U.S. Securities and Exchange Commission
Washington, D. C. 20549
FORM 10-K
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
For the year ended: Commission File No.:
December 31, 1998 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1779978
(State or other jurisdiction (I.R.S. Employer or
of incorporation or organization) Identification Number)
37 East Main Street, Warrenton, Virginia 20186
(Address of principal executive office)(Zip Code)
(540) 349-3900
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12 (g) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not considered herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant computed by reference to the last reported bid price of such stock as
of February 26, 1999 was $14,710,127 (726,426 shares @ $20.25 per share). For
purposes of this computation, it is assumed that directors, executive officers
and persons beneficially owning more than 5% of the Common Stock of the
registrant are affiliates. As of February 26, 1999, there were 1,603,220 shares
of the registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
I. Portions of Annual Report to Stockholders for the Year Ended December
31, 1998 incorporated by reference into certain items of Parts I. and
II.
II. Portions of Proxy Statement for the Annual Meeting of Stockholders to be
held on April 29, 1999 incorporated by reference into certain items of
Part III.
<PAGE>
PART I.
ITEM 1. BUSINESS
GENERAL
Southern Financial Bancorp, Inc. ("Southern Financial" or "the Bancorp")
was incorporated in Virginia as a bank holding company under the Bank Holding
Company Act of 1956, as amended. On December 1, 1995, Southern Financial
Bancorp, Inc. acquired all of the outstanding shares of Southern Financial Bank.
Southern Financial Bank, formerly Southern Financial Federal Savings Bank,
converted from a savings bank to a state chartered commercial bank effective
December 1, 1995. The only activity of the Bancorp is to own and control all of
the capital stock of Southern Financial Bank. Hereafter, references to Southern
Financial and the Bancorp include the activities of Southern Financial Bank.
Headquartered in Warrenton, Virginia, the Bancorp serves the retail and
commercial financial market as a deposit and loan specialist from eleven full
service offices located in Warrenton, Herndon, Middleburg, Winchester, Leesburg,
Fairfax, Sterling and Woodbridge, Virginia. Southern Financial's defined market
area forms a semi-circle to the west of the Metropolitan Washington, D.C. area
roughly centered on Warrenton. The counties included in the defined market area
where the Bancorp currently operates branches include: Loudoun (Middleburg,
Leesburg and Sterling branches), Fauquier (Warrenton branches), Fairfax (Herndon
and Fairfax branches), Frederick (Winchester branches) and Prince William
(Woodbridge branch). Other counties in the defined market area include:
Spotsylvania, Culpeper, Rappahanock, Clarke and the three counties in the West
Virginia panhandle.
The inner ring of the semi-circle that comprises the Bancorp's market
area is the bedroom community for the close-in greater Metropolitan Washington
commercial centers that have grown up in Northern Virginia in the past 30 years.
As the economy of the Metropolitan Washington area has diversified away from its
concentration in government and government-related employment, the Dulles
Corridor has developed into a major center for communication and high-tech
activities. In the process, Reston, Herndon, Tysons Corner and Fairfax have
become important employment centers in their own right much as Stamford and
White Plains have done outside Manhattan. As a consequence, the commutable
radius has pushed west out to Loudoun and Fauquier Counties and south and
southwest to Stafford, Spotsylvania and Prince William Counties. The branch
locations in these areas situate Southern Financial to take advantage of the
rapid economic growth of these communities.
The principal business of the Bancorp is the acquisition of deposits
from the general public through its home and branch offices and use of these
deposits to fund its loan and investment portfolios. The Bancorp seeks to be a
full service community bank which provides a wide variety of financial services
to its middle market corporate clients as well as to its retail clients. The
Bancorp is an active commercial lender that often lends in conjunction with the
Small Business Administration ("SBA") 504 and 7(a) loan programs. In addition,
the Bancorp is an active residential construction lender and offers its retail
clients a full menu of permanent residential mortgage loan alternatives. The
Bancorp also invests funds in mortgage-backed securities, securities issued by
Agencies of the Federal Government, obligations of counties and municipalities,
corporate obligations and preferred stock of the Federal Home Loan Mortgage
Corporation.
The principal sources of funds for the Bancorp's lending and investment
activities are deposits, amortization and repayment of loans, proceeds from the
sales of loans, prepayments from mortgage-backed securities, repayments of
maturing investment securities, FHLB advances and other borrowed money.
Principal sources of revenue are interest and fees on loans and
investment securities and gains from the sale of loans, as well as fee income
derived from the maintenance of deposit accounts. The Bancorp's principal
expenses include interest paid on deposits and advances from the FHLB and other
borrowings, and operating expenses.
LENDING ACTIVITIES
The principal lending activity of the Bancorp is the origination of
loans on commercial real estate primarily through various lending programs of
the U.S. Small Business Administration (SBA) program. The Bancorp is a Preferred
Lender in the Richmond District of SBA and a Certified Lender in the Washington,
D.C. District. In addition, the Bancorp makes conventional and government fixed
and adjustable rate real estate loans to enable borrowers to purchase or
refinance one-to-four-family, owner-occupied residential properties. The Bancorp
also makes owner-occupied residential construction loans secured by first liens
on the properties to which they relate. At December 31, 1998, approximately 80%
of the Bancorp's total loan portfolio, or $107.3 million, consisted of loans
secured by real estate. The Bancorp also makes commercial business and secured
and unsecured consumer loans.
COMMERCIAL REAL ESTATE LENDING
U.S. SMALL BUSINESS ADMINISTRATION 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 U.S. Small Business
Administration. The Small Business Administration, in cooperation with banks and
other lending institutions, finances the expansion of small businesses. As noted
above, Southern Financial is a Preferred SBA Lender in the Richmond District
Office and a Certified Lender in the Washington, D. C. District Office.
Section 7(a) loans may be used for the purchase of real estate,
construction, renovation or leasehold improvements, as well as machinery,
equipment, furniture, fixtures, inventory, and in some instances, working
capital and debt refinance. Start-up businesses are eligible. The SBA guarantees
up to 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 Program is used to finance long-term fixed assets, primarily
real estate and large/heavy equipment. The 504 Program is an economic
development program designed to create new jobs or retain existing jobs. The
credit structure of the 504 Program gives borrowers access to 90% financing of
the project 50% is provided by the financial institution (in the form of a first
trust) and 40% is provided by the certified development company (the 504
representative) with a second trust. The borrower provides the remaining 10% of
the funds required for the project. Of the bank'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 Program.
<PAGE>
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 the Bancorp'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, the Bancorp also provides
commercial construction financing for projects outside of the SBA programs. At
December 31, 1998, approximately 8% of the Bancorp'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 Section 7(a) Program of the SBA to reduce the inherent risk
associated with this type of lending. The real estate loan, as a collateral
loan, is a stable asset. At December 31, 1998, Southern Financial had $24.8
million in commercial business loans, which represent 18% of the Bancorp's total
loans receivable. Of the bank's $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 7(a) Program and sold $8 million on the
secondary market.
RESIDENTIAL LENDING
The Bancorp 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. These second mortgages typically have
terms of 5 to 15 years and have rates 2% to 3% above the prevailing rate for
fixed rate and adjustable rate first mortgages at the time of origination.
Southern Financial makes construction loans and permanent loans on individual
single family residences and on other residential properties. Construction loans
generally have interest rates of prime plus one to 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. The Bancorp requires private mortgage insurance for
loans exceeding 80% of the appraised value.
Residential mortgage loans are secured by single-family homes. At
December 31, 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 the bank'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.
