MERGER PROPOSED - YOUR VOTE IS VERY IMPORTANT
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
The Boards of Directors of Southern Financial Bancorp, Inc. and First
Savings Bank of Virginia have agreed to merge the two companies. After the
merger, Southern Financial will have total assets of almost $500 million and
will span the area from Fredericksburg to Winchester, Virginia, with 19 banking
offices.
If shareholders of First Savings approve the merger, it will merge into
Southern Financial Bank, a bank owned by Southern Financial and First Savings
shareholders will receive 0.44 shares of Southern Financial common stock for
each share of First Savings common stock they own. Southern Financial
shareholders will continue to hold their existing shares of Southern Financial
common stock after the merger. We estimate that upon completion of the merger,
approximately 13% of the outstanding Southern Financial common stock will be
owned by current First Savings shareholders and approximately 87% will be owned
by persons who are Southern Financial shareholders just before the merger is
completed.
We cannot complete the merger unless shareholders of First Savings
approve the merger agreement.
The First Savings meeting will be a special meeting at which
shareholders will only be asked to consider the proposed merger. Whether or not
you plan to attend the shareholder meeting, please take the time to vote by
completing and mailing the enclosed proxy card to us. If you sign, date and mail
your proxy card without indicating how you want to vote, your proxy will be
counted as a vote in favor of the transaction. If you do not return your card,
the effect will be a vote against the merger. If your shares are held in "street
name," you must instruct your broker in order to vote.
The date, time and place of the First Savings meeting are as follows:
August 11, 2000 at 10:00 a.m.
6551 Loisdale Court, Suite 150
Springfield, Virginia 22150
The document accompanying this letter contains additional information
regarding the merger agreement, the proposed merger and the two companies. We
encourage you to read this entire document carefully.
We strongly support this merger of Southern Financial and First Savings
and appreciate your prompt attention to this very important matter.
/s/ Barbara J. Fried
Barbara J. Fried
Chairman
First Savings Bank of Virginia
[END OF TWO-COLUMN FORMAT]
--------------------------------------------------------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this document. Any representation to the contrary is a
criminal offense. The securities offered hereby are not savings accounts,
deposits or other obligations of a bank or savings association and are not
insured by the Federal Deposit Insurance Corporation or any other government
agency.
--------------------------------------------------------------------------------
The date of this proxy statement/prospectus is July 17, 2000, and it is first
being mailed to shareholders on or about July 17, 2000.
<PAGE>
FIRST SAVINGS BANK OF VIRGINIA
6551 LOISDALE COURT, SUITE 900
SPRINGFIELD, VIRGINIA 22150
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON AUGUST 11, 2000
A special meeting of shareholders of First Savings Bank of Virginia
("First Savings") will be held at 10:00 a.m. on August 11, 2000 at First
Savings' Springfield branch, 6551 Loisdale Court, Suite 150, Springfield,
Virginia, to consider the following matters:
(1) The proposal to approve the Agreement and Plan of
Reorganization dated March 31, 2000 by and between First
Savings and Southern Financial Bancorp, Inc. ("Southern
Financial") and Southern Financial Bank, a wholly owned
subsidiary of Southern Financial, which agreement provides for
First Savings to be merged with and into Southern Financial
Bank; and
(2) Any other business properly brought before the special meeting
or any adjournment or postponement thereof.
YOUR BOARD OF DIRECTORS RECOMMENDS A VOTE IN FAVOR OF THE APPROVAL OF
THE MERGER AGREEMENT.
Only First Savings shareholders of record at the close of business on
July 3, 2000 are entitled to notice of, and to vote at, this special meeting and
any adjournments or postponements thereof.
Your attention is directed to the proxy statement/prospectus delivered
with this Notice.
By Order of the Board of Directors
/s/ Stephen I. Nadler
Stephen I. Nadler
Corporate Secretary
Springfield, Virginia
July 17, 2000
REGARDLESS OF WHETHER YOU PLAN TO ATTEND THE SPECIAL MEETING IN PERSON,
YOU ARE URGED TO VOTE PROMPTLY BY DATING, SIGNING AND RETURNING THE ENCLOSED
PROXY IN THE ACCOMPANYING ENVELOPE. YOU MAY REVOKE YOUR PROXY AT ANY TIME PRIOR
TO ITS EXERCISE IN THE MANNER PROVIDED IN THE ACCOMPANYING PROXY
STATEMENT/PROSPECTUS.
<PAGE>
TABLE OF CONTENTS
Page
CHAPTER I
QUESTIONS AND ANSWERS ABOUT THE MERGER.................................... 1
WHO CAN HELP ANSWER YOUR QUESTIONS........................................ 3
SUMMARY................................................................... 4
The Companies........................................................ 4
Issuance of Shares................................................... 4
Reasons for the Merger............................................... 4
The Meeting.......................................................... 5
Record Date; Voting Power............................................ 5
Opinion of First Savings' Financial Advisor.......................... 5
No Right to Appraisal................................................ 5
Southern Financial to Use Purchase Accounting Treatment.............. 5
Comparative Per Share Market Price Information....................... 5
Fee for Termination.................................................. 5
Share Ownership of Management........................................ 6
Benefits to Management in the Merger................................. 6
Conditions that Must Be Satisfied for the Merger to Occur............ 6
Termination of the Merger Agreement.................................. 7
Selected Historical Financial Data................................... 8
Selected Pro Forma Financial Data.................................... 9
Comparative Per Share Data........................................... 10
THE MERGER................................................................ 11
Background of the Merger............................................. 11
First Savings' Reasons for the Merger................................ 12
Accounting Treatment................................................. 12
Material Federal Income Tax Consequences of the Merger............... 12
Absence of Appraisal Rights.......................................... 13
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION....................... 14
OPINION OF FIRST SAVINGS' FINANCIAL ADVISOR............................... 19
INTERESTS OF CERTAIN PERSONS IN THE MERGER................................ 22
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS............................. 23
TERMS OF THE MERGER AGREEMENT............................................. 23
Representations and Warranties; Conditions to the Merger............. 23
Regulatory Approvals................................................. 24
Business Pending the Merger.......................................... 24
No Solicitation; Board Action........................................ 25
Effective Date....................................................... 25
Surrender of Stock Certificates...................................... 26
Waiver, Amendment and Termination.................................... 26
Resales of Southern Financial Common Stock........................... 27
Expenses of the Merger and Termination Fee........................... 27
MARKET PRICES AND DIVIDENDS............................................... 27
Market Prices........................................................ 27
Dividends............................................................ 28
<PAGE>
Page
CHAPTER II
INFORMATION ABOUT THE MEETING AND VOTING
General.............................................................. 30
First Savings Meeting................................................ 30
CHAPTER III
DESCRIPTION OF SOUTHERN FINANCIAL
BUSINESS.................................................................. 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................................ 48
CHAPTER IV
DESCRIPTION OF FIRST SAVINGS
BUSINESS.................................................................. 59
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................................ 71
CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors.................................................... 80
