4,099,325 4,223,773 1,352,984 27,045 9,703,127
(Unaudited)
Exercise of Stock
Options 3,500 8,750 8,750 - - 17,500
Net Change in
Unrealized Gain on
Securities Available
for Sale - - - - (32,787) (32,787)
Net Income for the
Period Ended
March 31, 1999 - - - 189,470 - 189,470
- -------------------------------------------------------------------------------------------------------------------
Balance,
March 31, 1999 1,643,229 $4,108,075 $4,232,523 $1,542,454 $(5,742) $9,877,310
===================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-27
<PAGE>
The Horizon Bank of Virginia
Statements of Cash Flows
Three Months Ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
March 31, March 31,
1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 189,470 $ 188,337
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 78,305 67,976
Provision for loan losses 66,036 63,500
Provision for losses on other real estate owned - (30,000)
Net amortization of premiums on investment securities (53,386) (2,423)
Decrease in other assets 82,138 26,311
Increase (Decrease) in other expenses (111,094) 203,638
- -------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 440,939 517,339
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Net Federal funds sold 17,145,000 12,628,000
Increase in premises and equipment (171,147) (4,126)
Loans collected (made), net 2,773,091 (1,645,060)
Proceeds from the maturities of investment securities 2,700,000 2,100,000
Purchase of securities available for sale (4,689,416) (1,800,000)
Purchase of investment securities (3,926,622) (3,128,315)
Proceeds from the maturities of securities available for sale 3,750,000 2,700,000
- -------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Investing Activities 17,580,906 10,850,499
- -------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from sale of common stock 17,500 20,570
Net decrease in deposits (16,160,764) (11,122,982)
- --------------------------------------------------------------------------------------------------------------------
Net Cash Used by Financing Activities (16,143,264) (11,102,412)
- --------------------------------------------------------------------------------------------------------------------
Net Increase in Cash and Due from Banks 1,878,581 265,426
Cash and Due from Banks, beginning of period 5,445,820 6,467,421
- -------------------------------------------------------------------------------------------------------------------
Cash and Due from Banks, end of period $ 7,324,401 $ 6,732,847
===================================================================================================================
Noncash
Unrealized gain (loss) on securities available for sale, net $ (32,787) $ 9,499
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
D-28
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with the instructions to Form 10-Q, and, therefore, do not
include all information or footnotes necessary for a fair presentation
of financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles. However, all
adjustments which are, in the opinion of management, necessary for a
fair presentation have been included. All adjustments are of a normal
recurring nature. The results of operations for the three-month period
ended March 31, 1999 are not necessarily indicative of the results of
the full year. These financial statements should be read in conjunction
with the financial statements and the notes included in The Horizon
Bank of Virginia's Annual Report for the year ended December 31, 1998.
2. INVESTMENT SECURITIES
The following table sets forth the Bank's investment securities
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
<S> <C> <C> <C> <C>
Available-for-sale
securities:
U.S. Government
Treasury and
agency obligations $10,608,584 $10,595,604 $ 9,595,877 $ 9,636,855
=========== =========== ============ ============
Held-to-maturity
securities:
U.S. Government
Treasury and
agency obligations $20,737,192 $20,679,647 $19,531,871 $19,553,348
=========== =========== =========== ===========
</TABLE>
D-29
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
3. LOANS RECEIVABLE
Loans receivable consist of the following:
March 31, December 31,
1999 1998
----------- ------------
Mortgage:
Residential $25,939,000 $28,776,000
Nonresidential 21,807,000 20,234,000
Construction: 1,878,000 1,764,000
Non-Mortgage:
Business 15,923,000 16,041,000
Consumer 7,560,203 9,134,586
----------- -----------
Total loan receivable 73,107,203 75,949,586
Less:
Deferred loan fees, net 201,650 228,973
Allowance for loan losses 1,056,706 1,011,019
----------- -----------
Loans receivable, net $71,848,847 $74,709,594
=========== ===========
The following sets forth information regarding the allowance for loan
losses:
Three Months Three Months
Ended Ended
3/31/99 3/31/98
---------- --------
Allowance at beginning of period $1,011,019 $706,838
Provision for losses charged to income 66,036 63,500
Charge-offs, net (20,349) (4,636)
---------- --------
Allowance at end of period $1,056,706 $765,702
========== ========
4. EARNINGS PER SHARE
The following table shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average number
of shares of dilutive common stock equivalents.
<TABLE>
<CAPTION>
For the three months ended
March 1999 March 1998
------------------------ -------------------------
Per Per
Share Share
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Basic EPS 1,640,917 $0.12 1,572,318 $0.12
===== =====
Effect of dilutive
Securities:
Stock Options
unexercised 1,836 25,990
--------- ---------
Diluted EPS 1,665,170 $0.11 1,598,309 $0.12
========= ===== ========= =====
</TABLE>
D-30
<PAGE>
THE HORIZON BANK OF VIRGINIA
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
5. OTHER SIGNIFICANT MATTERS
The Bank signed a definitive Merger Agreement providing for a merger
with Southern Financial Bancorp, Inc. Stockholders of the Bank will
receive .63 shares of Southern Financial Bancorp common stock in
exchange for each share of its common stock. Subject to certain
conditions including receipt of regulatory approval and approval of the
shareholders of the Southern Financial Bancorp and the Bank, closing of
the merger is anticipated to occur in the third quarter of 1999. The
merger will be accounted for under the pooling method.
