U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20459
FORM 10-Q
Quarterly Report under Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For the Quarter Ended: Commission File No.:
June 30, 1999 0-22836
SOUTHERN FINANCIAL BANCORP, INC.
Virginia 54-1779978
- ------------------------------ ----------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
37 East Main Street
Warrenton, Virginia 20186
- ------------------------------ -----------------------------------
(address of principal executive office) (Zip Code)
Registrant's Telephone Number, including area code: (540) 349-3900
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 for 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 _____
As of July 31, 1999, there were 1,610,673 shares of the registrant's Common
Stock outstanding.
2
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
JUNE 30, 1999
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
Number
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
as of June 30, 1999 (Unaudited) and
December 31, 1998 3
Consolidated Statements of Income for the
Three and Six Months Ended June 30, 1999 and 1998
(Unaudited)
4
Consolidated Statements of Comprehensive Income
for the Three and Six Months Ended June 30, 1999 and
1998 (Unaudited)
5
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998
(Unaudited)
6
Notes to Consolidated Financial Statements
(Unaudited) 7 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 - 17
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
PART III. SIGNATURES 19
- ----------------------------
</TABLE>
3
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30,
1999 December 31,
(Unaudited) 1998
----------- ------------
<S> <C>
ASSETS
Cash and due from banks $ 8,085,237 $ 5,374,945
Overnight earning deposits 3,984,530 928,435
Investment securities, available-for-sale 77,020,065 74,438,682
Investment securities, held-to-maturity 30,624,858 38,151,121
Loans held for sale 762,900 602,500
Loans receivable, net 140,039,080 131,645,482
Federal Home Loan Bank stock, at cost 1,253,700 1,082,500
Premises and equipment, net 2,870,763 2,370,711
Other assets 7,007,904 4,248,673
------------- --------------
Total assets $ 271,649,037 $ 258,843,049
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 247,449,555 $ 231,925,592
Advances from Federal Home Loan Bank - 3,500,000
Other liabilities 2,172,220 2,494,717
------------ -------------
Total liabilities 249,621,775 237,920,309
------------ -------------
Commitments
Stockholders' equity:
Preferred stock 136 136
Common stock 16,405 16,331
Capital in excess of par value 15,724,465 15,648,527
Retained earnings 6,587,083 5,469,135
Accumulated other comprehensive income 170,260 259,698
Treasury stock, at cost (471,087) (471,087)
------------- --------------
Total stockholders' equity 22,027,262 20,922,740
------------- --------------
Total liabilities and stockholders' equity $ 271,649,037 $ 258,843,049
============= ==============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
----------- ------------- --------------- -------------
<S> <C>
Interest income:
Loans $ 3,222,141 $ 3,104,518 $ 6,330,856 $ 6,210,820
Investment securities 1,778,186 1,514,394 3,583,119 2,971,014
----------- ------------- ------------- ------------
Total interest income 5,000,327 4,618,912 9,913,975 9,181,834
----------- ------------- ------------- ------------
Interest expense:
Deposits 2,407,562 2,455,354 4,844,305 4,901,042
Borrowings 104,492 43,540 207,325 83,107
----------- ------------- ------------- ------------
Total interest expense 2,512,054 2,498,894 5,051,630 4,984,149
----------- ------------- ------------- ------------
Net interest income 2,488,273 2,120,018 4,862,345 4,197,685
Provision for loan losses 395,000 225,000 670,000 450,000
----------- ------------- ------------- ------------
Net interest income after
provision for loan losses 2,093,273 1,895,018 4,192,345 3,747,685
----------- ------------- ------------- ------------
Other income:
Gain on sale of loans 268,191 81,715 540,768 219,678
Unrealized gain on interest rate swap 138,700 - 138,700 -
Fee income 387,404 336,069 790,420 679,997
Other 95,642 20,371 106,451 27,971
----------- ------------- ------------ ------------
Total other income 889,937 438,155 1,576,339 927,646
Other expense:
Employee compensation and benefits 943,609 713,740 1,840,051 1,371,025