Senior Officers of Southern Financial Who Are Not Directors............... 81
Security Ownership of Management.......................................... 82
Security Ownership of Certain Beneficial Owners........................... 84
Director Compensation..................................................... 85
Executive Officer Compensation............................................ 85
Stock Options............................................................. 86
Employment Agreements..................................................... 87
Certain Relationships and Related Transactions............................ 87
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF SOUTHERN FINANCIAL CAPITAL STOCK........................... 88
Common Stock......................................................... 88
Preferred Stock...................................................... 88
COMPARATIVE RIGHTS OF SHAREHOLDERS........................................ 89
General.............................................................. 89
Authorized Capital................................................... 89
Amendment of Articles of Incorporation or Bylaws..................... 90
Mergers, Consolidations and Sales of Assets.......................... 91
Size and Classification of Board of Directors........................ 92
<PAGE>
Page
Vacancies and Removal of Directors................................... 93
Director Liability and Indemnification............................... 93
Special Meetings of Shareholders..................................... 95
Shareholder Nominations and Proposals................................ 95
Shareholder Voting Rights in General................................. 96
State Anti-Takeover Statutes......................................... 96
REGULATION................................................................ 98
General.............................................................. 98
Bank Holding Company Regulation...................................... 98
Bank Supervision..................................................... 99
Regulatory Capital Requirements...................................... 100
Limits on Dividends and Other Payments............................... 100
FDIC Regulations..................................................... 101
Deposit Insurance.................................................... 102
Community Reinvestment Act........................................... 102
Fiscal and Monetary Policy........................................... 103
Federal Home Loan Bank System........................................ 103
Federal Reserve System............................................... 103
RESALES OF SOUTHERN FINANCIAL COMMON STOCK................................ 103
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS................ 104
EXPERTS................................................................... 104
LEGAL OPINIONS............................................................ 104
WHERE YOU CAN FIND MORE INFORMATION....................................... 105
APPENDICES
----------
General
-------
A Agreement and Plan of Reorganization between First Savings Bank of Virginia
and Southern Financial Bancorp, Inc. and Southern Financial Bank, dated as
of March 31, 2000
Southern Financial Bancorp, Inc.
--------------------------------
B Southern Financial Bancorp, Inc. Financial Statements (including the
audited December 31, 1999 financial statements and the unaudited March 31,
2000 financial statements)
First Savings Bank of Virginia
------------------------------
C First Savings Bank of Virginia Financial Statements (including the audited
December 31, 1999 financial statements and the unaudited March 31, 2000
financial statements)
D Opinion of RP Financial, LC.
<PAGE>
CHAPTER I
QUESTIONS AND ANSWERS ABOUT THE MERGER
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
Q: Why is First Savings merging with Southern Financial?
A: Both the First Savings board of directors and the Southern Financial
board of directors believe the merger is in the best interests of their
respective companies and will provide significant benefits to their respective
shareholders, customers and employees. The boards believe the merger will create
a company with enhanced financial performance which will be better positioned to
be a strong competitor in the rapidly changing and consolidating financial
services industry in Virginia. To review the background and reasons for the
merger in greater detail, see pages 11 and 12.
Q: What will I receive in the merger?
A: First Savings shareholders will receive 0.44 shares of Southern
Financial common stock in exchange for each share of First Savings common stock
they hold. This is the "exchange ratio." Southern Financial will not issue
fractional shares in the merger. Instead, First Savings shareholders will
receive a cash payment, without interest, for the value of any fraction of a
share of Southern Financial common stock that they would otherwise be entitled
to receive, based upon the market value (as determined in the merger agreement)
of a share of Southern Financial common stock at the time of the merger.
After the merger, First Savings' former shareholders will own approximately 13%
of Southern Financial's outstanding shares of common stock and current Southern
Financial shareholders will own approximately 87% of Southern Financial's
outstanding shares of common stock.
FOR EXAMPLE:
o IF YOU OWN 100 SHARES OF FIRST SAVINGS COMMON STOCK, AFTER THE MERGER YOU
WILL RECEIVE 44 SHARES OF SOUTHERN FINANCIAL COMMON STOCK.
o IF YOU OWN 30 SHARES OF FIRST SAVINGS COMMON STOCK, AFTER THE MERGER YOU
WILL RECEIVE 13 SHARES OF SOUTHERN FINANCIAL COMMON STOCK AND A CHECK FOR
0.20 TIMES THE MARKET VALUE OF ONE SHARE OF SOUTHERN FINANCIAL COMMON
STOCK.
Q: What will my dividends be after the merger?
A: In the third quarter of 1999, Southern Financial increased its
quarterly dividend to $0.12 per share. The board intends to continue dividends
at or above this rate. However, Southern Financial cannot assure that these
payments will continue in the future. The Southern Financial board will use its
discretion to decide whether and when to declare dividends and in what amount,
and it will consider all relevant factors in doing so.
Q: What happens as the market price of Southern Financial common stock
fluctuates?
A: The exchange ratio is fixed at 0.44 shares of Southern Financial common
stock for each share of First Savings common stock. Since the market value of
Southern Financial common stock will fluctuate before and after the closing of
the merger, the value of the Southern Financial common stock that First Savings
shareholders will receive in the merger will fluctuate as well and could
increase or decrease. The last sale price of Southern Financial common stock on
July 10, 2000 was $13.25 per share. First Savings shareholders should obtain
current market prices for shares of Southern Financial common stock and shares
of First Savings common stock.
1
<PAGE>
Q: When is the merger expected to be completed?
A: We are working to complete the merger during the third quarter of 2000.
Q: What are the tax consequences of the merger to me?
A: We expect that the exchange of shares by First Savings shareholders
generally will be tax-free to First Savings shareholders for U.S. federal income
tax purposes. First Savings shareholders will, however, have to pay taxes on
cash received for fractional shares. To review the tax consequences to First
Savings shareholders in greater detail, see page 12. Your tax consequences may
depend on your personal situation. You should consult your tax advisor for a
full understanding of the tax consequences of the merger to you.
Q: What am I being asked to vote upon?
A: You are being asked to approve the merger agreement which provides for
the merger of First Savings into Southern Financial Bank, a bank owned by
Southern Financial, and the issuance of 0.44 shares of Southern Financial common
stock for each outstanding share of First Savings common stock. Approval of the
proposal requires the affirmative vote of more than two-thirds of the
outstanding shares of First Savings common stock.
The First Savings board has unanimously approved and adopted the merger
agreement. The First Savings board recommends voting for the approval of the
merger agreement.
Q: What should I do now?
A: Just indicate on your proxy card how you want to vote, and sign and
mail it in the enclosed envelope as soon as possible, so that your shares will
be represented at the meeting.
If you sign and send in your proxy and do not indicate how you want to vote,
your proxy will be voted in favor of the proposal to approve the merger.