<PAGE>
LOAN PORTFOLIO COMPOSITION
The following table sets forth the composition of the Bancorp's loan
portfolio during the periods indicated:
<TABLE>
<CAPTION>
At December 31, At June 30,
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 December 31, 1998:
<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 $ 5,185 $ - $ - $ - $ - $ 5,185
Nonresidential 10,967 - 247 - - 11,214
Business 11,702 2,670 2,728 994 6,679 24,773
------------- ------------- ------------- ------------- ------------- -------------
Total $ 27,854 $ 2,670 $ 2,975 $ 994 $ 6,679 $ 41,172
============= ============= ============= ============= ============= =============
</TABLE>
LOAN UNDERWRITING POLICIES
Because future loan losses are so closely intertwined with its
associated underwriting policy, Southern Financial has instituted what it
believes is a stringent loan underwriting policy. Its underwriting guidelines
are tailored for particular credit types, including lines of credit, revolving
credit facilities, demand loans, term loans, equipment loans, real estate loans,
SBA loans, stand-by letters of credit and unsecured loans.
More specifically, it is Southern Financial's policy to encourage all
loan applicants for sound and lawful purposes, regardless of race, religion or
creed. Extensions of credit will be made if the criteria of creditworthiness,
likelihood of repayment and proximity to market areas served indicate that such
extensions of credit will provide acceptable profitability to the Bancorp.
Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All property valuations are performed by independent outside
appraisers who are reviewed by the Vice President of Real Estate Lending who
reports his findings annually to Southern Financial's Board of Directors.
<PAGE>
It is the Bancorp's policy to retain a mortgage creating a valid lien on
real estate and to obtain a title insurance policy that insures the property is
free of encumbrances. Also required from the borrower is hazard insurance, and
flood insurance is required if the property is in a flood plain as designated by
the Department of Housing and Urban Development. Most borrowers are also
required to advance funds on a monthly basis from which Southern Financial makes
disbursements for items such as real estate taxes, private mortgage insurance
(required when the loan to value ratio exceeds 80%) and hazard insurance.
Under the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989 ("FIRREA"), the aggregate amount of loans that Southern Financial may
make to one borrower is limited to 15% of the Bancorp's unimpaired capital and
surplus. The maximum amount of loans that Southern Financial could have made to
one borrower as of December 31, 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 the default, including
commencing foreclosure action with respect to mortgage loans and repossessions
of collateral in the case of consumer loans.
If foreclosure is effected, the property is sold at a public auction in
which Southern Financial may participate as a bidder. If Southern Financial is
the successful bidder, the acquired real estate property is then included in its
real estate owned account until it is sold. Such assets are carried at the lower
of cost or fair value net of estimated selling costs. To the extent there is a
decline in value, that amount is charged to operating expense.
<PAGE>
PAST DUE LOANS AND NONPERFORMING ASSETS
The following table sets forth information regarding past due loans and
nonperforming assets as of the periods indicated:
<TABLE>
<CAPTION>
At December 31, At June 30,
1998 1997 1996 1995 1995
------------- ------------- ------------- ------------- -------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Accruing Loans 90 Days
or More Delinquent
Residential $ - $ - $ - $ 878 $ 607
Nonresidential - - 28 - 196
Business 225 1 - - -
Consumer 11 - - 3 2
------------- ------------- ------------- ------------- -------------
Total 236 1 28 881 805
============= ============= ============= ============= =============
Nonperforming Loans
Residential 291 443 321 541 -
Nonresidential 1,033 1,002 1,257 - -
Business 659 - 49 - 39
Consumer - - 7 50 15
------------- ------------- ------------- ------------- -------------
Subtotal 1,983 1,445 1,634 591 54
------------- ------------- ------------- ------------- -------------
Real Estate Owned
Residential 72 176 340 357 387
------------- ------------- ------------- ------------- -------------
Total Nonperforming Assets $ 2,055 $ 1,621 $ 1,974 $ 948 $ 441
============= ============= ============= ============= =============
Nonperforming Assets
to Total Assets 0.91% 0.72% 1.03% 0.58% 0.28%
============= ============= ============= ============= =============
</TABLE>
The Bancorp's loss and delinquency experience on its residential real
estate loan portfolio has been limited by a number of factors, including the
Bancorp's underwriting standards. Whether Southern Financial's loss and
delinquency experience will increase significantly depends upon the value of the
real estate securing its loans, economic factors such as an increase in
unemployment as well as the overall economy of the region. As a result of
economic conditions and other factors beyond its control, the Bancorp's future
loss and delinquency experience cannot be accurately predicted. However,
management has provided an allowance for loan losses which it believes will be
adequate to absorb future losses.
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. The Bancorp has also contracted with an
outside, independent company to perform a detailed loan review, including an
assessment of the adequacy of the allowance for loan losses. The allowance is
also subject to regulatory examinations and determination as to the adequacy of
the allowance in comparison to peer institutions identified by the regulatory
agencies.
<PAGE>
The following table summarizes activity in the Bancorp's allowance for
loan losses during the periods indicated.
<TABLE>
<CAPTION>
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
1998 1997 1996 1995 1995
-------------- --------------- --------------- -------------- --------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Allowance at Beginning of Period $ 2,037 $ 1,501 $ 1,190 $ 1,057 $ 1,008
Provision for Losses 975 880 695 150 60
Charge-offs:
Residential (221) (65) (8) - -
Nonresidential (261) (200) (300) - -
Business (492) (77) (38) (16) -
Consumer (3) (27) (43) (1) (11)
-------------- --------------- --------------- -------------- --------------
Total Charge-offs (977) (369) (389) (17) (11)
-------------- --------------- --------------- -------------- --------------
Recoveries:
Residential - 12 - - -
Business 13 6 3 - -
Consumer 3 7 2 - -
-------------- --------------- --------------- -------------- --------------
Total Recoveries 16 25 5 - -
-------------- --------------- --------------- -------------- --------------
Net Charge-offs (961) (344) (384) (17) (11)
-------------- --------------- --------------- -------------- --------------
Allowance at End of Period $ 2,051 $ 2,037 $ 1,501 $ 1,190 $ 1,057
============== =============== =============== ============== ==============
Loans at End of Period $ 133,696 $ 130,995 $ 109,788 $ 105,441 $ 93,137
Ratio of Allowance to Loans 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 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% - 0% - 0% - 0%
---------- ------ -------- ------- ----------- ------- ---------- ------ ---------- -----
Allowance for Loan Losses $ 2,051 100% $ 2,037 100% $ 1,501 100% $ 1,190 100% $ 1,057 100%
========== ====== ======== ======= =========== ======= ========== ====== ========== =====
</TABLE>
The Bancorp has allocated the allowance according to the amount deemed
to be reasonably necessary to provide for the possibility of losses being
incurred within each of the above categories of loans. These figures are based
on gross loans. The allocation of the allowances as shown in the table above
should not be interpreted as an indication that loan losses in future years will
occur in the same proportions or that the allocation indicates future loan loss
trends. Furthermore, the portion allocated to each loan category is not the
total amount available for future losses that might occur within such categories
since the total allowance is a general allowance applicable to the entire
portfolio.
