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.:
March 31, 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 April 30, 1998, there were 1,603,220 shares of the registrant's Common
Stock outstanding.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
March 31, 1999
TABLE OF CONTENTS
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
as of March 31, 1999 (Unaudited) and
December 31, 1998 3
Consolidated Statements of Income for the
Three Months Ended March 31, 1999 and 1998
(Unaudited) 4
Consolidated Statements of Comprehensive Income
for the Three Months Ended March 31, 1999 and
1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 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
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
March 31,
1999 December 31,
(Unaudited) 1998
---------- ------------
Assets
Cash and due from banks $ 6,306,346 $ 5,374,945
Overnight earning deposits 1,050,376 928,435
Investment securities, available-for-sale 83,676,421 74,438,682
Investment securities, held-to-maturity 33,702,604 38,151,121
Loans held for sale 990,950 602,500
Loans receivable, net 136,352,860 131,645,482
Federal Home Loan Bank stock, at cost 1,253,700 1,082,500
Premises and equipment, net 2,870,329 2,370,711
Other assets 3,540,589 4,248,673
----------- -----------
Total assets $269,744,175 $258,843,049
=========== ===========
Liabilities and Stockholders' Equity
Liabilities:
Deposits $242,689,282 $231,925,592
Advances from Federal Home Loan Bank 3,000,000 3,500,000
Other liabilities 2,419,688 2,494,717
----------- -----------
Total liabilities 248,108,970 237,920,309
----------- -----------
Commitments
Stockholders' equity:
Preferred stock 136 136
Common stock 16,331 16,331
Capital in excess of par value 15,648,527 15,648,527
Retained earnings 5,987,341 5,469,135
Accumulated other comprehensive income 453,957 259,698
Treasury stock, at cost (471,087) (471,087)
----------- -----------
Total stockholders' equity 21,635,205 20,922,740
----------- -----------
Total liabilities and stockholders' equity$269,744,175 $258,843,049
=========== ===========
The accompanying notes are an integral part of these financial statements.
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1999 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Loans $ 3,108,715 $ 3,106,302
Investment securities 1,804,933 1,456,620
---------- ----------
Total interest income 4,913,648 4,562,922
---------- ----------
Interest expense:
Deposits 2,436,743 2,445,688
Borrowings 102,833 39,567
---------- ----------
Total interest expense 2,539,576 2,485,255
---------- ----------
Net interest income 2,374,072 2,077,667
Provision for loan losses 275,000 225,000
---------- ----------
Net interest income after provision for loan losses 2,099,072 1,852,667
---------- ----------
Other income:
Gain on sale of loans 272,577 137,963
Fee income 403,016 343,928
Other 10,809 7,600
---------- ----------
Total other income 686,402 489,491
---------- ----------
Other expense:
Employee compensation and benefits 896,442 657,285
Premises and equipment 299,484 249,001
Data processing expense 182,628 178,260
Deposit insurance assessments 34,056 30,065
Advertising 75,285 48,089
Other 302,556 248,121
---------- ----------
Total other expense 1,790,451 1,410,821
---------- ----------
Income before income taxes 995,023 931,337
Provision for income taxes 297,500 301,500
---------- ----------
Net income $ 697,523 $ 629,837
========== ==========
Earnings per common share:
Basic $ 0.43 $ 0.39
Diluted 0.41 0.37
Weighted average shares outstanding:
Basic 1,603,220 1,592,548
Diluted 1,685,143 1,709,010
</TABLE>
The accompanying notes are an integral part of these financial statements
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended
March 31,
1999 1998
--------- ---------
Net income $ 697,523 $ 629,837
Other comprehensive income, net of tax:
Unrealized holding loss on securities (55,409) (18,582)
Unrealized gain on cash flow hedges 249,668 -
--------- ---------
Other comprehensive income 194,259 (18,582)
Comprehensive income $ 891,782 $ 611,255
========= =========
The accompanying notes are an integral part of these financial statements
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------
1999 1998
--------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 697,523 $ 629,837