Premises and equipment 351,339 271,395 650,823 520,396
Data processing expense 201,853 170,270 384,481 348,530
Deposit insurance assessments 33,546 31,020 67,602 61,085
Advertising 58,749 33,286 134,034 81,375
Other 328,739 267,011 631,295 515,132
----------- ------------- ------------ ------------
Total other expense 1,917,835 1,486,722 3,708,286 2,897,543
----------- ------------- ------------ ------------
Income before income taxes 1,065,375 846,451 2,060,398 1,777,788
Provision for income taxes 278,300 172,000 575,800 473,500
----------- ------------- ------------ ------------
Net income $ 787,075 $ 674,451 $ 1,484,598 $ 1,304,288
=========== ============= ============ ============
Earnings per common share:
Basic $ 0.49 $ 0.42 $ 0.92 $ 0.81
Diluted 0.47 0.39 0.88 0.76
Weighted average shares outstanding:
Basic 1,605,082 1,593,260 1,604,156 1,592,906
Diluted 1,683,300 1,720,913 1,684,217 1,714,763
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C>
Net income $ 787,075 $ 674,451 $ 1,484,598 $ 1,304,288
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain 322,860 - 701,145 -
Reclassification adjustment for net interest
expense included in net income 27,155 - 27,155 -
Available-for-sale securities:
Unrealized holding loss (691,742) (67,208) (775,695) (95,362)
Reclassification adjustment for gains
included in net income (88,117) - (88,117) -
------------ ----------- ------------ -------------
Other comprehensive income before tax (429,844) (67,208) (135,512) (95,362)
Income tax expense related to items of other
comprehensive income 146,147 22,851 46,074 32,423
------------ ----------- ------------ -------------
Other comprehensive income, net of tax (283,697) (44,357) (89,438) (62,939)
Comprehensive income $ 503,378 $ 630,094 $ 1,395,160 $ 1,241,349
============ ============ ============ =============
</TABLE>
The accompanying notes are an integral part of these financial statements
5
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
------------- -------------
<S> <C>
Cash flows from operating activities:
Net Income $ 1,484,598 $ 1,304,288
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 482,251 422,948
Provision for loan losses 670,000 450,000
Gain on sale of loans (540,768) (219,678)
Gain on sale of securities (88,117) (5,067)
Amortization of deferred loan fees (289,101) (348,467)
Net change in loans held for sale 380,368 (445,971)
(Increase) decrease in other assets 228,055 (237,653)
Increase (decrease) in other liabilities (322,497) 383,761
------------ -------------
Net cash provided by operating activities 2,004,789 1,304,161
------------ -------------
Cash flows from investing activities:
(Increase) decrease in loans receivable (10,898,831) 5,797,714
Purchase of investment securities, held-to-maturity - (1,959,970)
Purchase of investment securities, available-for-sale (23,196,100) (26,345,725)
Sale of investment securities available-for-sale 5,404,657 2,969,870
Paydowns of investment securities 21,597,047 15,826,622
Increase in overnight earning deposits, net (3,056,095) (6,837,331)
Increase in premises and equipment, net (707,301) (229,024)
Increase in Federal Home Loan Bank stock (171,200) (152,000)
------------ -------------
Net cash used in investing activities (11,027,823) (10,929,844)
------------ -------------
Cash flows from financing activities:
Net increase in deposits 15,523,963 15,838,479
Decrease in advances from FHLB (3,500,000) (4,000,000)
Proceeds from stock options exercised 76,013 58,542
Dividends on preferred and common stock (366,650) (277,574)
------------ -------------
Net cash provided by financing activities 11,733,326 11,619,447
------------- -------------
Net increase in cash and due from banks 2,710,292 1,993,764
Cash and due from banks, beginning of period 5,374,945 4,559,266
------------- -------------
Cash and due from banks, end of period $ 8,085,237 $ 6,553,030
============= =============
</TABLE>
The accompanying notes are an integral part of these statements
6
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q, and, therefore, do
not include all information or footnotes necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
generally accepted accounting principles. However, all adjustments which are, in
the opinion of management, necessary for a fair presentation have been included.