INVESTMENT ACTIVITIES
The following table sets forth the Bancorp's investment portfolio as of
the periods indicated:
<TABLE>
<CAPTION>
December 31, December 31, December 31,
1998 1997 1996
------------------- ----------------- -----------------
(amounts in thousands)
<S> <C> <C> <C>
Available-for-sale securities:
FHLMC preferred stock $ 3,808 $ 3,866 $ 4,310
FHLMC MBS 11,996 - -
GNMA MBS 3,826 - -
FNMA MBS 29,671 782 903
Collateralized mortgage obligations 1,527 - -
Commercial MBS 18,044 - -
Obligations of counties and municipalities 3,234 - -
Corporate obligations 989 - -
U.S. Government agency obligations 949 - -
------------------- ----------------- -----------------
$ 74,044 $ 4,648 $ 5,213
=================== ================= =================
Held-to-maturity securities:
FHLMC MBS $ 4,091 $ 6,078 $ 7,300
GNMA MBS 24,305 42,471 27,388
FNMA MBS 6,780 27,075 21,982
Collateralized mortgage obligations 1,015 4,203 6,547
Obligations of counties and municipalities 1,960 - -
U.S. Government agency obligations - 642 2,000
------------------- ----------------- -----------------
$ 38,151 $ 80,469 $ 65,217
=================== ================= =================
</TABLE>
SOURCE OF FUNDS
DEPOSITS
Deposit accounts have been the primary source of the Bancorp's funds for
use in lending, making other investments, and for other general business
purposes. In addition to deposits, Southern Financial obtains funds from loan
repayments, maturing investments, loan sales, cash flows generated from
operations and FHLB advances. Borrowings may be used as an alternative source of
lower costing funds or to fund the origination of certain assets.
<PAGE>
The following table shows the average balances and rates
(presented on a monthly average basis) for the Bancorp's deposits for the
periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
(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%
--------------- --------------- ---------------
$ 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 December 31,
1998:
Time Deposits of
Maturity Period $100,000 or More
- --------------- -----------------------
(amounts in thousands)
Three months or less $ 28,038
Over three months through twelve months 21,114
Over twelve months 5,008
-----------------------
Total $ 54,160
=======================
BORROWINGS
Borrowings consist of short-term advances from the Federal Home Loan
Bank of Atlanta ("FHLB"). The following table sets forth information regarding
the Bancorp's borrowings for the periods indicated:
Year Ended
December 31,
1998 1997 1996
- -------------------------------------------------------------------------------
Ending Balance $ 3,500 $ 4,000 $ 8,500
Average Balance for the Period 4,907 5,979 6,077
Maximum Month-end Balance
During the Period 13,500 8,500 12,000
Average Interest Rate for the Period 5.50% 5.59% 5.63%
Weighted Average Interest Rate at
the End of the Period 5.15% 5.95% 6.57%
<PAGE>
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 Bank's Board of Directors approved a Plan to mitigate the
risks associated with the Year 2000.
This Plan, which is managed as outlined by the Federal Financial
Institutions Examination Council ("FFEIC") addresses the essential five phases:
Awareness, Assessment, Renovation, Validation and Implementation.
The Awareness and Assessment phases of the Plan were completed in 1998.
The Bank has ensured that customers received statement stuffers and newsletters
apprising them of the status of the Plan. Year 2000 status updates have been
incorporated into the Bank's website, www.southernfinancialbank.com and are
regularly updated. The Bank contacted its material business partners to
determine their state of readiness and the potential impact on the Company by
sending letters to them requesting updates on their own year 2000 initiatives.
Through these endeavors, systems were upgraded and tested to ensure meeting Year
2000 Readiness. Those systems that do not meet Year 2000 requirements have been
replaced.
The phases of the Plan which include Renovation, Validation and
Implementation were completed by December 31, 1998. The Bank completed upgrading
and/or replacements of the entire Bank's branch operating computer systems ahead
of schedule. The upgrades and/or replacements of the computers were necessitated
by the requirement to perform end-to-end testing with Intrieve, Inc, the Bank's
data processing system provider, on November 8, 1998. All Intrieve-related
systems passed the Year 2000 performance test. Additionally, the EFT operating
systems have been tested to confirm the capability to receive and send account
information. EFT systems include the ATM Network and Direct Teller System.
Through a partnership with Intrieve, Inc., OnLine Resources Corporation,
("ORCC"), based in McLean, Va., manages Southern OnLine, the bank's remote
banking service, with all transactions flowing through the EFT system. ORCC
received Year 2000 certification in February 1999. Testing between Intrieve and
ORCC will be scheduled for the second quarter of 1999. Since Intrieve, Inc., is
responsible for the major portion of the Bank's Year 2000 Plan, continued focus
will be directed throughout 1999. Intrieve is actively addressing all issues
associated with this time critical issue. Intrieve has completed the upgrades
for its mission critical system for Year 2000 Readiness. Additionally,
throughout 1999, Intrieve, Inc., will continue to test and further develop their
systems.
The Bank, as well as Intrieve, Inc., is focusing on the completion of
its Year 2000 Contingency Plan, which is due for completion June 30, 1999. This
critical phase of the Plan provides the details concerning how the Bank will
operate in the event there are system failures, power failures, etc. Southern
Financial's 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 the Bank'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, Inc.,
has implemented two additional services, the first being a special trial balance
run on December 25, 1999. This information will prove to be critical if 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, the Bank had
incurred approximately $50 thousand of costs to become Year 2000 compliant.
Intrieve, Inc., the Bank's data processing system provider, has made substantial
investments in software and hardware to become Year 2000 compliant. Costs
related to these investments have not been passed on to Southern Financial.
The costs of the project and the date on which the Bank plans to
complete the Year 2000 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.
<PAGE>
REGULATION
Set forth below is a brief description of certain laws and regulations
that relate to the regulation of Southern Financial. The description of these
laws and regulations, as well as descriptions of laws and regulations contained
elsewhere herein, does not purport to be complete and is qualified in its
entirety by reference to applicable laws and regulations.
GENERAL
Southern Financial is a bank holding company within the meaning of the
Bank Holding Company Act of 1956 as amended. As a bank holding company, Southern
Financial is supervised by the Board Of Governors of the Federal Reserve System
("FRB") and is required to file reports with the FRB and provide such additional
information as the FRB may require. Southern Financial is also subject to
Virginia laws regarding financial institution holding companies administered by
the Bureau of Financial Institutions of the State Corporation Commission of
Virginia. The Bank is also affected by rules and regulations of the Federal
Deposit Insurance Corporation ("FDIC"). Southern Financial is a member of the
Federal Reserve System and the FHLB of Atlanta. The various laws and regulations
administered by the regulatory agencies affect corporate practices, expansion of
business, and provisions of services. Also, monetary and fiscal policies of the
United States directly affect bank loans and deposits and thus may affect the
Bancorp's earnings. The future impact of these policies and of the continuing
regulatory changes in the financial services industry cannot be predicted.
FIRREA
Under the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989 ("FIRREA"), certain independent appraisal requirements are imposed upon
a bank's real estate lending activities, and certain loan-to-value restrictions
are imposed on a bank's real estate lending activities. The Bancorp's regulators
have promulgated regulations in these areas. Further, under FIRREA the failure
to meet capital guidelines could subject a bank to a variety of enforcement
remedies available to federal regulatory authorities, including termination of
deposit insurance by the FDIC.
FDICIA
The Federal Deposit Insurance Corporation Act of 1991 ("FDICIA"), which
became law in December, 1991, required each federal banking agency to revise its
risk-based capital standards to ensure that those standards take adequate
account of interest rate risk, concentration of credit risk and the risks of
non-traditional activities. In addition, pursuant to FDICIA, each federal
banking agency has promulgated regulations, specifying the levels at which a
financial institution would be considered "well capitalized", "adequately
capitalized", "under capitalized", "significantly under capitalized", or
"critically under capitalized", and to take certain mandatory and discretionary
supervisory actions based on the capital level of the institution.