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 264,036 198,684
Provision for loan losses 275,000 225,000
Gain on sale of loans (272,577) (137,963)
Amortization of deferred loan fees (148,859) (181,935)
Net change in loans held for sale (115,873) 248,908
(Increase) decrease in other assets 1,011,538 (189,622)
Increase (decrease) in other liabilities (75,029) 475,622
--------- ---------
Net cash provided by operating activities 1,635,759 1,268,531
--------- ---------
Cash flows from investing activities:
(Increase) decrease in loans receivable (4,866,213) 714,777
Purchase of investment securities, available-for-sale (20,072,629) (13,206,693)
Paydowns of investment securities 15,040,602 6,547,487
Increase in overnight earning deposits, net (121,941) (736,322)
Increase in premises and equipment, net (597,350) (38,948)
Increase in Federal Home Loan Bank stock (171,200) (152,000)
----------- -----------
Net cash used in investing activities (10,788,731) (6,871,699)
----------- -----------
Cash flows from financing activities:
Net increase in deposits 10,763,690 9,651,462
Decrease in advances from FHLB (500,000) (4,000,000)
Proceeds from stock options exercised - 15,031
Dividends on preferred and common stock (179,317) (130,823)
---------- ----------
Net cash provided by financing activities 10,084,373 5,535,670
---------- ----------
Net increase (decrease) in cash and due from banks 931,401 (67,498)
Cash and due from banks, beginning of period 5,374,945 4,559,266
----------- -----------
Cash and due from banks, end of period $ 6,306,346 $ 4,491,768
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q, and, therefore, do
not include all information or footnotes necessary for a fair presentation of
financial position, results of operations, and cash flows in conformity with
generally accepted accounting principles. However, all adjustments which are, in
the opinion of management, necessary for a fair presentation have been included.
All adjustments are of a normal recurring nature. The results of operations for
the three-month period ended March 31, 1999 are not necessarily indicative of
the results of the full year. These consolidated financial statements should be
read in conjunction with the consolidated financial statements and the notes
included in Southern Financial Bancorp, Inc.'s Annual Report for the year ended
December 31, 1998.
NOTE 2 - HEDGE ACCOUNTING
During the first quarter of 1999, the Bancorp entered into four interest
rate swap agreements that are accounted for as cash flow hedges. In accordance
with SFAS 133, the Bancorp records the change in fair value of the swaps in
comprehensive income. To the extent that the hedge is not completely effective,
the ineffective portion is charged or credited to interest expense. The amounts
recorded in comprehensive income subsequently are reclassified into interest
expense as a yield adjustment in the same period in which the related interest
on the certificates of deposit (CD's) affects earnings.
Each of the four swap agreements has a notional amount of $5 million, and
the Bancorp agreed to pay a rate fixed for the period of the swap and receive 3
month LIBOR. Three of the swaps are for a period of five years and have fixed
rates ranging from 5.23% to 5.29%; the fourth swap is for a period of ten years
and has a fixed rate of 5.45%. The purpose of all four of these swaps was to
hedge the variability of cash flows resulting from changes in interest rates in
the Bancorp's floating rate liabilities, specifically the Bancorp's CD's in
amounts greater than $90,000, which have maturities of one month to six months.
The Bancorp performed a regression analysis using monthly averages of both 3
month LIBOR and the Bancorp's hedged CD's and determined that there was a highly
effective correlation. The Bancorp designated CD's that were outstanding on the
inception dates of the swaps as being hedged by the swaps, and as the hedged
CD's mature, the Bancorp has identified other individual CD's to replace them.
During the year ending December 31, 1999, approximately $61,900 of gains in
accumulated other comprehensive income related to the interest rate swaps are
expected to be reclassified into interest expense as a yield adjustment of the
hedged CD's.