All adjustments are of a normal recurring nature. The results of operations for
the six-month period ended June 30, 1999 are not necessarily indicative of the
results of the full year. These consolidated financial statements should be read
in conjunction with the consolidated financial statements and the notes included
in Southern Financial Bancorp, Inc.'s Annual Report for the year ended December
31, 1998.
NOTE 2 - HEDGE ACCOUNTING
During the first quarter of 1999, the Bancorp entered into four
interest rate swap agreements that are accounted for as cash flow hedges. In
accordance with SFAS 133, the Bancorp records the change in fair value of the
swaps in comprehensive income. To the extent that the hedge is not completely
effective, the ineffective portion is charged or credited to other income or
expense. The amounts recorded in comprehensive income subsequently are
reclassified into interest expense as a yield adjustment in the same period in
which the related interest on the certificates of deposit (CD's) affects
earnings.
Each of the four swap agreements has a notional amount of $5 million,
and the Bancorp agreed to pay a rate fixed for the period of the swap and
receive 3 month LIBOR. Three of the swaps are for a period of five years and
have fixed rates ranging from 5.23% to 5.29%; the fourth swap is for a period of
ten years and has a fixed rate of 5.45%. The purpose of all four of these swaps
was to hedge the variability of cash flows resulting from changes in interest
rates in the Bancorp's floating rate liabilities, specifically the Bancorp's
CD's in amounts greater than $90,000, which have maturities of one month to six
months. The Bancorp performed a regression analysis using monthly averages of
both 3 month LIBOR and the Bancorp's hedged CD's and determined that there was a
highly effective correlation. The Bancorp designated CD's that were outstanding
on the inception dates of the swaps as being hedged by the swaps, and as the
hedged CD's mature, the Bancorp has identified other individual CD's to replace
them. During the year ending December 31, 1999, approximately $46,213 of gains
in accumulated other comprehensive income related to the interest rate swaps are
expected to be reclassified into interest expense as a yield adjustment of the
hedged CD's.
During the quarter ended June 30, 1999, a portion of the hedge was
"ineffective" as the spread between LIBOR (the denomination of the floating rate
side of the interest rate swaps) versus the Bancorp's CD issuance costs moved in
favor of the Bancorp by approximately 15 basis points. As required under SFAS
133, the Bancorp recognized income of $139 thousand which represented the net
present value of the favorable variance in the spread for the weighted average
remaining life of the interest rate swaps.
<PAGE>
NOTE 3 - INVESTMENT SECURITIES
The following table sets forth the Bancorp's investment securities
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
--------------- ------------- -------------- --------------
<S> <C>
Available-for-sale securities:
FHLMC preferred stock $ - $ - $ 3,807,585 $ 3,888,524
FHLMC MBS 8,901,856 8,928,979 11,996,172 12,005,667
GNMA MBS 3,028,114 3,028,328 3,825,601 3,771,448
FNMA MBS 18,828,511 18,891,442 29,671,448 29,813,650
Collaterized mortgage obligations 19,234,520 18,921,544 1,526,527 1,529,095
Commercial MBS 22,105,655 22,054,658 18,043,819 18,246,250
Obligations of counties and municipalities 3,909,954 3,759,294 3,234,489 3,220,498
Corporate obligations 990,008 956,054 989,319 992,300
U.S. Treasury securities 490,604 479,766 - -
U.S. Government agency obligations - - 949,066 971,250
----------- ----------- ----------- -----------
$77,489,222 $77,020,065 $74,044,026 $74,438,682
=========== =========== =========== ===========