If you do not sign and send in your proxy or you abstain, it will have the
effect of a vote against the merger, as approval requires the affirmative vote
of more than two-thirds of the shares outstanding.
You may attend the shareholders' meeting and vote your shares in person, rather
than voting by proxy. In addition, you may withdraw your proxy up to and
including the day of the shareholders' meeting by following the directions on
pages 30 and 31 and either change your vote or attend the shareholders' meeting
and vote in person.
Q: If my shares are held in "street name" by my broker, will my broker
vote my shares for me?
A: Your broker will vote your shares of First Savings common stock only if
you provide instructions on how to vote. You should instruct your broker how to
vote your shares, following the directions your broker provides. If you do not
provide instructions to your broker, your shares will not be voted. If you do
not provide instructions to your broker, your shares will not be voted and this
will have the effect of voting against the merger.
Q: Should I send in my stock certificates now?
A: No. After the merger is completed we will send you written instructions
for exchanging your First Savings common stock certificates for Southern
Financial common stock certificates.
[END OF TWO-COLUMN FORMAT]
2
<PAGE>
WHO CAN HELP ANSWER YOUR QUESTIONS
If you want additional copies of this document, or if you want to ask
any questions about the merger, you should contact:
Barbara J. Fried, Chairman
First Savings Bank of Virginia
6551 Loisdale Court, Suite 900
Springfield, Virginia 22150
3
<PAGE>
SUMMARY
This summary highlights selected information from this document and may
not contain all the information that is important to you. For a more complete
understanding of the merger and for a more complete description of the legal
terms of the merger, you should read this entire document carefully, as well as
the additional documents to which we refer you, including the merger agreement.
See "Where You Can Find More Information" (page 105).
[THE FOLLOWING IS PRESENTED IN TWO-COLUMN FORMAT]
The Companies
Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, Virginia 20186
(540) 349-3900
Southern Financial is a Virginia bank holding company that began
operations in 1995. Southern Financial owns one bank, Southern Financial Bank,
headquartered in Warrenton, Virginia, which opened in 1986 and now operates 17
banking offices in northern Virginia. Southern Financial Bank is a member of the
Federal Reserve System and its deposits are insured by the Federal Deposit
Insurance Corporation. On March 31, 2000, Southern Financial had total assets of
$427.8 million, total deposits of $387.8 million, total loans of $236.9 million
and stockholders' equity of $29.9 million.
Southern Financial stock is listed and traded on The Nasdaq National
Market under the symbol "SFFB."
First Savings Bank of Virginia
6551 Loisdale Court, Suite 900
Springfield, Virginia 22150
(703) 922-7100
First Savings is a Virginia savings association incorporated in 1983.
Its deposits are insured by the Federal Deposit Insurance Corporation. First
Savings' headquarters are in Springfield, Virginia. First Savings operates a
second office in Fredericksburg, Virginia. On March 31, 2000, First Savings had
total assets of $71.1 million, total deposits of $54.0 million, total loans of
$48.1 million, and stockholders' equity of $4.8 million.
Issuance of Shares
The exchange ratio is 0.44 shares of Southern Financial common stock
for each share of First Savings common stock. Accordingly, the 931,605 currently
outstanding shares of First Savings common stock will be converted into
approximately 409,906 shares of Southern Financial common stock. Fractional
shares of Southern Financial common stock will not be issued, and First Savings
shareholders will receive cash payment, without interest, for the value of any
fraction of a share of Southern Financial common stock that they would otherwise
be entitled to receive based upon the market value of a share of Southern
Financial common stock at the time of the merger.
Reasons for the Merger
The First Savings board of directors carefully considered the merger
decision and unanimously approved and adopted the merger agreement. The board
had several reasons for approving the merger. A few of the reasons are set forth
below. For a complete discussion, see pages 11 and 12.
o The terms of the merger agreement, including the exchange ratio.
o Southern Financial common stock is more liquid since it is traded on The
Nasdaq National Market while First Savings common stock has been traded
only internally by matching prospective buyers and sellers.
o The fact that Southern Financial has consistently paid cash dividends to
its shareholders in the past.
o The compatibility of First Savings' and Southern Financial's community bank
operating philosophies and the similarity of products and customer
orientation.
4
<PAGE>
o An association with Southern Financial will result in First Savings'
participation in a banking organization with 19 offices in Virginia and the
board's conclusion that the resulting geographic diversification and
economies of scale would enable First Savings to compete more effectively
in the financial services industry of the future.
o The representation of RP Financial, LC. to the board that the exchange
ratio is fair from a financial point of view to the First Savings
shareholders.
o The expectation that the merger will be tax-free for federal income tax
purposes to First Savings and its shareholders, except for cash paid
instead of fractional shares.
The Meeting (pages 30 and 31)
The First Savings meeting will be held at First Savings' Springfield
branch, 6551 Loisdale Court, Suite 150, Springfield, Virginia, at 10:00 a.m.,
local time, on August 11, 2000.
Record Date; Voting Power (pages 30 and 31)
You are entitled to vote at the First Savings meeting if you owned
shares on July 3, 2000, the record date. On that date, there were 931,605 issued
and outstanding shares of First Savings common stock held by approximately 180
holders of record. First Savings shareholders are entitled to one vote per share
on any matter that may properly come before the First Savings meeting.
Opinion of First Savings' Financial Advisor (page 19)
At the March 31, 2000 meeting of the First Savings board, RP
Financial, LC., financial advisor to the First Savings board, gave its opinion
to the First Savings board that as of that date, the exchange ratio was fair to
the First Savings shareholders from a financial point of view. RP Financial
subsequently confirmed its March 31, 2000 opinion by delivery to the First
Savings board of a written opinion dated as of the date of this document. A copy
of the fairness opinion, setting forth the information reviewed, assumptions
made and matters considered, is attached to this document as Appendix D. First
Savings shareholders should read the fairness opinion of RP Financial.
No Right to Appraisal (page 13)
Under Virginia law, you have no right to an appraisal of the fair value
of your shares in connection with the merger.
Southern Financial to Use Purchase Accounting Treatment (page 12)
We expect that the merger will be accounted for as a purchase.
Comparative Per Share Market Price Information (page 27)
First Savings common stock is traded in private transactions through a
matching of prospective buyers and sellers. To First Savings management's
knowledge, the last sales of First Savings common stock took place in the first
quarter of 2000 at an average price of $5.25 per share.
Southern Financial common stock is traded on The Nasdaq National Market
under the symbol "SFFB." Southern Financial common stock is thinly traded. On
March 30, 2000, the last full trading day before First Savings and Southern
Financial issued a joint press release announcing the merger, Southern Financial
common stock closed at $14.19. On July 10, 2000, Southern Financial common
stock closed at $13.25.