Under the FRB's regulations implementing the prompt corrective action
provisions, an institution shall be deemed to be (i) "well capitalized" if it
has total risk-based capital of 10% or more, has a Tier I risk-based capital
ratio of 6% or more, has a leverage capital ratio of 5% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii)"adequately capitalized" if it has a
total risk-based capital ratio of 8% or more, a Tier I risk-based ratio of 4% or
more and a leverage capital ratio of 4% or more (3% under certain circumstances)
and does not meet the definition of "well capitalized", (iii) "undercapitalized"
if it has a total risk-based capital ratio that is less than 8%, a Tier I
risk-based capital ratio that is less than 4% or a leverage capital ratio that
is less than 4% (3% in certain circumstances), (iv) "significantly
undercapitalized" if it has a total risk-based capital ratio that is less than
6%, a Tier I risk-based capital ratio that is less than 3% or a leverage capital
ratio that is less than 3% and (v) "critically undercapitalized" if it has a
ratio of tangible equity to total assets that is equal to or less than 2%. In
addition, under certain circumstances, a federal banking agency may reclassify a
well capitalized institution as adequately capitalized and may require an
adequately capitalized institution or an undercapitalized institution to comply
with supervisory actions as if it were in the next lower category (except that
the FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized). Immediately upon becoming undercapitalized, or
upon failing to submit or implement a capital plan as required, an institution
shall become subject to various regulatory restrictions.
FDICIA also contained the Truth in Savings Act, which requires certain
disclosures to be made in connection with deposit accounts offered to consumers.
The FRB has adopted regulations implementing the provisions of the Truth in
Savings Act.
In addition, significant provisions of FDICIA required federal banking
regulators to draft standards in a number of other important areas to assure
bank safety and soundness, including internal controls, information systems and
internal audit systems, credit underwriting, asset growth, compensation, loan
documentation and interest rate exposure. FDICIA also required the regulators to
establish maximum ratios of classified assets to capital, and minimum earnings
sufficient to absorb losses without impairing capital. The legislation also
contained other provisions which restricted the activities of state-chartered
banks, amended various consumer banking laws, limited the ability of "under
capitalized" banks to borrow from the Federal Reserve's discount window, and
required federal banking regulators to perform annual onsite bank examinations
and set standards for real estate lending.
REGULATORY CAPITAL REQUIREMENT
The Federal Reserve Board mandates minimum capital requirements for bank
holding companies. In 1990, the FRB adopted a risk based capital measure to
determine capital adequacy. Under this system all balance sheet assets are
assigned a certain risk category with a prescribed weight. Off-balance sheet
items, such as loan commitments and letters of credit, also are classified by
risk with duly assigned weights. The sum of the balance sheet and off balance
sheet amounts multiplied by their respective risk weight factors must then meet
a required minimum capital test. Tier 1 capital is defined as stockholders'
equity minus certain intangible assets. Tier 2 capital includes a certain amount
of the allowance for loan losses. At December 31, 1998, the minimum total
capital ratio (Tier 1 plus Tier 2) required was 8 percent. Southern Financial's
Tier 1 ratio of 13.4% and its total capital ratio of 14.8% were well in excess
of minimum requirements. The FRB also utilizes a Tier 1 leverage ratio in
conjunction with its risk based capital standard. This ratio measures Tier 1
capital as a percent of total average assets less intangible assets. The minimum
leverage ratio is 4 percent. At December 31, 1998, the Bancorp's leverage ratio
was 8%.
<PAGE>
DEPOSIT INSURANCE
The deposits of the Bancorp are currently insured to a maximum of
$100,000 per depositor, subject to certain aggregation rules. The FDIC has
implemented a risk-related assessment system for deposit insurance premiums. All
depository institutions have been assigned to one of nine risk assessment
classifications based on certain capital and supervisory measures. The Bancorp's
deposits are subject to the rates of the Savings Associations Insurance Fund
("SAIF") since Southern Financial converted to a commercial bank from a federal
savings bank on December 1, 1995. Based on the Bancorp's current risk
classification, the Bancorp is required to pay the minimum SAIF assessment.
FEDERAL HOME LOAN BANK SYSTEM
Southern Financial is a member of the Federal Home Loan Bank System
which consists of 12 district Federal Home Loan Banks ("FHLBs") with each
subject to supervision and regulation by the Federal Housing Finance Board. The
FHLBs provide a central credit facility for member institutions. The Bancorp, as
a member of the FHLB of Atlanta, is required to acquire and hold shares of
capital stock in that FHLB in an amount equal to at least 1% of the aggregate
principal amount of its unpaid residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each year, or 5% of its
advances (borrowings) from the FHLB of Atlanta, whichever is greater. At
December 31, 1998, Southern Financial had an investment of $1.1 million in the
stock of the FHLB of Atlanta and was in compliance with these requirements.
Advances from the FHLB of Atlanta are secured by mortgage-backed
securities. Interest rates charged for advances vary depending upon maturity,
the cost of funds to the FHLB of Atlanta and the purpose of the borrowing. At
December 31, 1998, Southern Financial had $3.5 million outstanding in borrowings
from the FHLB of Atlanta.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board of Governors requires all depository
institutions to maintain reserves against their transaction accounts (primarily
NOW and Super NOW checking accounts) and non-personal time deposits. Because
required reserves must be maintained in the form of vault cash or a
noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce the earning assets of Southern Financial
SUBSEQUENT EVENT
Southern Financial has signed a letter of intent in principal for a
merger with The Horizon Bank of Virginia. Southern Financial 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 Southern Financial and
The Horizon Bank of Virginia, closing of the merger is anticipated to occur in
the third quarter of 1999.
<PAGE>
ITEM 2. PROPERTIES
OFFICES AND OTHER MATERIAL PROPERTIES
At December 31, 1998, the Bancorp conducted its business from its main
office in Warrenton, Virginia and ten branch offices. The following table sets
forth certain information with respect to the offices of the Bancorp as of
December 31, 1998:
<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
=====================================================================================
</TABLE>
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
Neither the Bancorp nor the Bank is a party to, nor is any of their
property the subject of, any material pending legal proceedings incidental to
the business of the Bancorp and its subsidiary other than those arising in the
ordinary course of business. Although the amount of any ultimate liability with
respect to such matters cannot be determined, in the opinion of management, any
such liability will not have a material adverse effect on the consolidated
financial position or results of operations of the Bancorp.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference from page
36 of the Annual Report.
ITEM 6. SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference from page 1
of the Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.
The information required herein is incorporated by reference from pages 6
through 13 of the Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The information required herein is incorporated by reference from pages 11
through 13 of the Annual Report.
ITEM 8. FINANCIAL STATEMENTS.
The information required herein is incorporated by reference from pages 14
through 33 of the Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required herein is incorporated by reference from pages
3 through 8 of the definitive proxy statement of Southern Financial Bancorp,
Inc. filed on March 23, 1999 ("Definitive Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from pages 10
through 12 of the Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference from pages 7
through 9 of the Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from page 6
of the Definitive Proxy Statement.
<PAGE>
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON
FORM 8-K.
(a) Documents filed as a part of the report:
(1) The following is an index to the financial statements of the
Registrant included in the Annual Report to Stockholders for the
year ended December 31, 1998, and incorporated herein by reference
in Item 8. The remaining information appearing in the Annual Report
to Stockholders is not deemed to be filed as part of this Report,
except as expressly provided herein.
Page(s) in
Annual Report
Independent Auditors' Report. 14
Balance Sheets:
December 31, 1998 and December 31, 1997. 15
Statements of Income:
Years Ended December 31, 1998, 1997 and 1996, 16
Statements of Comprehensive Income:
Years Ended December 31, 1998, 1997 and 1996 17
Statements of Changes in Stockholders' Equity:
Years Ended December 31, 1998, 1997 and 1996, 18
Statements of Cash Flows:
Years Ended December 31, 1998, 1997 and 1996, 19
Notes to Consolidated Financial Statements. 20 - 33
(2) All other schedules have been omitted as the required information is
either inapplicable or included in the Notes to Financial
Statements.
(3) Exhibits (listed numbers correspond to item 601 of Regulation S-K)
(3) Articles of Incorporation of Southern Financial Bancorp,
Inc., by reference to the Form S-4 Registration Statement
filed with the Securities and Exchange Commission on August
4, 1995, and By-Laws, by reference to Form S-4 Registration
Statement filed with the Securities and Exchange Commission
on August 4, 1995.