<PAGE>
NOTE 3 - INVESTMENT SECURITIES
The following table sets forth the Bancorp's investment securities
portfolio as of the dates indicated:
<TABLE>
<CAPTION>
March 31, 1999 December 31,
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Available-for-sale securities:
FHLMC preferred stock $ - $ - $ 3,807,585 $ 3,888,524
FHLMC MBS 9,716,786 9,739,266 11,996,172 12,005,667
GNMA MBS 3,405,838 3,372,653 3,825,601 3,771,448
FNMA MBS 25,570,688 25,806,657 29,671,448 29,813,650
Collaterized mortgage obligations 19,352,320 19,346,575 1,526,527 1,529,095
Commercial MBS 20,137,415 20,115,640 18,043,819 18,246,250
Obligations of counties and municipalities 3,241,278 3,331,000 3,234,489 3,220,498
Corporate obligations 989,797 969,320 989,319 992,300
U.S. Government agency obligations 951,598 995,310 949,066 971,250
--------------- --------------- ---------------- -----------------
$ 83,365,720 $ 83,676,421 $ 74,044,026 $ 74,438,682
=============== =============== ================ =================
Held-to-maturity securities:
FHLMC MBS $ 3,662,594 $ 3,673,172 $ 4,091,316 $ 4,070,132
GNMA MBS 21,798,212 21,734,954 24,305,052 24,004,669
FNMA MBS 6,199,807 6,218,010 6,779,894 6,731,670
Collateralized mortgage obligations 82,635 86,556 1,015,264 1,013,565
Obligations of counties and municipalities 1,959,356 1,986,408 1,959,595 1,974,308
--------------- --------------- ---------------- -----------------
$ 33,702,604 $ 33,699,100 $ 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>
March 31, December 31,
1999 1998
-------------- ----------------
<S> <C> <C>
Mortgage:
Residential $ 26,277,400 $ 26,046,289
Nonresidential 67,763,647 64,890,406
Construction:
Residential 5,732,802 5,184,844
Nonresidential 13,613,438 11,213,848
Non-Mortgage:
Business 23,610,847 24,773,003
Consumer 2,401,071 2,424,602
-------------- ---------------
Total loans receivable 139,399,205 134,532,992
Less:
Deferred loan fees, net 899,225 836,898
Allowance for loan losses 2,147,120 2,050,612
-------------- ---------------
Loans receivable, net $ 136,352,860 $ 131,645,482
============== ===============
</TABLE>
The following sets forth information regarding the allowance for loan
losses:
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
3/31/99 3/31/98
----------------- -----------------
<S> <C> <C>
Allowance at beginning of period $ 2,050,612 $ 2,036,532
Provision for losses charged to income 275,000 225,000
Charge-offs (380,368) (111,045)
Recoveries 201,876 346
----------------- -----------------
Allowance at end of period $ 2,147,120 $ 2,150,833
================= =================
</TABLE>
<PAGE>
NOTE 5 - EARNINGS PER SHARE
The following table shows the weighted average number of shares used
in computing earnings per share and the effect on weighted average number of
shares of dilutive common stock equivalents.
<TABLE>
<CAPTION>
For the three months ended
March 1999 March 1998
------------------------- --------------------------
Per Per
Share Share
Shares Amount Shares Amount
------ --------- ------ -----------
<S> <C> <C> <C> <C>
Basic EPS 1,603,220 $ 0.43 1,592,548 $ 0.39
============ ============
Effect of dilutive
Securities:
Stock Options 59,948 91,239
Convertible Preferred Stock 21,975 25,223
------------ -----------
Diluted EPS 1,685,143 $ 0.41 1,709,010 $ 0.37
============ ============ =========== ============
</TABLE>
NOTE 6 - OTHER SIGNIFICANT MATTERS
The Bancorp signed a definitive Merger Agreement providing for a
merger with The Horizon Bank of Virginia. The Bancorp will issue .63 shares of
its common stock in exchange for each share of common stock of The Horizon Bank
of Virginia. Subject to certain conditions including receipt of regulatory
approval and approval of the shareholders of the Bancorp and The Horizon Bank of
Virginia, closing of the merger is anticipated to occur in the third quarter of
1999. The merger will be accounted for under the pooling method.
<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 March
31, 1999 were $269.7 million, an increase of $10.9 million, or 4.2%, from total
assets of $258.8 million at December 31, 1998. Total liabilities increased by
$10.2 million, or 4.3%, to $248.1 million at March 31, 1999 from $237.9 million
at December 31, 1998.
The growth in total assets resulted primarily from increases of $4.8
million in investment securities and $4.7 million in loans receivable from
December 31, 1998 to March 31, 1999.