Held-to-maturity securities:
FHLMC MBS $ 3,322,857 $ 3,303,181 $ 4,091,316 $ 4,070,132
GNMA MBS 19,767,506 19,746,184 24,305,052 24,004,669
FNMA MBS 5,575,369 5,505,795 6,779,894 6,731,670
Collateralized mortgage obligations - - 1,015,264 1,013,565
Obligations of counties and municipalities 1,959,126 1,900,914 1,959,595 1,974,308
----------- ----------- ----------- -----------
$30,624,858 $30,456,074 $38,151,121 $37,794,344
=========== =========== =========== ===========
</TABLE>
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- ------------
<S> <C>
Mortgage:
Residential $ 24,500,670 $ 26,046,289
Nonresidential 74,075,478 64,890,406
Construction:
Residential 5,926,912 5,184,844
Nonresidential 12,407,423 11,213,848
Non-Mortgage:
Business 23,823,376 24,773,003
Consumer 2,490,191 2,424,602
----------- ------------
Total loans receivable $143,224,050 $134,532,992
Less:
Deferred loan fees, net 977,816 836,898
Allowance for loan losses 2,207,154 2,050,612
------------ ------------
Loans receivable, net $140,039,080 $131,645,482
============ ============
The following sets forth information regarding the allowance for loan losses:
Six Months Six Months
Ended Ended
6/30/99 6/30/98
------------------ -----------------
Allowance at beginning of period $ 2,050,612 $ 2,036,532
Provision for losses charged to income 670,000 450,000
Charge-offs (717,781) (405,210)
Recoveries 204,323 7,261
------------------ -----------------
Allowance at end of period $ 2,207,154 $ 2,088,583
================== =================
</TABLE>
<PAGE>
NOTE 5 - EARNINGS PER SHARE
The following table shows the weighted average number of shares used
in computing earnings per share and the effect on weighted average number of
shares of dilutive common stock equivalents.
<TABLE>
<CAPTION>
For the three months ended For the six months ended
June 1999 June 1998 June 1999 June 1998
--------------------- -------------------- ------------------ ------------------
Per Per Per Per
Share Share Share Share
Shares Amount Shares Amount Shares Amount Shares Amount
---------- -------- --------- ------- --------- ------ --------- -------
<S> <C>
Basic EPS 1,605,082 $ 0.49 1,593,260 $ 0.42 1,604,156 $ 0.92 1,592,906 $ 0.81
======= ====== ====== ======
Effect of dilutive
Securities:
Stock Options 21,975 25,223 58,086 96,634
Convertible Preferred Stock 56,243 102,430 21,975 25,223
--------- --------- --------- ---------
Diluted EPS 1,683,300 $ 0.47 1,720,913 $ 0.39 1,684,217 $ 0.88 1,714,763 $ 0.76
========= ====== ========= ====== ========= ====== ========= ======
</TABLE>
NOTE 6 - OTHER SIGNIFICANT MATTERS
The Bancorp signed a definitive Merger Agreement providing for a
merger with The Horizon Bank of Virginia. The Bancorp will issue .63 shares of
its common stock in exchange for each share of common stock of The Horizon Bank
of Virginia. Subject to certain conditions including receipt of regulatory
approval and approval of the shareholders of the Bancorp and The Horizon Bank of
Virginia, closing of the merger is anticipated to occur in the third quarter of
1999. The merger will be accounted for under the pooling method.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION
- -------------------
Total assets of Southern Financial Bancorp, Inc. (the "Bancorp") at
June 30, 1999 were $271.6 million, an increase of $12.8 million, or 4.9%, from
total assets of $258.8 million at December 31, 1998. Total liabilities increased
by $11.7 million, or 4.9%, to $249.6 million at June 30, 1999 from $237.9
million at December 31, 1998.
The growth in total assets resulted primarily from increases of $8.4
million in loans receivable and $5.8 million in cash and overnight earning
deposits, while there was a decrease in investment securities of $4.9 million
from December 31, 1998 to June 30, 1999.