(4) Instruments Defining the Rights of Security Holders,
Including Indentures--Reference is made to Exhibit (3)
above.
(9) Voting Trust Agreement--Not applicable.
(11) Statement re Computation of Per Share Earnings--Reference
is made to Note 1 and Note 14 to Financial Statements, Page
21and Page 33, respectively, in Annual Report.
(12) Statement re Computation of Ratios--Not applicable.
(13) Pages 14-33 of Annual Report to Stockholders for the Year
Ended December 31, 1998.
(18) Letter re Change in Accounting Principles--Not applicable.
<PAGE>
(21) Subsidiaries of the registrant:
Percentage of Voting
Jurisdiction of Securities Owned by
Name Incorporation the Parent
---- --------------- --------------------
Southern Financial Bank Virginia 100%
(22) Published Report Regarding Matters Submitted to Vote of
Security Holders--Not applicable.
(23) (a) Consent of KPMG LLP
(23) (b) Consent of Arthur Andersen LLP
(24) Power of Attorney - Not applicable
(28) Information from Reports Furnished to State Insurance
Regulatory Authorities - Not applicable
(b) No reports on Form 8-K were filed during the quarter ended December 31,
1998.
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
SOUTHERN FINANCIAL BANCORP, INC.
By: /s/ Georgia S. Derrico
---------------------------------
Georgia S. Derrico
Chairman of the Board and Chief
Executive Officer
Dated: March 31, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ Georgia S. Derrico Director and Chairman of March 31, 1999
- ------------------------ the Board and Chief
Georgia S. Derrico Executive Officer
/s/ R. Roderick Porter Director and President and March 31, 1999
- ------------------------ Chief Operating Officer
R. Roderick Porter
/s/ David de Give Director and Senior Vice March 31, 1999
- ------------------------ President/Treasurer
David de Give
/s/ William H. Lagos Senior Vice President/Controller March 31, 1999
- ------------------------ (Principal Accounting Officer)
William H. Lagos
/s/ Virginia Jenkins Director March 31, 1999
- ------------------------
Virginia Jenkins
/s/ Neil J. Call Director March 31, 1999
- ------------------------
Neil J. Call
/s/ John L Marcellus, Jr. Director March 31, 1999
- ------------------------
John L. Marcellus, Jr.
/s/ Michael P. Rucker Director March 31, 1999
- ------------------------
Michael P. Rucker
</TABLE>
<PAGE>
INDEX TO EXHIBITS
Number and Descriptions
13 Southern Financial Bancorp, Inc.
December 31, 1998 Annual Report to Stockholders
23 (a) Consent of KPMG LLP
23 (b) Consent of Arthur Andersen LLP
27 Financial Data Schedule
Exhibit 13
Southern Financial Bancorp, Inc.
December 31, 1998 Annual Report to Stockholders
<TABLE>
(dollars in thousands, except per share data)
at December 31, at June 30,
------------------------------------------------------------------------------
Financial Condition 1998 1997 1996 1995 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total Assets $ 258,843 $ 226,598 $190,809 $164,801 $157,201
Net Loans 131,645 128,958 108,287 104,251 92,080
Total Deposits 231,926 202,200 164,279 143,814 137,680
Stockholders' Equity 20,923 18,543 16,401 15,775 15,173
Six Months
Year Ended Ended Year Ended
December 31, December 31, June 30,
---------------------------------------------- ------------------------------
Results of Operations 1998 1997 1996 1995 1995
- ----------------------------------------------------------------------------------------------------------------------
Interest Income $ 18,731 $ 17,005 $14,615 $6,731 $11,027
Interest Expense 10,205 9,043 7,776 3,629 5,931
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income 8,526 7,962 6,839 3,101 5,095
Provision for Loan Losses 975 880 695 150 60
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income After
Provision for Loan Losses 7,551 7,082 6,144 2,951 5,035
Other Income 2,347 1,728 1,186 514 814
Special SAIF Assessment 0 0 830 0 0
Other Expense 6,155 5,582 5,077 2,316 3,716
- ----------------------------------------------------------------------------------------------------------------------
Income before Taxes 3,743 3,228 1,423 1,150 2,134
Provision for Income Taxes 1,084 1,022 469 414 833
- ----------------------------------------------------------------------------------------------------------------------
NET INCOME 2,659 2,206 954 735 1,301
- ----------------------------------------------------------------------------------------------------------------------
Per Common Share Data:
Net Income Diluted $ 1.55 $ 1.33 $ 0.59 $ 0.46 $ 0.85
Dividends Paid per Share $ 0.365 $ 0.28 $ 0.24 $ 0.12 $ 0.20
Book Value per Share $ 12.87 $ 11.47 $ 10.32 $ 10.05 $ 9.82
Weighted Average Diluted Shares
Outstanding 1,713,815 1,657,706 1,621,958 1,608,231 1,530,255
Actual Shares Outstanding 1,603,220 1,591,679 1,564,248 1,385,092 1,369,149
Cumulative Convertible Preferred Stock
Actual Shares Outstanding 13,621 15,634 15,634 16,634 16,634
at or for the
Six Months at or for the
at or for the Ended Year Ended
Year Ended December 31, December 31, June 30,
---------------------------------------------- ------------------------------
Growth & Financial Ratios 1998 1997 1996 1995 1995
- ----------------------------------------------------------------------------------------------------------------------
% Change in Equity 12.84% 13.06% 3.97% 3.97% 8.23%
% Change in Assets 14.23% 18.76% 15.78% 4.83% 26.66%
% Change in Loans 2.08% 19.09% 3.87% 13.22% 37.52%
Equity/Assets Ratio 8.08% 8.18% 8.60% 9.57% 9.65%
Return on Average Assets 1.09% 1.05% 0.52% 0.91% 0.90%
Operating Expense to
Average Assets 2.53% 2.66% 3.25% 2.88% 2.56%
Return on Average Equity 13.52% 12.70% 5.91% 9.50% 8.95%
Net Interest Margin 3.66% 3.92% 3.93% 3.98% 3.60%
Efficiency Ratio 56.61% 57.61% 73.61% 64.05% 62.88%
Other Data:
Number of Full Service Branches 11 10 10 9 9
Number of ATMs 10 9 8 7 7
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW. 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 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. 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 $129 million at December 31, 1997. During the year ended December 31, 1998,
the Bancorp continued to emphasize loan originations connected with various
lending programs of the U.S. Small Business Administration (SBA). In addition,
the Bancorp 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. 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. The Bancorp
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 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
1
<PAGE>
reflects the April 1998 opening of a new branch in Sterling, as well as growth
in the Bank's customer base at all branches.
Advances from the Federal Home Loan Bank of Atlanta ("FHLB") totaled
$3.5 million at December 31, 1998, a decrease of $.5 million from $4.0 million
at December 31, 1997.
RESULTS OF OPERATION
The operating results of the Bank depend primarily on its net interest
income, which is the difference between interest and dividend income on
interest-earning assets, such as loans and investments, and interest expense on
interest-bearing liabilities such as deposits and borrowings. Operating results
are also affected by the level of its noninterest income, including income or
loss from the sale of loans and fees and service charges on deposit accounts,
and by the level of its operating expenses, including compensation, premises and
equipment, deposit insurance assessments and income taxes. The following tables
provide information regarding changes in interest income and interest expense,
as well as the underlying components of interest-earning assets and
interest-bearing liabilities.
The following table presents, for the periods indicated, average monthly
balances of and weighted average yields on interest-earning assets and average
balances and weighted average effective interest paid on interest bearing
liabilities.