Total loans receivable increased by $4.7 million to $136.3 million at
March 31, 1999 from $131.6 million at December 31, 1998, as new loan
originations more than offset loan sales and prepayments of residential mortgage
loans during the period. In this period the Bancorp sold the guaranteed portion
of some of the Small Business Administration (SBA) loans that it held in
portfolio. These sales totaled $2.8 million. Residential mortgage loans
(permanent and construction) increased $779 thousand from $31.2 million at
December 31, 1998, to $32 million at March 31, 1999. Non-residential
construction mortgage loans increased by $2.4 million, or 21.4%, to $13.6
million at March 31, 1999, from $11.2 million at December 31, 1998.
Non-residential permanent mortgage loans increased by $2.9 million to $67.8
million at March 31, 1999, from $64.9 million at December 31, 1998. Non-mortgage
business loans decreased $1.2 million to $23.6 million at March 31, 1999, from
$24.8 million at December 31, 1998.
Investment securities available-for-sale increased from $74.4 million at
December 31, 1998, to $83.7 million at March 31, 1999. There were purchases of
$20.1 million of investment securities, all of which were designated as
available-for-sale. There were repayments and amortization of $10.8 million of
investment securities available-for-sale during the period.
Investment securities held-to-maturity decreased by $4.4 million to $33.7
million at March 31, 1999, from $38.1 million at December 31, 1998. This
decrease resulted from repayments and amortization during the period.
The increase in total assets was funded by an increase in customer
deposits of $10.8 million, or 4.6%, to $242.7 million at March 31, 1999 from
$231.9 million at December 31, 1998.
Results of Operations
The Bancorp's principal sources of revenue are interest on loans, gains on
sales of loans, fees and service charges on loans, interest and dividends on
investment securities, and service charges on deposit accounts. Net income is
affected by interest on deposits and borrowings and operating expenses.
The following table presents, for periods indicated, average balances of
and weighted average yields on interest-earning assets and average balances of
and weighted average effective rates paid on interest-bearing liabilities.
Calculations have been made utilizing month-end average balances for loans and
investment securities and daily average balances for borrowings and deposits,
and the effect of the interest rate swaps is reflected in the average rate on
deposits. Loan balances do not include non-accrual loans.
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended March 31,
1999 1998
----------------------------------------------------------------
Average Average Average Average
Balance Yield/Rate Balance Yield/Rate
----------------------------------------------------------------
<S> <C> <C> <C> <C>
($ in thousands)
Interest-earning assets
Loans receivable $ 135,549 9.30 % $ 128,222 9.82 %
Investment securities 118,759 6.16 91,549 6.45
------------ -------- --------- -------
Total interest-earning assets 254,308 7.84 219,771 8.42
------------ -------- --------- -------
Interest-bearing liabilities
Deposits 236,180 4.18 205,984 4.82
Borrowings 8,383 4.91 2,832 5.58
------------ -------- --------- -------
Total interest-bearing liabilities 244,563 4.21 208,816 4.83
------------ -------- --------- -------
Average dollar difference
between interest-earning assets
and interest-bearing liabilities 9,745 10,955
============ =========
Interest rate spread 3.63 3.59
======== =======
Interest margin 3.79 3.83
======== =======
</TABLE>
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>
Three Months Ended
March 31, 1999
Compared to Three Months Ended
March 31, 1998
- ----------------------------------------------------------------------------------------
Volume Rate Total
- ----------------------------------------------------------------------------------------
($ in thousands)
<S> <C> <C> <C>
Interest income
Loans receivable $ 171 $ (168) $ 3
Investment securities 415 (67) 348
------ ------- -----
Total interest income 586 (235) 351
------ ------- -----
Interest expense
Deposits 339 (348) (9)
Borrowings 69 (6) 63
------ ------- -----
Total interest expense 408 (354) 54
------ ------- -----
Net interest income 178 119 297
====== ======= =====
</TABLE>
<PAGE>
The Bancorp's net income was $698 thousand for the three months ended
March 31, 1999, compared to $630 thousand for the three months ended March 31,
1998, an increase of $68 thousand, or 10.7%. Diluted earnings per share were
$0.41 and $0.37 for the three months ended March 31, 1999 and 1998,
respectively. The weighted average number of diluted shares of common stock
outstanding were 1,685,143 and 1,709,010 for the same periods in 1999 and 1998,
respectively.