Total loans receivable increased by $8.4 million to $140 million at
June 30, 1999 from $131.6 million at December 31, 1998, as new loan originations
more than offset loan sales and prepayments of residential mortgage loans during
the period. In this period the Bancorp sold the guaranteed portion of some of
the Small Business Administration (SBA) loans that it held in portfolio. These
sales totaled $5.6 million. Non-residential permanent mortgage loans increased
by $9.2 million to $74.1 million at June 30, 1999, from $64.9 million at
December 31, 1998. Non-residential construction mortgage loans increased by $1.2
million to $12.4 million at June 30, 1999, from $11.2 million at December 31,
1998. Residential construction loans increased $742 thousand from $5.2 million
at December 31, 1998, to $5.9 million at June 30, 1999. Residential permanent
mortgage loans decreased $1.5 million from $26 million at December 31, 1998, to
$24.5 million at June 30, 1999. Non-mortgage business loans decreased $950
thousand to $23.8 million at June 30, 1999, from $24.8 million at December 31,
1998.
Investment securities available-for-sale increased from $74.4 million
at December 31, 1998, to $77 million at June 30, 1999. There were purchases of
$23.1 million of investment securities, all of which were designated as
available-for-sale. There were repayments and amortization of $14.3 million of
investment securities available-for-sale during the period. There were sales of
$5.4 million of investment securities available-for-sale during the six months
ended June 30, 1999.
Investment securities held-to-maturity decreased by $7.5 million to
$30.6 million at June 30, 1999, from $38.1 million at December 31, 1998. This
decrease resulted from repayments and amortization during the period.
Other assets increased by $2.8 million from $4.2 million at December
31, 1998, to $7 million at June 30, 1999. Most of the increase was due to an
addition to real estate owned of $2.1 million representing nonresidential
property. Management is confident of realizing the book value of this property.
The increase in total assets was funded by an increase in customer
deposits of $15.5 million, or 6.7%, to $247.4 million at June 30, 1999 from
$231.9 million at December 31, 1998.
RESULTS OF OPERATIONS
- ---------------------
The Bancorp's principal sources of revenue are interest on loans, gains
on sales of loans, fees and service charges on loans, interest and dividends on
investment securities, and service charges on deposit accounts. Net income is
affected by interest on deposits and borrowings and operating expenses.
The following table presents, for periods indicated, average balances
of and weighted average yields on interest-earning assets and average balances
of and weighted average effective rates paid on interest-bearing liabilities.
Calculations have been made utilizing month-end average balances for loans and
investment securities and daily average balances for borrowings and deposits,
and the effect of the interest rate swaps is reflected in the average rate on
deposits. Loan balances do not include non-accrual loans.
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
1999 1998
--------------------------------------------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
---------------------------- ---------------------------------
<S> <C>
($ in thousands)
Interest-earning assets
Loans receivable $ 138,886 9.12% $ 127,294 9.76%
Investment securities 116,802 6.14 95,625 6.21
--------- ---- --------- ----
Total interest-earning assets 255,688 7.76 222,919 8.24
--------- ---- --------- -----
Interest-bearing liabilities
Deposits 236,837 4.13 207,071 4.77
Borrowings 8,390 4.98 2,939 5.69
--------- ---- --------- -----
Total interest-bearing liabilities 245,227 4.16 210,010 4.78
--------- ---- --------- -----
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 10,461 12,909
========= =========
Interest rate spread 3.60 3.46
==== ====
Interest margin 3.77 3.74
==== ====
</TABLE>
The following table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to changes in volume (changes in volume
multiplied by old rate) and changes in rate (changes in rate multiplied by old
volume). The dollar changes in interest income and interest expense attributable
to changes in rate/volume (change in rate multiplied by change in volume) have
been allocated between rate and volume variances based on the percentage
relationship of such variances to each other. The effect of the interest rate
swaps is reflected in interest expense on deposits.
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1999
Compared to Six Months Ended
June 30, 1998
-------------------------------------------
Volume Rate Total
-------- --------- -------
($ in thousands)
<S> <C>
Interest income
Loans receivable $ 542 $ (425) $ 117
Investment securities 649 (34) 615
----- ------ -----
Total interest income 1,191 (459) 732
----- ------ -----
Interest expense
Deposits 655 (702) (47)
Borrowings 126 (12) 114
----- ------ -----
Total interest expense 781 (714) 67
----- ------ -----
Net interest income 410 255 665
===== ====== =====
</TABLE>
<PAGE>
The Bancorp's net income was $1.5 million for the six months ended June
30, 1999, compared to $1.3 million for the six months ended June 30, 1998, an
increase of $180 thousand, or 13.8%. Diluted earnings per share were $0.88 and
$0.76 for the six months ended June 30, 1999 and 1998, respectively. The
weighted average number of diluted shares of common stock outstanding were
1,684,217 and 1,714,763 for the same periods in 1999 and 1998, respectively.