The subsequent table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning asset and interest-bearing liability, information is provided
on changes attributable to changes in volume (changes in volume multiplied by
old rate) and changes in rates (changes in rates multiplied by old volume). The
dollar amount changes in interest income and interest expense attributable to
changes in rate/volume (change in rate multiplied by change in volume) have been
allocated between rate and volume variances based on the percentage relationship
of such variances to each other.
2
<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>
<TABLE>
Rate /Volume Analysis
(in thousands)
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 $ 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>
3
<PAGE>
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 WITH THE YEAR ENDED DECEMBER 31,
1997
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. The Bancorp has established the allowance for loan losses to absorb
the inherent risk in lending after considering an evaluation of the loan
portfolio, current economic conditions, changes in the nature and volume of
lending and past loan experience. During the year ended December 31, 1998, the
Bank's volume of nonresidential mortgages and commercial loans increased. These
loans tend to carry a higher risk classification. The increase in the provision
for loan losses reflects the growth in the portfolio as well as the change in
the type of loans. The Bank's opinion is that the allowance for loan losses at
December 31, 1998 remains adequate. Although the Bank believes that the
allowance is adequate, there can be no assurances that additions to such
allowance will not be necessary in future periods, which would adversely affect
the Bank's results of
4
<PAGE>
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.
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 the Bancorp 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
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
5
<PAGE>
yield on average investment securities increased from 6.35% during 1996 to 6.48%
for the year ended December 31, 1997. The greater increase in lower yielding
investment securities than in loans caused the overall average yield to remain
flat as compared to 1996.
TOTAL INTEREST EXPENSE. Total interest expense for the year ended
December 31, 1997 was $9.0 million, an increase of 16.3% over $7.8 million for
the year ended December 31, 1996. This increase was due primarily to growth in
the average balance of deposits, which were $184.3 million for the year ended
December 31, 1997 compared to $158.2 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.76% for the year ended
December 31, 1997, an increase of only 3 basis points from 4.73% for the year
ended December 31, 1996.
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, the Bank's volume of nonresidential mortgages and
commercial loans increased. These loans tend to carry a higher risk
classification. The increase in the provision for loan losses reflects the
growth in the portfolio as well as the change in the type of loans. The
allowance for loan losses at December 31, 1997 was $2.0 million, or 1.55% of
total loans receivable compared to $1.5 million, or 1.37% at December 31, 1996.
OTHER INCOME. Other income totaled $1.7 million for the year ended
December 31, 1997, an increase of 45.7%, from $1.2 million for the year ended
December 31, 1996. The increase was attributable primarily to fee income, which
increased by 52.3% to $1.4 million for the year ended December 31, 1997 from
$950 thousand for the prior year. Fee income, consisting primarily of
transaction fees on NOW accounts, increased due to increased volume in these
types of deposit accounts. Gain on sale of loans decreased 8.7% to $192 thousand
for the year ended December 31, 1997 from $210 thousand for the year ended
December 31, 1996, reflecting lower originations of residential loans held for
sale which decreased 20.0% to $8.4 million for the year ended December 31, 1997
from $10.5 million for the year ended December 31, 1996.
OTHER EXPENSES. Other expenses for the year ended December 31, 1997 were
$5.6 million, a decrease of 5.5% from $5.9 million for the year ended December
31, 1996. There were increases in most expense categories, such as employee
compensation and benefits, premises and equipment, and advertising during 1997,
but they were more than offset by the significant decrease in deposit insurance
assessments.
Employee compensation and benefits increased 17.9% to $2.5 million for
the year ended December 31, 1997 from $2.1 million for the prior year. The
increase reflects the cost of staffing the new branch opened in July 1996 for a
full year, as well as increased staffing levels to accommodate growth in the
Bank's customer base and normal wage increases for existing personnel.
Expenses for premises and equipment increased 15.6% to $1.8 million for
the year ended December 31, 1997 from $1.6 million for the year ended December
31, 1996. This increase is primarily the result of operating the Millwood branch
opened in June 1996 for a full year and the cost associated with relocating the
Fairfax branch during 1997. Data processing costs also increased $92 thousand
because of growth in the number of accounts and transaction volumes related to
customer deposits.
Deposit insurance assessments decreased from $1.1 million for the year
ended December 31, 1996 to $109 thousand for the year ended December 31, 1997.
The 1996 expense reflected a one-time assessment on thrifts and banks with
thrift deposits to recapitalize the Savings Association Insurance Fund. The
Bank's one-time assessment was $830 thousand.
6
<PAGE>
Advertising expense increased 49.9% to $214 thousand for the year ended
December 31, 1997 from $143 thousand for the prior year because of an increased
reliance on advertising to expand the Bank's customer base.
Other expenses remained relatively constant during the year ended
December 31, 1997 compared to the prior year.
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 Bank's residential mortgage loan portfolio, it is
Southern Financial's policy to keep in portfolio those mortgage loans which have
an adjustable interest rate and to sell most fixed rate mortgage loans
originated into the secondary market. In addition, the Bank's commercial loans
generally have rates that are tied to the prime rate, the one-year CMT rate, or
the three-year CMT rate. Both of these policies help control Southern
Financial's exposure to rising interest rates.
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, the Bank 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.
As a result of the restructuring, the Bancorp's interest sensitivity
increased. The Bancorp's interest rate sensitivity is primarily monitored by
management through the use of a model which generates estimates of the change in
the Bancorp's market value of portfolio equity ("MVPE") over a range of interest
rate scenarios. Such analysis was prepared by a third party for Southern
Financial. MVPE is the present value of expected cash flows from assets,
liabilities, and off-balance sheet contracts using standard industry assumptions
about estimated loan prepayment rates, reinvestment rates, and deposit decay
rates. The following table sets forth an analysis of the Bancorp's interest rate
risk as measured by the estimated change in MVPE resulting from instantaneous
and sustained parallel shifts in the yield curve (plus or minus 400 basis
points, measured in 100 basis point increments) as of December 31, 1998.
7
<PAGE>
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rate Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------
Up 400 $18,296 ($7,308) -28.54% 7.07% 87.44%
Up 300 20,448 (5,156) -20.14% 7.90% 97.73%
Up 200 22,601 (3,003) -11.73% 8.73% 108.01%
Up 100 24,102 (1,502) -5.86% 9.31% 115.19%
Base 25,604 - 0.00% 9.89% 122.37%
Down 100 27,372 1,768 6.91% 10.58% 130.82%
Down 200 29,141 3,537 13.82% 11.26% 139.27%
Down 300 32,464 6,860 26.80% 12.54% 155.15%
Down 400 35,788 10,184 39.78% 13.83% 171.04%
Southern Financial's interest rate sensitivity is also monitored by
management through the use of a model that generates estimates of the change in
the adjusted net interest income over a range of interest rate scenarios. Such
analysis was also prepared by a third party for the Bancorp. Net interest income
represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities. Net interest income also depends upon the
relative amounts of interest-earning assets and interest-bearing liabilities and
the interest rate earned or paid on them. In this regard, the model assumes that
the composition of the Bancorp's interest sensitive assets and liabilities
existing at the beginning of a period remains constant over the period being
measured and also assumes that a particular change in interest rates is
reflected uniformly across the yield curve regardless of the duration to
maturity or repricing of specific assets and liabilities.