Net interest income before provision for loan losses for the three months
ended March 31, 1999 was $2.4 million, an increase of $296 thousand, or 14.3%,
from $2.1 million for the three months ended March 31, 1998. The increase
resulted primarily from growth in average interest-earning assets, which was
partially offset by a decrease in interest margin. Total interest-earning assets
in the three months ended March 31, 1999 averaged $254.3 million as compared to
$219.8 million for the same period in 1998. For the three months ended March 31,
1999, the interest rate spread was 3.63%, an increase of 4 basis points from
3.59% for the three months ended March 31, 1998. The yield on interest-earning
assets for the three months ended March 31, 1999 was 7.84%, a decrease of 58
basis points from the same period last year. The cost of interest-bearing
liabilities decreased by 62 basis points to 4.21% for the three months ended
March 31, 1999 from 4.83% for the three months ended March 31, 1998.
Total interest income increased by $351 thousand, or 7.9%, to $4.9 million
for the three months ended March 31, 1999 from $4.6 million for the three months
ended March 31, 1998. This increase was primarily due to an increase of $27.2
million in average investment securities to $118.8 million for the three months
ended March 31, 1999 from $91.5 million for the three months ended March 31,
1998. The yield on average investment securities decreased 29 basis points from
6.45% for the quarter ended March 31, 1998, to 6.16% for the quarter ended March
31, 1999. Average loans receivable increased by $7.3 million from $128.2 million
in the three months ended March 31, 1998 to $135.5 million in the three months
ended March 31, 1999. The yield on average loans receivable was 9.30% for the
three months ended March 31, 1999, a decrease of 52 basis points from a yield of
9.82% for the same period last year.
Total interest expense increased by $54 thousand, or 2.2%, to $2.54
million for the three months ended March 31, 1999 from $2.49 million for the
three months ended March 31, 1998. Customer deposits averaged $236.2 million for
the three months ended March 31, 1999, up $30.2 million from $206 million for
the three months ended March 31, 1998. The average effective rate paid on
deposits decreased by 64 basis points to 4.18% in the 1999 period from 4.82% in
the 1998 period. Average borrowings were $8.4 million for the three months ended
March 31, 1999, an increase of $5.6 million from $2.8 million for the three
months ended March 31, 1998. The average effective rate paid on borrowings
decreased to 4.91% for the three months ended March 31 1999 from 5.58% for the
same period in 1998.
The provision for loan losses for the three months ended March 31, 1999
was $275 thousand, as compared to $225 thousand for the three months ended March
31, 1998. The provision for loan losses is a current charge to earnings to
increase the allowance for loan losses. 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
three months ended March 31, 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 March 31, 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 March 31, 1999 was $2.15 million,
or 1.54% of total loans receivable, versus $2.05 million at December 31, 1998,
which was 1.52% of total loans receivable.
During the three months ended March 31, 1999 charge-offs amounted to $380
thousand compared to $111 thousand during the same period last year. These
charge-offs were related to non-mortgage business loans. Recoveries amounted to
$202 thousand during the three months ended March 31, 1999, most of which was
related to one non-residential mortgage loan that was charged off in 1996.
Other income for the three months ended March 31, 1999 was $686 thousand
as compared to $489 thousand for the three months ended March 31, 1998, an
increase of $197 thousand, or 40.2%. Gain on sale of loans increased by $135
thousand from $138 thousand during the three months ended March 31, 1998, to
$273 thousand for the three months ended March 31, 1999. This increase was
primarily the result of the sale of the guaranteed portion of SBA loans on which
gains have been recognized. Fee income increased $59 thousand during the three
months ended March 31, 1999, compared to the same period last year, primarily
because of more loan-related income.
<PAGE>
Other expense increased by $380 thousand, or 26.9%, to $1.8 million for
the three months ended March 31, 1999 from $1.4 million for the three months
ended March 31, 1998, primarily because of expenses related to operating three
new branches that have been open since April 1998. Employee compensation and
benefits increased by $239 thousand, or 36.4%, reflecting normal wage increases
for existing personnel and the cost of staffing the three new branches. Expenses
for premises and equipment increased by $50 thousand, or 20.3%, primarily
because of the new branches. Advertising expense increased by $27 thousand, or
56.6%, primarily because the Bancorp commenced its internet banking promotion.