The Bancorp's net income was $787 thousand for the three months ended
June 30, 1999, compared to $674 thousand for the three months ended June 30,
1998, an increase of $113 thousand, or 16.7%. Diluted earnings per share were
$0.47 and $0.39 for the three months ended June 30, 1999 and 1998, respectively.
The weighted average number of diluted shares of common stock outstanding were
1,683,300 and 1,720,913 for the same periods in 1999 and 1998, respectively.
Net interest income before provision for loan losses for the six months
ended June 30, 1999 was $4.9 million, an increase of $665 thousand, or 15.8%,
from $4.2 million for the six months ended June 30, 1998. The increase resulted
primarily from growth in average interest-earning assets, which was partially
offset by a decrease in interest margin. Total interest-earning assets in the
six months ended June 30, 1999 averaged $255.7 million as compared to $222.9
million for the same period in 1998. For the six months ended June 30, 1999, the
interest rate spread was 3.60%, an increase of 14 basis points from 3.46% for
the six months ended June 30, 1998. The yield on interest-earning assets for the
six months ended June 30, 1999 was 7.76%, a decrease of 48 basis points from the
same period last year. The cost of interest-bearing liabilities decreased by 62
basis points to 4.16% for the six months ended June 30, 1999 from 4.78% for the
six months ended June 30, 1998.
Total interest income increased by $732 thousand, or 8%, to $9.9
million for the six months ended June 30, 1999 from $9.2 million for the six
months ended June 30, 1998. This increase was due to an increase of $11.6
million in average loans receivable to $138.9 million for the six months ended
June 30, 1999 from $127.3 million for the six months ended June 30, 1998, in
spite of a decrease in the average yield on loans from 9.76% to 9.12% for the
same periods. Average investment securities increased by $21.2 million from
$95.6 million in the six months ended June 30, 1998 to $116.8 million in the six
months ended June 30, 1999. The yield on average investment securities for the
six months ended June 30, 1999 was 6.14%, a decrease of 7 basis points from
6.21% for the six months ended June 30, 1998.
Total interest expense increased by $67 thousand, or 1.3%, to $5.1
million for the six months ended June 30, 1999 from $5 million for the six
months ended June 30, 1998. Customer deposits averaged $236.8 million for the
six months ended June 30, 1999, up $29.7 million from $207.1 million for the six
months ended June 30, 1998. The average effective rate paid on deposits
decreased by 64 basis points to 4.13% in the 1999 period from 4.77% in the 1998
period. Average borrowings were $8.4 million for the six months ended June 30,
1999, an increase of $5.5 million from $2.9 million for the six months ended
June 30, 1998. The average effective rate paid on borrowings decreased to 4.98%
for the six months ended June 30, 1999 from 5.69% for the same period in 1998.
The provision for loan losses for the six months ended June 30, 1999
was $670 thousand, as compared to $450 thousand for the six months ended June
30, 1998. 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, past loan experience and other
relevant factors. During the six months ended June 30, 1999, the Bancorp's
volume of non-residential mortgage loans has increased, and these loans tend to
carry a higher risk classification. The increase in the provision for loan
losses reflects the growth in the portfolio of non-residential mortgage loans.
It is the opinion of the Bancorp that the allowance for loan losses at June 30,
1999 remains adequate. Although the Bancorp 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 Bancorp's
results of operations. The allowance for loan losses at June 30, 1999 was $2.2
million, or 1.54% of total loans receivable, versus $2.05 million at December
31, 1998, which was 1.52% of total loans receivable.