8
<PAGE>
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 400 $7,105 -10.79% 2.75% -0.33%
Up 300 7,501 -5.83% 2.90% -0.18%
Up 200 7,896 -0.87% 3.05% -0.03%
Up 100 7,930 -0.43% 3.06% -0.01%
Base 7,965 0.00% 3.08% 0.00%
Down 100 8,112 1.85% 3.13% 0.06%
Down 200 8,260 3.70% 3.19% 0.11%
Down 300 8,653 8.64% 3.34% 0.27%
Down 400 9,046 13.58% 3.50% 0.42%
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in MVPE and in Sensitivity of
Net Interest Income require the making of certain assumptions which may or may
not reflect the manner in which actual yields and costs respond to changes in
market interest rates. Accordingly, although the MVPE table and Sensitivity of
Net Interest Income table provide an indication of the Bancorp's interest rate
risk exposure at a particular point in time, such measurements are not intended
to and do not provide a precise forecast of the effect of changes in market
interest rates on the Bancorp's worth and net interest income.
In January 1999, the Bank entered into four interest rate swaps with
maturities from five to ten years in an aggregate notional amount of $20 million
designed to offset part of the interest rate risk resulting from the increase in
fixed-rate investment securities.
LIQUIDITY AND CAPITAL RESOURCES
Southern Financial's principal sources of funds are deposits, loan
repayments, proceeds from the sale of loans, repayments from mortgage-backed
securities, repayments from federal agency bonds, FHLB advances, other
borrowings and retained income.
At December 31, 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 FHLB 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
9
<PAGE>
risk-weighted assets; (c) tier I and II capital of 8% of risk-weighted assets.
At December 31, 1998, the Bank's capital ratios were 8% leverage capital; 13.4%
tier I capital; and 14.8% tier I and II capital.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related notes presented herein have been
prepared in accordance with generally accepted accounting principles. These
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing power
of money over time due to inflation.
Unlike many industrial companies, substantially all of the assets and
virtually all of the liabilities of Southern Financial are monetary in nature.
As a result, interest rates have a more significant impact on the Bank's
performance than the effects of general levels of inflation. Interest rates may
not necessarily move in the same direction or in the same magnitude as the
prices of goods and services. However, other expenses do reflect general levels
of inflation.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
Quarterly Report and the documents incorporated herein by reference constitute
"forward-looking statements" within the meaning of the United States Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Bancorp, or industry
results, to be materially different from any future results, performance, or
achievements expressed or implied by such forward-looking statements. Such
factors include, among others, the following: general economic and business
conditions in the Bancorp's market area, inflation, fluctuations in interest
rates, changes in government regulations and competition, which will, among
other things, impact demand for loans and banking services; the ability of the
Bancorp to implement its business strategy; and changes in, or the failure to
comply with, government regulations.
Forward-looking statements are intended to apply only at the time they
are made. Moreover, whether or not stated in connection with a forward-looking
statement, the Bancorp undertakes no obligation to correct or update a
forward-looking statement should the Bancorp later become aware that it is not
likely to be achieved. If the Bancorp were to update or correct a
forward-looking statement, investors and others should not conclude that the
Bancorp will make additional updates or corrections thereafter.
10
<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.
Washington, D.C.,
February 2, 1999
11
<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.
12
<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 losse7,551,280 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.
13
<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.
14
<PAGE>
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
Convertible Capital in
Preferred Common Excess of Retained Treasury
Stock Stock Par Value Earnings Stock
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 $ 166 $ 13,912 $ 12,796,014 $ 3,050,284 $ (99,990)
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 - - - - -
Net income - - - 953,712 -
- ------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 156 15,941 15,276,373 1,655,575 (471,087)
Dividends on preferred and common stock - - - (455,344) -
Options exercised - 275 280,509 - -
Change in other comprehensive income - - - - -
Net income - - - 2,206,270 -
- ------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 156 16,216 15,556,882 3,406,501 (471,087)
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 - - - - -
Net income - - 2,658,761 -
- ------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 $ 136 $ 16,331 $ 15,648,527 $ 5,469,135 $ (471,087)
- ------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Accumulated
Other Total
Comprehensive Stockholders'
Income Equity
- ------------------------------
<S> <C> <C>
$ 14,685 $ 15,775,071
- (360,971)
- -
- 495,372
- -
- (371,541)
(90,691) (90,691)
- 953,712
- ------------------------------
(76,006) 16,400,952
- (455,344)
- 280,784
109,939 109,939
- 2,206,270
- -----------------------------
33,933 18,542,601
- (596,127)
- -
- 91,740
225,765 225,765
- 2,658,761
- ------------------------------
$ 259,698 $ 20,922,740
- ------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements
15
<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.
16
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
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 as of December 31, 1998 and 1997, and for the years
ended December 31, 1998, 1997 and 1996. 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.
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
17
<PAGE>
and anticipated general economic conditions and the value and adequacy of
collateral. Changes in the estimate of future losses may occur due to changing
economic conditions and the economic conditions of borrowers.
A loan is considered impaired when, based on all current information and
events, it is probable that the Bancorp will be unable to collect all amounts
due according to the contractual terms of the agreement, including all scheduled
principal and interest payments. Such impaired loans are measured based on the
present value of expected future cash flows, discounted at the loan's effective
interest rate or, as a practical expedient, impairment may be measured based on
the loan's observable market price, or if, the loan is collateral - dependent,
the fair value of the collateral. When the measure of the impaired loan is less
than the recorded investment in the loan, the impairment is recorded through a
valuation allowance. Loans for which foreclosure is probable continue to be
accounted for as loans.
Each impaired loan is evaluated individually to determine the income
recognition policy. Generally, payments received are applied in accordance with
the contractual terms of the note or as a reduction of principal.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Expenditures for maintenance and repairs that do not
materially prolong the useful lives of the assets are charged to expense as
incurred.
Depreciation is computed using the straight-line method over estimated
useful lives of three to ten years for furniture and equipment and 30 years for
buildings. Amortization of leasehold improvements is computed using the
straight-line method over the shorter of ten years or the lease term.
REAL ESTATE 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 as of October 1, 1998, which increased Stockholders'
Equity by $151.5 thousand.
18
<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:
19
<PAGE>
<TABLE>
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. Governmental ageny obligations 949,066 22,184 _ 971,240
-------------------------------------------------------------------------------------------------------------------
$74,044,026 $556,883 172,227 74,438,682
- --------------------------------------------------------------------------------------------------------------------
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
- -------------------------------------------------------------------------------------------------------------------------
Available-for-sale: $ 3,865,985 $ 480,630 $ 39,054 $ 3,907,561
FHLMC preferred stock 782,186 3,011 - 785,197
- -------------------------------------------------------------------------------------------------------------------------
FHLMC MBS $ 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
FNMA MBS 6,779,894 577,253 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
Obligations of counties and municipalities 641,932 - 1,932 640,000
- ---------------------------------------------------------------------------------------------------------------------
$80,468,952 $518,792 $191,815 $80,795,929
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
20
<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>
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>
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.
21
<PAGE>
<TABLE>
3. LOANS RECEIVABLE:
Loans receivable consist of the following:
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:
December 31,
1998 1997
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
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.
22
<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:
December 31,
1998 1997 1996
- --------------------------------------------------------------------------------
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
3. 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.
23
<PAGE>
5. DEPOSITS:
Deposits consist of the following:
<TABLE>
<CAPTION>
Decembr 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:
December 31,
1998 1997 1996
- --------------------------------------------------------------------------------
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
- --------------------------------------------------------------------------------
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.
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
24
<PAGE>
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>
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>
25
<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, 1997and 1996 is presented below. Average prices and
shares subject to options have been adjusted to reflect stock dividends.
<TABLE>
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
- -----------------------------------------------------
26
<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.)
<TABLE>
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>
27
<PAGE>
During 1996, the Bancorp paid an additional $830,270 one-time SAIF
assessment required by legislation to recapitalize the SAIF.
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:
Balance Sheets
December 31,
1998 1997
- ----------------------------------------------------------------------------
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
- ----------------------------------------------------------------------------
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 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:
28
<PAGE>
<TABLE>
($ 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.