Fee for Termination (page 27)
First Savings would be required to pay Southern Financial $100,000 if
the merger agreement is terminated and before the date of termination First
Savings receives a merger or acquisition proposal or initiates merger or
acquisition discussions with a third party and within 12 months after the date
of termination the First Savings board determines by vote that a merger or
acquisition by the third party is in the best interests of First Savings and its
shareholders. No fee is payable in that situation, however, if Southern
Financial wrongfully terminates the
5
<PAGE>
merger agreement. Similarly, no fee is payable if, at the time the merger
agreement terminates, First Savings is entitled to terminate on the basis of a
breach by Southern Financial or there has been a failure to satisfy certain
closing conditions (other than approval by First Savings' shareholders).
This provision is intended to discourage another party from interfering
with the merger agreement between Southern Financial and First Savings.
Share Ownership of Management (page 84)
On the First Savings record date, the executive officers and directors
of First Savings, including their affiliates, had voting power with respect to
an aggregate of 408,787 shares of First Savings common stock, or approximately
43.9% of the shares of First Savings common stock then outstanding.
We currently expect that the directors and executive officers of First
Savings will vote their shares of First Savings common stock FOR the merger.
Benefits to Management in the Merger (page 22)
When considering the recommendation of the First Savings board, you
should be aware that some First Savings directors and officers have interests in
the merger that differ from the interests of other First Savings shareholders.
One director of First Savings, Barbara J. Fried, will become a director of
Southern Financial. Ms. Fried will receive an annual fee of $4,000 for service
on the Southern Financial board, $500 for attendance at each board meeting and
$150 for attendance at each board committee meeting.
On the effective date of the merger, Mr. Jeffrey C. Constantz,
President and Chief Executive Officer of First Savings, will receive an
aggregate of $125,000 under the terms of his employment agreement with First
Savings, which provides for such payment in connection with termination of Mr.
Constantz' employment in connection with a change in control of First Savings.
Mr. Constantz will also receive a payment of $100,000 pursuant to a "pay to
stay" incentive program adopted by First Savings as a means of retaining key
management through the date of the merger. Mr. Glenn Rhodes, First Savings'
Controller, will receive a payment of $37,500 as of the effective date of the
merger under his employment agreement with First Savings. Mr. Rhodes and
Patricia Bhatia, Vice President of First Savings, will also receive payments of
$37,500 and $21,500, respectively, under the pay to stay program.
The First Savings board was aware of these and other interests and
considered them before approving and adopting the merger agreement.
Conditions that Must Be Satisfied for the Merger to Occur (page 23)
The following conditions must be met for us to complete the merger:
o approval by First Savings shareholders of the merger agreement;
o the continuing effectiveness of Southern Financial's registration statement
filed with the Securities and Exchange Commission; and
o receipt of an opinion of Southern Financial's counsel that the merger will
be treated for U.S. federal income tax purposes as a reorganization within
the meaning of Section 368 of the Internal Revenue Code of 1986, as
amended.
We cannot complete the merger unless Southern Financial obtains the
approval of the Board of Governors of the Federal Reserve System and the
Virginia State Corporation Commission. Southern Financial has filed applications
with the Federal Reserve Board and the Virginia State Corporation Commission.
While we cannot predict whether or when Southern Financial will obtain all
required regulatory approvals, we see no reason why the approvals will not be
obtained in a timely manner.
Unless prohibited by law, either First Savings or Southern Financial
could elect to waive a condition that has not been satisfied and complete the
merger anyway.
6
<PAGE>
Termination of the Merger Agreement (page 26)
We can agree with Southern Financial to terminate the merger agreement
at any time without completing the merger. Either company may also terminate the
merger agreement if:
o the merger is not completed on or before February 28, 2001; or
o any event occurs which renders impossible, in a material way, the
satisfaction by one company of one or more of the conditions described
above, unless the other company waives such satisfaction.
In addition, there are other situations in which one or both parties may
terminate the merger.
[END OF TWO-CLOUMN FORMAT]
7
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
We are providing the following information to help you analyze the
financial aspects of the merger. We derived this information from audited
financial statements for 1997 through 1999 and unaudited financial statements
for the three months ended March 31, 2000 and 1999. This information is only a
summary, and you should read it in conjunction with the information about
Southern Financial that begins on page 32, Southern Financial's historical
financial statements in Appendix B, the information about First Savings that
begins on page 59, and First Savings' historical financial statements in
Appendix C. You should not rely on the three-month information as being
indicative of results expected for the entire year.
SOUTHERN FINANCIAL - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
2000 1999 1999 1998 1997
---------------------------------- -------------------------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Net interest income $ 4,198 $ 3,620 $ 15,448 $ 13,637 $ 12,910
Net income 1,176 887 961 3,352 2,808
Diluted net income per share 0.44 0.32 0.35 1.22 1.06
Cash dividends per share 0.12 0.067 0.33 0.22 0.17
Book value per share 11.22 11.94 10.87 11.62 10.69
Total assets 427,739 399,058 406,222 404,254 354,016
Shareholders' equity 29,928 31,508 28,864 30,626 27,508
</TABLE>
FIRST SAVINGS - HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
2000 1999 1999 1998
---------------------------------- -----------------------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net interest income $ 664 $ 522 $ 2,332 $ 1,887
Net income 76 86 365 438
Diluted net income per share 0.08 0.09 0.39 0.51
Cash dividends per share -- -- -- --
Book value per share 5.15 4.77 5.07 4.68
Total assets 71,117 72,400 69,045 65,064
Shareholders' equity 4,802 4,441 4,728 4,350
</TABLE>
8
<PAGE>
SELECTED PRO FORMA FINANCIAL DATA
The following table sets forth certain unaudited pro forma combined
financial data for Southern Financial giving effect to the merger accounted for
as a purchase. This information should be read in conjunction with the
historical financial statements of Southern Financial and First Savings,
including respective notes thereto, appearing elsewhere in this proxy
statement/prospectus. See "Unaudited Pro Forma Condensed Financial Information"
on page 14. The pro forma financial data may not be indicative of the results
that actually would have occurred had the merger been consummated on the dates
indicated or that may be obtained in the future.
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
2000 1999
-------------------- -------------------
(in thousands, except per share data)
<S> <C> <C>
Net interest income 4,862 17,780
Net income 1,225 1,218
Diluted net income per share 0.40 0.39
Cash dividends per share 0.12 0.33
Book value per share 11.73 n/a
Total assets 500,225 n/a
Shareholders' equity 36,099 n/a
</TABLE>
9
<PAGE>
COMPARATIVE PER SHARE DATA
The following unaudited financial information reflects comparative per
share data relating to (i) net income, cash dividends, and book value per common
share for both Southern Financial and First Savings on a historical basis, (ii)
net income and book value per common share on a pro forma basis for Southern
Financial assuming the First Savings merger had been effected for the periods
presented, and (iii) net income and book value per common share on a pro forma
equivalent basis per common share for First Savings assuming the First Savings
merger has been effected for the periods indicated and accounted for as a
purchase. See "The Merger - Accounting Treatment" on page 12. The pro forma data
reflects the conversion of each share of First Savings common stock into 0.44
shares of Southern Financial common stock. The information shown below should be
read in conjunction with the historical financial statements of Southern
Financial and First Savings, including the respective notes thereto, and in
conjunction with the unaudited pro forma financial statements, including the
notes thereto, appearing elsewhere in this proxy statement/prospectus. See
"Unaudited Pro Forma Condensed Financial Information" on page 14.