Regulatory Capital Requirements
At March 31, 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> <C> <C> <C> <C> <C>
Leverage capital $ 21,154 8.00% $ 10,577 4.00% $ 10,577 4.00%
Tier 1 capital 21,154 12.99% 6,515 4.00% 14,639 8.99%
Tier 1 and Tier 2 capital 23,191 14.24% 13,030 8.00% 10,161 6.24%
</TABLE>
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
March 31, 1999, the Bancorp had $8 million of unfunded lines of credit and
undisbursed construction loan funds of $6.8 million. Approved loan commitments
were $12.6 million at March 31, 1999, and the Bancorp had commitments from
investors to purchase loans in the amount of $2 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 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.
<PAGE>
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 significant
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 significant 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.
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.
<PAGE>
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
March 31, 1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
<TABLE>
<CAPTION>
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From Base From Total Portfolio
(Rate Shock) Base Assets Equity
Book Value
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Up 300 22,287 (4,567) -17.01% 8.26% 103.01%
Up 200 24,191 (2,663) -9.92% 8.97% 111.80%
Up 100 25,565 (1,289) -4.80% 9.48% 118.15%
Base 26,854 - 0.00% 9.96% 124.11%
Down 100 27,356 502 1.87% 10.14% 126.43%
Down 200 27,442 588 2.19% 10.17% 126.83%
Down 300 28,103 1,249 4.65% 10.42% 129.88%
</TABLE>
<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)
<TABLE>
<CAPTION>
Change in Adjusted Net
Interest Rates Interest Income Net Interest Margin
In Basis Points % Change % Change
(Rate Shock) Amount From Base Percent From Base
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Up 300 9,330 -1.76% 3.46% -0.06%
Up 200 9,595 1.03% 3.56% 0.04%
Up 100 9,600 1.08% 3.56% 0.04%
Base 9,497 0.00% 3.52% 0.00%
Down 100 9,390 -1.13% 3.48% -0.04%
Down 200 9,474 -0.24% 3.51% -0.01%
Down 300 9,753 2.70% 3.62% 0.10%
</TABLE>
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in MVPE and in Sensitivity of
Net Interest Income require the making of certain assumptions which may or may
not reflect the manner in which actual yields and costs respond to changes in
market interest rates. Accordingly, although the MVPE table and Sensitivity of
Net Interest Income table provide an indication of the Bancorp's interest rate
risk exposure at a particular point in time, such measurements are not intended
to and do not provide a precise forecast of the effect of changes in market
interest rates on the Bancorp's worth and net interest income.
<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
Not applicable
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
March 31, 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 5/17/99 By:
------- ----------------------------
Georgia S. Derrico
Chairman and
Chief Executive Officer
(Duly Authorized Representative)
Date 5/17/99 By:
------- -----------------------------
William H. Lagos
Senior Vice President and Controller
Principal Accounting Officer
(Duly Authorized Representative)
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 6306346
<INT-BEARING-DEPOSITS> 1050376
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 83676421
<INVESTMENTS-CARRYING> 33702604
<INVESTMENTS-MARKET> 33699100
<LOANS> 139399205
<ALLOWANCE> 2147120
<TOTAL-ASSETS> 269744175
<DEPOSITS> 242689282
<SHORT-TERM> 3000000
<LIABILITIES-OTHER> 2419688
<LONG-TERM> 0
0
136
<COMMON> 16331
<OTHER-SE> 21618738
<TOTAL-LIABILITIES-AND-EQUITY> 269744175
<INTEREST-LOAN> 3108715
<INTEREST-INVEST> 1804933
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 4913648
<INTEREST-DEPOSIT> 2436743
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<INTEREST-INCOME-NET> 2374072
<LOAN-LOSSES> 275000
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<EXPENSE-OTHER> 1790451
<INCOME-PRETAX> 995023
<INCOME-PRE-EXTRAORDINARY> 697523
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 697523
<EPS-PRIMARY> 0.43
<EPS-DILUTED> 0.41
<YIELD-ACTUAL> 7.84
<LOANS-NON> 1519006
<LOANS-PAST> 138455
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 4633647
<ALLOWANCE-OPEN> 2050612
<CHARGE-OFFS> 380368
<RECOVERIES> 201876
<ALLOWANCE-CLOSE> 2147120
<ALLOWANCE-DOMESTIC> 2147120
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 392863
</TABLE>