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
29
<PAGE>
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:
Year Ended
December 31,
1998 1997 1996
- ------------------------------------------------------------------------------
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
- ------------------------------------------------------------------------------
Deferred income taxes reflect temporary differences in the recognition
of revenue and expenses for tax reporting and financial statement purposes,
principally because certain items, such as the allowance for loan losses and
loan fees, are recognized in different periods for financial reporting and tax
return purposes. A valuation allowance has not been established for deferred tax
assets. Realization of the deferred tax asset is dependent on generating
sufficient taxable income. Although realization is not assured, management
believes it is more likely than not that all of the deferred tax asset will be
realized.
Deferred tax assets and liabilities were comprised of the following
significant components as of December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Provision for losses on loans and real estate owned $269,986 $ 602,857
Deferred loan fees (213,565) (186,538)
Depreciation 131,726 111,006
Other 4,947 4,947
- --------------------------------------------------------------------------------------------
Gross deferred tax assets 193,094 532,272
- --------------------------------------------------------------------------------------------
Liabilities:
FHLB dividend 35,771 35,771
Valuation of loans and securities (134,183) (17,328)
- --------------------------------------------------------------------------------------------
Gross deferred tax liabilities (98,412) 18,443
- --------------------------------------------------------------------------------------------
Net deferred tax assets $291,506 $ 513,829
- --------------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory Federal income tax rate to
pretax income as a result of the following differences:
Year Ended
December 31,
1998 1997 1996
- --------------------------------------------------------------------------------
Pretax income 34% 34% 34%
Adjustment for prior year accrual (3%) -- --
Dividends received deduction (2%) (2%) (1%)
- --------------------------------------------------------------------------------
Effective tax rate 29% 32% 33%
- --------------------------------------------------------------------------------
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:
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.
31
<PAGE>
<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 23,657 25,223 26,660
--------- --------- ---------
Diluted EPS 1,713,815 $ 1.55 1,657,706 $ 1.33 1,621,958 $ 0.59
========= ====== ========= ====== ========= ======
</TABLE>
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>
32
<PAGE>
CORPORATE INFORMATION
ADDRESS:
37 East Main Street
Warrenton, Virginia 20186
(540) 349-3900
FAX: (540) 349-3904
FORM 10-K:
The Bank's Annual Report on Form 10-K to the Securities and Exchange Commission
will be furnished without charge to stockholders upon written request to:
MAGGIE BROMENSHENKEL
INVESTOR RELATIONS
37 E. MAIN STREET
WARRENTON, VIRGINIA 20186
REGISTRAR & TRANSFER AGENT:
Chase Mellon Shareholder Services
450 West 33rd Street
15th Floor
New York, New York 10001
(800) 526-0801
ANNUAL MEETING:
The Annual Meeting of stockholders of Southern Financial Bancorp, Inc. will be
held on April 29, 1999 at the Fauquier Springs Country Club, Springs Road,
Warrenton, Virginia commencing at 2:00 pm.
STOCK DATA:
NASDAQ Symbol SFFB
As of December 14, 1993, the Common Stock of Southern Financial Federal Savings
Bank commenced trading on the NASDAQ Small Cap Stock Market under the symbol
SFFB. On February 21, 1995, the Common Stock commenced trading on the NASDAQ
National Market under the symbol SFFB. On December 1, 1995, Southern Financial
Federal Savings Bank merged into Southern Financial Bank, a wholly owned
subsidiary of Southern Financial Bancorp, Inc. The Bancorp's Common Stock
continues to be traded under the NASDAQ National Market under the symbol SFFB.
As of December 1, 1998, there were approximately 252 stockholders of record, not
including the number of persons or entities whose stock is held in nominee or
"street" name through various brockerage firms or banks. The following table
sets forth the high and low stock prices for the periods indicated:
1998
HIGH LOW
1ST Quarter $30.00 $20.00
2nd Quarter 28.00 25.25
3rd Quarter 27.00 24.00
4th Quarter 24.75 21.00
<PAGE>
MARKET MAKERS
<TABLE>
<CAPTION>
<S> <C> <C>
Ferris, Baker, Watts, Inc. Friedman, Billings, Ramsey & Co. Scott & Stringfellow
(202) 429-3545 (703) 312-9531 (800) 552-7757
Herzog, Heine, Geduld, Inc. Ryan, Lee & Company, Inc. McKinnon & Co.
(800) 221-3600 (703) 847-3100 (703) 623-4636
</TABLE>
Exhibit 23 (a)
Consent of KPMG LLP
The Board of Directors
Southern Financial Bancorp, Inc.
We consent to the incorporation by reference in Registration Statement
Nos. 33-80285 and 33-80287 on Form S-8, and 333-00916 on Form S-3 of
Southern Financial Bancorp, Inc. of our report dated February 2, 1999,
relating to the consolidated balance sheets of Southern Financial
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, which report appears in
the December 31, 1998 annual report on Form 10-K of Southern Financial
Bancorp, Inc.
KPMG LLP
Washington, D.C.
March 30, 1999
Exhibit 23 (b)
Consent of Arthur Andersen LLP
The Board of Directors
Southern Financial Bancorp, Inc.
As independent public accountants, we hereby consent to the use of our
report dated February 4, 1997, included in Southern Financial Bancorp,
Inc.'s Form 10-K for the year ended December 31, 1998, and to all
references to our Firm included in this Form 10-K. It should be noted
that we have not audited any financial statements of Southern Financial
Bancorp, Inc. subsequent to December 31, 1996, or performed any audit
procedures subsequent to the date of our report.
Arthur Andersen LLP
Washington, D. C.
March 30, 1999
Report of Independent Public Accountants
To the Board of Directors of
Southern Financial Bancorp, Inc.
We have audited the consolidated statements of income, changes in
stockholders'equity and cash flows of Southern Financial Bancorp, Inc.
(a Virginia corporation) for the year ended December 31, 1996. These
financial statements are the responsibility of the Bancorp's management.
Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the results of operations and cash
flows of Southern Financial Bancorp, Inc for the year ended December 31,
1996 in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D. C.
February 4, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 5,374,945
<INT-BEARING-DEPOSITS> 928,435
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 74,438,682
<INVESTMENTS-CARRYING> 38,151,121
<INVESTMENTS-MARKET> 37,794,344
<LOANS> 134,532,992
<ALLOWANCE> 2,050,612
<TOTAL-ASSETS> 258,843,049
<DEPOSITS> 231,925,592
<SHORT-TERM> 3,500,000
<LIABILITIES-OTHER> 2,494,717
<LONG-TERM> 0
0
136
<COMMON> 16,331
<OTHER-SE> 21,117,662
<TOTAL-LIABILITIES-AND-EQUITY> 258,843,049
<INTEREST-LOAN> 12,365,456
<INTEREST-INVEST> 6,365,474
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 18,730,930
<INTEREST-DEPOSIT> 9,934,551
<INTEREST-EXPENSE> 270,099
<INTEREST-INCOME-NET> 8,526,280
<LOAN-LOSSES> 975,000
<SECURITIES-GAINS> 67,817
<EXPENSE-OTHER> 6,155,615
<INCOME-PRETAX> 3,743,061
<INCOME-PRE-EXTRAORDINARY> 3,743,061
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,658,761
<EPS-PRIMARY> 1.66
<EPS-DILUTED> 1.55
<YIELD-ACTUAL> 8.02
<LOANS-NON> 1,982,938
<LOANS-PAST> 94,157
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,700,959
<ALLOWANCE-OPEN> 2,036,532
<CHARGE-OFFS> 976,920
<RECOVERIES> 16,000
<ALLOWANCE-CLOSE> 2,050,612
<ALLOWANCE-DOMESTIC> 2,050,612
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 439,673
</TABLE>