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
2000 1999
-------------------------- --------------------------
<S> <C> <C>
Per Common Share:
Net Income Basic
Southern Financial - Historical 0.44 0.36
First Savings - Historical 0.08 0.39
Pro Forma Combined 0.40 0.39
First Savings Pro Forma Equivalent 0.19 0.89
Net Income Diluted
Southern Financial - Historical 0.44 0.35
First Savings - Historical 0.08 0.39
Pro Forma Combined 0.39 0.38
First Savings Pro Forma Equivalent 0.19 0.89
Cash Dividends Declared:
Southern Financial - Historical 0.12 0.33
First Savings - Historical 0.00 0.00
Pro Forma Combined 0.12 0.33
First Savings Pro Forma Equivalent 0.00 0.00
Book Value:
Southern Financial - Historical 11.22 10.87
First Savings - Historical 5.16 5.07
Pro Forma Combined 11.72 n/a
First Savings Pro Forma Equivalent 11.73 n/a
</TABLE>
10
<PAGE>
THE MERGER
Background of the Merger
During the fall of 1999 Jeffrey C. Constantz, President of First
Savings, requested a personal meeting with Mr. Rick Hall, the then current
president of The Horizon Bank, which Southern Financial acquired by merger in
October 1999. Messrs. Constantz and Hall met and discussed the obstacles facing
small banks such as First Savings and The Horizon Bank in effectively delivering
satisfactory return on shareholders' capital. These included the increase in
technology costs and increased competition in community banking. The two
officers also discussed the difficulty of maintaining liquidity in the stock of
a small bank. Mr. Hall discussed the progress of his bank's then pending merger
with Southern Financial.
As a result of these discussions, Mr. Constantz asked Mr. Hall if he
would contact the principals of Southern Financial to see if they would be
interested in pursuing an acquisition of First Savings. The result of Mr. Hall's
discussions was a series of meetings with Southern Financial's financial advisor
at which the terms of a possible merger between First Savings and Southern
Financial were discussed. Mr. Constantz and Mrs. Barbara J. Fried, Chairman of
First Savings, advised First Savings' board of the progress of these meetings
over the course of several board meetings in late 1999. The position of the
First Savings' board was that it was appropriate and in the shareholders' best
interests that the board keep fully informed as to transactions that could
maximize shareholder value. Accordingly, the board authorized management to
engage in further discussions with Southern Financial.
In several meetings of First Savings' Board of Directors, the board
reviewed and discussed the alternatives facing First Savings -- i.e., continue
as an independent bank versus merger with a larger institution capable of
delivering a broader range of services than those offered by First Savings.
On November 22, 1999, Southern Financial delivered to First Savings a
non-binding letter of intent to enter into good faith negotiations to acquire
First Savings using a fixed exchange ratio of 0.44 shares of Southern Financial
stock for each share of First Savings common stock outstanding. The letter of
intent was subject to numerous conditions, including entering into a definitive
merger agreement. Following negotiations over the terms of the letter of intent,
the parties entered into the letter of intent on December 8, 1999.
Following execution of the letter of intent, the parties conducted
detailed due diligence examinations of the other's respective business and
operations.
On March 15, 2000, First Savings engaged RP Financial, LC. to advise
First Savings as to certain financial matters related to the merger and render
its opinion as to the fairness of the merger consideration from a financial
point of view. Negotiations over the terms of the merger agreement with Southern
Financial took place in late March.
At a special meeting of First Savings' board on March 31, 2000,
attended by legal counsel and RP Financial, the board reviewed the definitive
agreement that had been negotiated with Southern Financial. A representative of
RP Financial furnished the board with a written financial analysis of the
proposed transaction and presented RP Financial's opinion that the consideration
to be received by First Savings shareholders in the merger with Southern
Financial is fair to shareholders from a financial point of view. The board then
unanimously approved the merger agreement.
11
<PAGE>
First Savings' Reasons for the Merger
In deciding to enter into the merger agreement with Southern Financial,
the First Savings board of directors considered a number of factors. The board
did not assign any relative or specific weights to the factors considered. The
principal factors that led to the First Savings board of directors to approve
the merger with Southern Financial were:
o the value being offered First Savings' shareholders by Southern
Financial in relation to the market value, book value and earnings
per share of First Savings' common stock;
o information concerning the financial condition, results of
operations and prospects of Southern Financial as compared to that
of First Savings and, in particular, Southern Financial's dividend
yield, earnings per share and stock price history;
o the compatibility of the respective business management
philosophies of First Savings and Southern Financial;
o the ability of Southern Financial and Southern Financial Bank to
provide comprehensive financial services to customers in relevant
markets;
o the financial terms of other recent business combinations in the
local financial services industry; and
o the opinion of RP Financial, LC. that the consideration to be
received by First Savings' shareholders in the merger is fair to
such shareholders from a financial point of view.
Based upon the above, the First Savings board of directors concluded
that a merger with Southern Financial would be in the best interest of First
Savings and its shareholders and would further its goal of enhancing shareholder
value.
The First Savings board believes that the merger is in the best
interest of First Savings and the First Savings shareholders. The First Savings
board recommends that First Savings shareholders vote to APPROVE the merger.
Accounting Treatment
We anticipate that the merger will be accounted for as a purchase for
accounting and financial reporting purposes. Under this method of accounting,
the assets and liabilities of First Savings will be recorded on the books of
Southern Financial at their respective fair values as of the effective date of
the merger. The excess of value of consideration paid by Southern Financial over
the fair value of First Savings' specifically identifiable tangible and
intangible assets acquired less liabilities assumed is considered goodwill,
which is expected to be amortized over 15 years. Southern Financial's
consolidated results of operations will include the results of First Savings
after the effective date of the merger.
Material Federal Income Tax Consequences of the Merger
The following is a discussion of the material federal income tax
consequences of the merger under the Internal Revenue Code of 1986, as amended,
to First Savings shareholders who receive Southern Financial common stock solely
in exchange for First Savings common stock and cash instead of fractional
shares. The discussion does not deal with all aspects of federal taxation that
may be relevant to
12
<PAGE>
particular First Savings shareholders. Certain tax consequences of the merger
may vary depending upon the particular circumstances of each First Savings
shareholder and other factors.
You are urged to consult with your tax advisor to determine the
particular tax consequences of the merger to you.
This summary is based on current law and the advice of Williams,
Mullen, Clark & Dobbins, legal counsel to Southern Financial. The advice in this
summary is based on, among other things, certain customary assumptions and
representations relating to certain facts and circumstances of, and the
intentions of the parties to, the merger. Neither Southern Financial nor First
Savings has requested a ruling from the Internal Revenue Service in connection
with the merger. To meet a condition to consummation of the merger, Southern
Financial and First Savings will receive from Williams, Mullen, Clark & Dobbins
an opinion as to certain federal income tax consequences of the merger. Such
opinion is not binding on the Internal Revenue Service.