During the six months ended June 30, 1999 charge-offs amounted to $718
thousand compared to $405 thousand during the same period last year. These
charge-offs were related primarily to non-mortgage business loans and
nonresidential mortgage loans. Recoveries amounted to $204 thousand during the
six months ended June 30, 1999, most of which was related to one non-residential
mortgage loan that was charged off in 1996.
<PAGE>
Other income for the six months ended June 30, 1999 was $1.6 million as
compared to $928 thousand for the six months ended June 30, 1998, an increase of
$649 thousand, or 70%. Gain on sale of loans increased by $321 thousand from
$220 thousand during the six months ended June 30, 1998, to $541 thousand for
the six months ended June 30, 1999. This increase was primarily the result of
the sale of the guaranteed portion of SBA loans on which gains have been
recognized. Fee income increased $110 thousand during the six months ended June
30, 1999, compared to the same period last year, because of more income related
to both loans and deposits. Other income increased by $78 thousand during the
six months ended June 30, 1999, compared to the same period last year, because
of increased gain on sale of investment securities available-for sale.
Unrealized gain on the ineffective portion of the interest rate swaps in the
amount of $139 thousand was recognized during the six months ended June 30,
1999.
Other expense increased by $811 thousand, or 28%, to $3.7 million for
the six months ended June 30, 1999 from $2.9 million for the six months ended
June 30, 1998, primarily because of expenses related to operating three new
branches that have been open since April 1998. Employee compensation and
benefits increased by $469 thousand, or 34.2%, reflecting normal wage increases
for existing personnel and the cost of staffing the three new branches. Expenses
for premises and equipment increased by $130 thousand, or 25.1%, primarily
because of the new branches. Advertising expense increased by $53 thousand, or
64.7%, primarily because the Bancorp commenced its internet banking promotion.
REGULATORY CAPITAL REQUIREMENTS
- -------------------------------
At June 30, 1999 the Bancorp exceeded all regulatory capital standards,
which were as follows:
<TABLE>
<CAPTION>
ACTUAL CAPITAL REQUIRED CAPITAL EXCESS CAPTIAL
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------------- ------------------- ------------------
(Dollars in thousands)
<S> <C>
Leverage capital $ 21,824 8.20% $ 10,644 4.00% $11,180 4.20%
Tier 1 capital 21,824 12.86% 10,644 4.00% 11,180 8.86%
Tier 1 and Tier 2 capital 23,947 14.11% 13,581 8.00% 10,366 6.11%
</TABLE>
LIQUIDITY
- ---------
The Bancorp's primary sources of funds are deposits, loan repayments,
proceeds from the sale of loans and investment securities, repayments and
maturities of investment securities, and borrowings from the Federal Home Loan
Bank of Atlanta under a credit availability in the amount of $45 million. At
June 30, 1999, the Bancorp had $9.3 million of unfunded lines of credit and
undisbursed construction loan funds of $6.5 million. Approved loan commitments
were $11.7 million at June 30, 1999, and the Bancorp had commitments from
investors to purchase loans in the amount of $2.5 million. It is anticipated
that funding requirements for these commitments can be met from the normal
sources of funds.
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 significant 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 was successfully completed in March 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., has completed its Year 2000
Contingency Plan. The Bank's Business Resumption and Contingency Planning was
reviewed by the Board of Directors at the Bank's July 16, 1999 board meeting.
The Business Recovery Plan for Intrieve, Inc. was received by the Bank in June
and has been incorporated into its Plan. Intrieve has also updated their
Disaster Recovery Plan, which will enable them to continue to provide the Bank
with data processing services in the event of a Year 2000 disaster. The Bank has
completed its installment of backup generators and will complete all final
testing no later than August 31, 1999. The Bank will also continue to prepare
the branches for processing in an "off-line mode" through the month of December.
This will insure smooth operations with little or no adverse affect on our
customers. The Bank has also contracted with Monarch Security to provide each of
the Bank branches with a security guard from December 27, 1999 through January
8, 2000. These guards will be on site during regular lobby hours. 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 systems communications are affected on the first day of business
in the 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.
As of June 30, 1999, the Bank had incurred approximately $60 thousand
of costs to become Year 2000 compliant, and additional costs are not expected to
have a significant impact on the results of operations., 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 testing 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.