D-31
<PAGE>
Appendix E
[MCKINNON & COMPANY LETTERHEAD]
July 28, 1999
Board of Directors
The Horizon Bank of Virginia
527-B Maple Avenue East
Vienna, Virginia 22180
Dear Board Members:
In connection with the proposed affiliation of The Horizon Bank of
Virginia ("HBV") with Southern Financial Bancorp, Inc. ("SFB") you have asked us
to render an opinion as to whether the financial terms of the Agreement and Plan
of Reorganization, including the Plan of Merger attached thereto (the
"Agreement") dated as of May 3, 1999 between HBV and SFB, are fair from a
financial point of view, to the stockholders of HBV. The Agreement provides for
the merger of HBV with and into Southern Financial Bank, a wholly owned
subsidiary of SFB (the "Bank") and stockholders of HBV will receive common stock
of SFB (the "Merger"). Under the terms of the Agreement, upon consummation of
the Merger, each share of common stock of HBV, par value $2.50 per share,
automatically shall become and be converted into .63 shares of the common stock
of SFB, par value $.01 per share ("SFB Common Stock"). Cash will be paid in lieu
of fractional shares. As of the date of the Agreement, HBV had 1,659,894 shares
of common stock issued and outstanding. Under the terms of the Agreement, and
based on the exchange ratio of .63 shares of SFB for each share of HBV common
stock, an aggregate of 1,045,734 shares of SFB Common Stock may be issued for
the HBV common stock outstanding.
McKinnon & Company, Inc. ("McKinnon") is an investment banking firm
that specializes in Virginia community banks and thrifts. In eleven years
McKinnon has been lead managing underwriter in approximately thirty-four public
stock offerings for Virginia community banks and thrifts and has served as
financial advisor, including providing fairness opinions, to numerous Virginia
community banks and thrifts. McKinnon, as part of its investment banking
business, is engaged in the evaluation of businesses, particularly banks, and
their securities, in connection with mergers and acquisitions, initial public
offerings, private placements and evaluations for estates and corporate
recapitalizations. McKinnon is also a market maker in SFB's Common Stock on the
NASDAQ National Market System. McKinnon is also a market maker in Virginia
community bank stocks listed on NASDAQ and the OTC Bulletin Board. McKinnon
believes it has a thorough working knowledge of the banking industry throughout
Virginia.
E-1
<PAGE>
Page 2
In developing our opinion, we have among other things, reviewed and
analyzed material bearing upon the financial and operating conditions of HBV,
SFB, and, on a pro forma basis, HBV and SFB combined, and material proposed in
connection with the Agreement, including, among other things, the following:
(1) the Agreement and Plan of Reorganization and the Plan of Merger,
dated as of May 3, 1999 among HBV and SFB;
(2) the registration statement filed with the Securities and Exchange
Commission in connection with the proposed Merger, including a prospectus
relating to 1,045,734 shares of common stock of SFB, and the Proxy Statement
relating to the special meetings of stockholders of HBV and SFB to be held on
September 9, 1999;
(3) HBV's and SFB's financial results for fiscal years 1991 through
1998, and the first quarter ended March 31, 1999, respectively, and certain
documents and information we deem relevant to our analysis;
(4) held discussions with senior management of HBV and SFB regarding
past and current business operations of, and outlook for, HBV, SFB, including
trends, the terms of the proposed Merger, and related matters;
(5) reviewed the reported price and trading activity of HBV's and SFB
Common Stock and compared financial and stock market information (when
available) for HBV and SFB with similar information for certain other companies,
and securities for which are publicly traded;
(6) reviewed the financial terms of certain recent business
combinations which we deemed comparable in whole or in part;
(7) performed such other studies and analyses as we considered
appropriate, including an analysis of the pro forma financial impact of the
Merger on HBV and SFB;
(8) reviewed other published information, performed certain financial
analyses and considered other factors and information which we deem relevant.
In conducting our review and arriving at our opinion, we have relied
upon and assumed the accuracy and completeness of the information furnished to
us by or on behalf of HBV and SFB. We have not attempted independently to verify
such information, nor have we made any independent appraisal of the assets of
HBV or SFB. We have taken into account our assessment of general economic,
financial market and industry conditions as they exist and can be evaluated at
the date hereof, as well as our experience in business valuation in general.
E-2
<PAGE>
Page 3
We have been retained by you as a financial advisor to HBV with respect
to the proposed Merger. In the normal course of business McKinnon & Company,
Inc. is a market maker in the common stock of SFB listed on the NASDAQ National
Market System. Our opinion is directed to the Board of Directors of HBV. We
participated in some of the discussions but we did not recommend the structure
or give any opinion regarding the business reasons for doing this proposed
Merger.
On the basis of our analysis and review and in reliance on the accuracy
and completeness of the information furnished to us and subject to the
conditions noted above, it is our opinion that, as of the date hereof, the terms
of the Agreement are fair, from a financial point of view, to the holders of HBV
Common Stock.
Very truly yours,
/s/ McKinnon & Company, Inc.
McKinnon & Company, Inc.
E-3