In the opinion of counsel, the merger will constitute a tax-free
reorganization under Section 368(a) of the Internal Revenue Code, if consummated
in the manner set forth in the merger agreement. Accordingly, among other
things, in the opinion of such counsel:
o The merger will constitute a reorganization within the meaning of
Section 368(a) of the Internal Revenue Code;
o No gain or loss will be recognized by Southern Financial or First
Savings as a result of the merger;
o No gain or loss will be recognized by a First Savings shareholder
to the extent he or she receives Southern Financial common stock
solely in exchange for his or her First Savings common stock
pursuant to the merger;
o The tax basis of the Southern Financial common stock received by
each First Savings shareholder will be the same as the tax basis of
the First Savings common stock surrendered in exchange therefor;
and
o The holding period for each share of Southern Financial common
stock received by each First Savings shareholder in exchange for
First Savings common stock will include the period for which the
shareholder held the First Savings common stock exchanged therefor,
provided the First Savings common stock is a capital asset in the
hands of the holder at the effective date of the merger.
Any cash received by a First Savings shareholder instead of fractional
shares could result in taxable income. The receipt of that cash will generally
be treated as a sale or exchange of the stock resulting in capital gain or loss
measured by the difference between the cash received and an allocable portion of
the basis of the stock relinquished. The receipt of the cash may be treated as a
dividend and taxed as ordinary income in certain limited situations.
Absence of Appraisal Rights
Under Section 6.1-194.8 of the Virginia Savings Institutions Act of
1985, shareholders of First Savings will not be entitled to dissent from the
merger and obtain the judicially determined fair value of their shares of First
Savings.
13
<PAGE>
UNAUDITED PRO FORMA CONDENSED FINANCIAL INFORMATION
The following unaudited pro forma combined condensed financial
statements give effect to the proposed merger using the purchase method of
accounting. Accordingly, the assets and liabilities of First Savings have been
recorded on Southern Financial's books at their fair market value and First
Savings' capital accounts have been eliminated. The amount by which the sum of
(1) the cash paid by Southern Financial and (2) the market value of the Southern
Financial common stock issued in the merger exceeds the net fair market value of
First Savings assets and liabilities has been allocated to goodwill.
The pro forma balance sheet combines the balance sheet of Southern
Financial and First Savings as of March 31, 2000. The pro forma income
statements for the three months ended March 31, 2000 and for the year ended
December 31, 1999 combine the results of operations of Southern Financial and
First Savings for the respective periods. The pro forma income statement for the
year ended December 31, 1999 has been derived from audited financial statements
included elsewhere herein. Pro forma adjustments on the income statement have
been computed assuming that the transaction was consummated at the beginning of
the period presented. Pro forma adjustments on the balance sheet have been
computed assuming the transaction was consummated at March 31, 2000.
The information shown is not necessarily indicative of the results of
future operations of the combined entity or the actual results that would have
occurred had the merger been in effect during the periods presented. These
statements and the related notes should be read in conjunction with the related
consolidated financial statements of Southern Financial and First Savings and
the notes thereto appearing elsewhere herein.
14
<PAGE>
SOUTHERN FINANCIAL AND FIRST SAVINGS
PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF MARCH 31, 2000
(in thousands)
<TABLE>
<CAPTION>
Southern Pro Forma
Financial First Savings Adjustments Combined
--------- ------------- ----------- --------
Assets
<S> <C> <C> <C> <C>
Cash and due from banks $ 12,722 $ 2,930 $ - $ 15,652
Overnight earning deposits 19,904 6,604 - 26,508
Investment securities, available for sale 99,824 1,040 - 100,864
Investment securities, held to maturity 39,847 11,192 (189) D 50,850
Loans held for sale 193 - - 193
Loans receivable, net 236,740 48,088 - 284,828
Premises and equipment 6,261 490 - 6,751
Other assets 12,248 773 1,958 A 14,979
--------- --------- --------- ---------
Total Assets $ 427,739 $ 71,117 $ 1,796 $ 500,625
Liabilities and Shareholders' Equity
Liabilities
Deposits $ 387,752 $ 54,044 $ - $ 441,796
Advances from the Federal Home Loan Bank 5,000 3,000 - 8,000
Securities sold under agreements to repurchase - 8,861 - 8,861
Other liabilities 5,059 410 - 5,469
--------- --------- --------- ---------
Total liabilities 397,811 66,315 - 464,126
Shareholders' Equity
Preferred stock - - - -
Common stock, par value $.01 per share 27 - 4 B 31
Common stock, par value $1.00 per share - 932 (932) C -
Capital in excess of par 23,813 3,276 (3,276) C 29,626
5,813 B
Retained earnings 7,751 587 167 C 8,505
Accumulated other comprehensive income (1,663) 7 (7) C (1,663)
--------- --------- --------- ---------
Total shareholders' equity 29,928 4,802 1,769 36,499
Total liabilities and shareholders' equity $ 427,739 $ 71,117 $ 1,769 $ 500,625
========= ========= ========= =========
</TABLE>
A: Goodwill of $1,957,888 acquired in the transaction as of March 31, 2000.
Southern Financial has reasonably estimated and included the remaining
transaction costs and severance costs prior to consummation of the merger.
B: Market value at March 31, 2000 of 409,906 shares of Southern Financial
common stock issued to First Savings shareholders.
C: Elimination of acquired company's equity under purchase accounting rules,
which includes additional estimated expenses of $755,000.
D: Unrealized loss on investment securities held-to-maturity based on fair
value at March 31, 2000 of $11,003,000.
See notes to Pro Forma Condensed Financial Information
15
<PAGE>
SOUTHERN FINANCIAL AND FIRST SAVINGS
PRO FORMA COMBINED CONDENSED INCOME STATEMENT
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(in thousands)
<TABLE>
<CAPTION>
Southern Pro Forma
Financial First Savings Adjustments Combined
----------- ------------- ----------- ------------
<S> <C> <C> <C> <C>
Interest Income
Loans $ 5,557 $ 1,148 $ - $ 6,705
Investment securities 2,482 264 - 2,746
----------- ------------ ----------- -----------
Total interest income 8,039 1,412 - 9,451
Interest Expense
Deposits 3,568 583 - 4,151
Borrowings 273 165 - 438
----------- ------------ ----------- -----------
Total interest expense 3,841 748 - 4,589
----------- ------------ ----------- -----------
Net interest income 4,198 664 - 4,862
----------- ------------ ----------- -----------
Provision for loan losses 350 225 - 575
----------- ------------ ----------- -----------
Net interest income after provision for loan losses 3,848 439 - 4,287
Other Income
Fee income 659 116 - 775
Gain on sale of loans 333 139 - 472
Other 31 11 - 42
----------- ------------ ----------- -----------
Total other income 1,023 266 1,289
Other Expenses
Employee compensation and benefits 1,658 279 - 1,937
Premises and equipment 616 91 - 707
Data processing 275 49 - 324
Deposit insurance 18 13 - 31
Other 554 150 33 A 737
----------- ------------ ----------- -----------
Total other expenses 3,121 582 33 3,736
Income before taxes 1,750 123 (33) 1,840
----------- ------------ ----------- -----------
Income tax expense 574 47 - 621
----------- ------------ ----------- -----------
Net income $ 1,176 $ 76 $ (33) $ 1,219
=========== ============ =========== ===========
Earnings per common share:
Basic $ 0.44 $ 0.08 $ 0.40
Diluted 0.44 0.08 0.39
Weighted average shares outstanding
Basic 2,666 932 3,076
Diluted 2,688 934 3,099
___________________________________________
</TABLE>
A: Amortization of goodwill over 15 years.