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.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
During the first quarter of 1999, the Bancorp entered into four swap
agreements, each for a notional amount of $5 million, in which the Bancorp
agreed to pay a rate fixed for the period of the swap and receive 3 month LIBOR
for the period of the swap. In addition, in the months of January and February
1999 the Bancorp purchased $20 million of residential and commercial CMO's. A
sustained shift in interest rates could have an impact on the market value of
these securities. A rise in interest rates would decrease their market value,
and a decline in interest rates would increase their market value.
As a result of entering into the swap agreements and purchasing the
CMO's, the Bancorp's interest sensitivity as reported in its Form 10K for the
year ended December 31, 1998 has changed. 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 the Bancorp. 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 300 basis points, measured in 100 basis point increments)
as of June 30, 1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------------
Up 300 26,429 (3,854) -12.73% 9.73% 120.69%
Up 200 27,812 (2,471) -8.16% 10.24% 127.01%
Up 100 29,177 (1,106) -3.65% 10.74% 133.24%
Base 30,283 - 0.00% 11.15% 138.29%
Down 100 31,015 732 2.42% 11.42% 141.63%
Down 200 30,914 631 2.08% 11.38% 141.17%
Down 300 31,018 735 2.43% 11.42% 141.65%
<PAGE>
The Bancorp'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 including the effect of the interest rate swaps.
Net interest income also depends upon the relative amounts of interest-earning
assets and interest-bearing liabilities and the interest rate earned or paid on
them. In this regard, the model assumes that the composition of 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.
Sensitivity of Net Interest Income
(amounts in thousands)
Change in Adjusted Net
Interest Rates Interest Income Net Interest Margin
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
- --------------------------------------- --------------------
Up 300 9,097 0.02% 3.35% 0.00%
Up 200 9,258 1.79% 3.41% 0.06%
Up 100 9,273 1.96% 3.41% 0.06%
Base 9,095 0.00% 3.35% 0.00%
Down 100 8,924 -1.88% 3.29% -0.06%
Down 200 8,816 -3.07% 3.25% -0.10%
Down 300 8,934 -1.77% 3.29% -0.06%
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.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Not applicable
Item 2. CHANGES IN SECURITIES
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders was held on April 29,
1999 at 2:00 p.m. at the Fauquier Springs Country Club,
Springs Road, Warrenton, Virginia. The following is a
summary of items voted upon at the meeting:
1. The following Directors were elected to serve three year terms
expiring in the year 2002:
Virginia Jenkins
Michael P. Rucker
Alfonso G. Fincchiaro
2. The following Director was elected to serve a two year term
expiring in the year 2001:
Fred L. Bollerer
3. The appointment of KPMG LLP as independent auditors for the year
ending December 31, 1999 was approved by the following vote:
For 1,396,001; Against 21,396; Abstain 18,598
4. The amendment to the Bancorp's 1993 Stock Option and Incentive Plan
was approved by the following vote: For 1,220,728; Against
184,523; Abstain 30,743.
Item 5. OTHER INFORMATION
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibits Required
None.
Reports on Form 8-K
No reports on Form 8-K were filed during the three months
ended June 30, 1999.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
PART III. SIGNATURES
Pursuant to the requirements 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.
(Registrant)
Date 8/13/99 By:
---------- ------------------------
Georgia S. Derrico
Chairman and
Chief Executive Officer
(Duly Authorized Representative)
Date 8/13/99 By:
---------- ------------------------
William H. Lagos
Senior Vice President and Controller
Principal Accounting Officer
(Duly Authorized Representative)
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 8085237
<INT-BEARING-DEPOSITS> 3984530
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 77020065
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<TOTAL-ASSETS> 271649037
<DEPOSITS> 247449555
<SHORT-TERM> 0
<LIABILITIES-OTHER> 2172220
<LONG-TERM> 0
0
136
<COMMON> 16405
<OTHER-SE> 22010721
<TOTAL-LIABILITIES-AND-EQUITY> 271649037
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</TABLE>