See Notes to Pro Forma Condensed Financial Information
16
<PAGE>
SOUTHERN FINANCIAL AND FIRST SAVINGS
PRO FORMA COMBINED CONDENSED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 1999
(in thousands)
<TABLE>
<CAPTION>
Southern Pro Forma
Financial First Savings Adjustments Combined
--------- ------------- ----------- --------
<S> <C> <C> <C> <C>
Interest Income
Loans $ 19,982 $ - $ - $ 24,123
Investment securities 9,774 1,072 - 10,846
-------- -------- -------- --------
Total interest income 29,756 5,213 - 34,969
Interest Expense
Deposits 13,576 2,429 - 16,005
Borrowings 732 452 - 1,184
-------- -------- -------- --------
Total interest expense 14,308 2,881 - 17,189
-------- -------- -------- --------
Net interest income 15,448 2,332 - 17,780
-------- -------- -------- --------
Provision for loan losses 2,130 130 - 2,260
-------- -------- -------- --------
Net interest income after provision for loan losses 13,318 2,202 - 15,520
Other Income
Fee income 2,155 556 - 2,711
Gain on sale of loans 1,115 22 - 1,137
Loss on sale of investment securities (692) - - (692)
Other 256 100 - 356
-------- -------- -------- --------
Total other income 2,834 678 - 3,512
Other Expenses
Employee compensation and benefits 6,449 1,099 - 7,548
Premises and equipment 3,362 379 - 3,741
Restructuring charges 685 - - 685
Merger expenses 1,752 - - 1,752
Other 2,341 814 131 A 3,286
-------- -------- -------- --------
Total other expenses 14,589 2,292 131 17,012
Income before taxes 1,563 588 (131) 2,020
-------- -------- -------- --------
Income tax expense 602 223 - 825
-------- -------- -------- --------
Net income $ 961 $ 36 $ (131) $ 1,195
======== ======== ======== ========
Earnings per common share:
Basic $ 0.36 $ 0.39 $ 0.39
Diluted 0.35 0.39 0.38
Weighted average shares outstanding
Basic 2,649 931 3,059
Diluted 2,722 939 3,135
________________________________________
</TABLE>
A: Amortization of goodwill over 15 years.
See Notes to Pro Forma Condensed Financial Information
17
<PAGE>
Notes to Pro Forma Condensed Financial Information
1. The pro forma information presented is not necessarily indicative of
the results of operations or the financial position that would have
resulted had the merger been consummated at the beginning of the period
indicated, nor is it necessarily indicative of the results of
operations in future periods or the future financial position of the
combined entities.
2. The merger involves the exchange of Southern Financial common stock
having a value of $5,816,569 which at March 31, 2000 would represent
approximately 409,906 shares, based on a market price of $14.19 per
share, for all the assets and liabilities of First Savings and will be
accounted for on a purchase accounting basis. Pro forma condensed
balance sheet amounts at March 31, 2000 and pro forma statements of
income for the three months ended March 31, 2000 and the year ended
December 31, 1999 include First Savings historical balance sheet and
income statement amounts.
As a result, information was appropriately adjusted for the merger by
the (i) addition of 409,906 shares of Southern Financial common stock
amounting to $4,099 (ii) elimination of 931,605 shares of First Savings
common stock amounting to $931,605, (iii) elimination of First Savings'
capital surplus of $3,276,339 and retained earnings of $587,386, and
(iv) increase in capital surplus of $5,812,470 to record the market
value of newly issued shares.
3. The excess of purchase price over net assets acquired is calculated as
follows:
<TABLE>
<CAPTION>
<S> <C>
Purchase Price $ 5,816,569
Less: Fair market value of net assets acquired
Cash and overnight earning deposits (9,534,097)
Investments (includes $189,000 unrealized loss on
investments held to maturity) (12,042,808)
Loans receivable (48,087,567)
Property and equipment, net (489,646)
Other assets (773,293)
Deposits 54,043,822
Other borrowings 11,860,751
Other liabilities 409,157
Add: First Savings and Southern Financial transaction costs 755,000
-------------
Excess of purchase price over net assets acquired (a) $ 1,957,888
=============
</TABLE>
The basis of all assets and liabilities acquired are assumed to
approximate market value as of March 31, 2000, except for investment
securities held-to-maturity, which had an unrealized loss of $189,000
as of March 31, 2000.
(a) Amortization of excess purchase price over net assets acquired
are being amortized over the estimated life of 15 years.
4. Per share data has been computed based on the combined historical net
income applicable to common shareholders of Southern Financial and
First Savings using the historical weighted average shares outstanding
of Southern Financial and the weighted average shares, adjusted to
equivalent shares of Southern Financial, of First Savings, as of the
earliest period presented.
18
<PAGE>
OPINION OF FIRST SAVINGS' FINANCIAL ADVISOR
The First Savings board retained RP Financial in March 2000 to render
its opinion with respect to the merger consideration from the financial point of
view of the First Savings shareholders. In requesting RP Financial's opinion,
the First Savings board did not give any special instructions to RP Financial,
nor did it impose any limitations upon the scope of the investigation that RP
Financial might wish to conduct to enable it to give its opinion. RP Financial
has delivered to First Savings its written opinion dated March 31, 2000, and its
updated opinion as of July 17, 2000, to the effect that, based upon and subject
to the matters set forth therein, as of the date thereof, the merger
consideration is fair to the First Savings shareholders from a financial point
of view. The opinion of RP Financial is directed toward the consideration to be
received by First Savings shareholders and does not constitute a recommendation
to any First Savings shareholder to vote in favor of approval of the merger
agreement. A copy of the RP Financial opinion is set forth as Appendix D to this
proxy statement/prospectus, and First Savings shareholders should read it in its
entirety. RP Financial has consented to the inclusion and description of its
written opinion in this proxy statement/prospectus.
RP Financial was selected by First Savings to act as its financial
advisor because of RP Financial's expertise in the valuation of businesses and
their securities for a variety of purposes, including its expertise in
connection with mergers and acquisitions of savings and loan associations,
savings banks, savings and loan holding companies, commercial banks and bank
holding companies. Pursuant to a letter agreement dated March 15, 2000 and
executed by First Savings on March 16, 2000 (the "Engagement Letter"), RP
Financial estimates that it will receive from First Savings total professional
fees of approximately $30,000, of which $20,000 has been paid to date, plus
reimbursement of certain out-of-pocket expenses, for its services in connection
with the merger. In addition, First Savings has agreed to indemnify and hold
harmless RP Financial, any affiliates of RP Financial, and the respective
directors, officers, agents and employees of RP Financial or their successors
and assigns who act for or on behalf of RP Financial from and against any and
all losses, claims, damages and liabilities, joint or several, in connection
with RP Financial's services pursuant to the Engagement Letter attributable to:
(i) any untrue statement or alleged untrue statement of a material fact
contained in the financial statements or other information furnished or
otherwise provided by First Savings to RP Financial, either orally or in
writing; (ii) the omission or alleged omission of a material fact from the
financial statements or other information furnished or otherwise made available
by First Savings to RP Financial, or (iii) any action or omission to act by
First Savings, or First Savings' respective officers, directors, employees or
agents, which action or omission is willful or negligent. First Savings will be
under no obligation to indemnify RP Financial hereunder if a court determines
that RP Financial was negligent or acted in bad faith with respect to any
actions or omissions of RP Financial related to a matter for which
indemnification is sought. In addition, if RP Financial is entitled to
indemnification from First Savings under the Engagement Letter, and in
connection therewith incurs legal expenses in defending any legal action
challenging the opinion of RP Financial where RP Financial is not negligent or
otherwise at fault or is found by a court of law to be not negligent or
otherwise at fault, First Savings will indemnify RP Financial for all reasonable
expenses.
In rendering this fairness opinion, RP Financial reviewed the following
material: (1) the merger agreement, dated March 31, 2000, including exhibits;
(2) financial and other information for First Savings, all with regard to
balance and off-balance sheet composition, profitability, interest rates,
volumes, maturities, trends, credit risk, interest rate risk, liquidity risk and
operations: (a) audited and unaudited financial statements for the fiscal years
ended December 31, 1996 through 1999 and the quarter ended March 31, 2000, (b)
shareholder, regulatory and internal financial and other reports through March
31, 2000, (c) the proxy statements for the last three years and this proxy
statement/prospectus, and (d) First Savings' management and board comments
regarding past and current business, operations, financial condition, and future
prospects; and (3) financial and other information for Southern Financial
including: (a) unaudited and audited financial statements for the fiscal years
ended December 31, 1996 through 1999
19
<PAGE>
and the quarter ended March 31, 2000, (b) shareholder, regulatory and internal
financial and other reports through March 31, 2000, (c) the annual proxy
statement for the last three years, (d) the registration statement and proxy
statement for the completed share exchange merger with The Horizon Bank in 1999,
which was accounted for as a pooling of interests, (e) the pending registration
statement for the issuance of trust preferred stock by Southern Financial, and
(f) Southern Financial's management comments regarding past and current
business, operations, financial condition, and future prospects.
RP Financial reviewed financial, operational, market area and stock
price and trading characteristics for First Savings and Southern Financial (on a
historical and pro forma basis) relative to publicly-traded savings institutions
and commercial banking institutions, respectively, with comparable resources,
financial condition, earnings, operations and markets. RP Financial also
considered the economic and demographic characteristics in the local market
area, and the potential impact of the regulatory, legislative and economic
environments on operations for First Savings and Southern Financial and the
public perception of the savings institution and commercial banking industries.
RP Financial also considered: (1) the financial terms, financial and operating
condition and market area of other recently completed acquisitions of comparable
savings institutions both regionally and nationally; (2) discounted cash flow
analyses incorporating future prospects for First Savings; (3) the future
prospects for Southern Financial; (4) the pro forma impact on Southern Financial
of the acquisition of First Savings, which is expected to be accounted for as a
purchase; and (5) the market for Southern Financial's common stock.
In rendering its opinion, RP Financial relied, without independent
verification, on the accuracy and completeness of the information concerning
First Savings and Southern Financial furnished by the respective institutions to
RP Financial for review, as well as publicly available information regarding
other financial institutions and economic and demographic data. First Savings
and Southern Financial did not restrict RP Financial as to the material it was
permitted to review. RP Financial did not perform or obtain any independent
appraisals or evaluations of the assets and liabilities and potential and/or
contingent liabilities of First Savings or Southern Financial.
RP Financial expresses no opinion on matters of a legal, regulatory,
tax or accounting nature or the ability of the merger as set forth in the merger
agreement to be consummated. In rendering its opinion, RP Financial assumed
that, in the course of obtaining the necessary regulatory and governmental
approvals for the proposed merger, no restriction will be imposed on Southern
Financial that would have a material adverse effect on the ability of the merger
to be consummated as set forth in the merger agreement.
RP Financial's opinion was based solely upon the information available
to it and the economic, market and other circumstances as they existed as of
March 31, 2000 and July 17, 2000. Events occurring after the most recent date
could materially affect the assumptions used in preparing the opinion. In
connection with rendering its opinion dated March 31, 2000, and updated as of
July 17, 2000, RP Financial performed a variety of financial analyses that are
summarized below. Although the evaluation of the fairness, from a financial
point of view, of the merger consideration was to some extent subjective based
on the experience and judgment of RP Financial, and not merely the result of
mathematical analyses of financial data, RP Financial relied, in part, on the
financial analyses summarized below in its determinations. The preparation of a
fairness opinion is a complex process and is not necessarily susceptible to
partial analyses or summary description. RP Financial believes its analyses must
be considered as a whole and that selecting portions of such analyses and
factors considered by RP Financial without considering all such analyses and
factors could create an incomplete view of the process underlying RP Financial's
opinion. In its analyses, RP Financial took into account its assessment of
general business, market, monetary, financial and economic conditions, industry
performance and other matters, many of which are beyond the control of First
Savings and Southern Financial, as well as RP Financial's experience in
securities valuation, its knowledge of financial institutions, and its
experience in
20
<PAGE>
similar transactions. With respect to the comparable transactions analysis
described below, no public company utilized as a comparison is identical to
First Savings and such analyses necessarily involve complex considerations and
judgments concerning the differences in financial and operating characteristics
of the companies and other factors that could affect the acquisition values of
the companies concerned. The analyses were prepared solely for purposes of RP
Financial providing its opinion as to the fairness of the merger consideration,
and they do not purport to be appraisals or necessarily reflect the prices at
which businesses or securities actually may be sold. Any estimates contained in
RP Financial's analyses are not necessarily indicative of future results of
values, which may be significantly more or less favorable than such estimates.
None of the analyses performed by RP Financial was assigned a greater
significance by RP Financial than any other. Additionally, RP Financial
considered other expressions of interest from regional financial institutions
with the perceived ability to consummate an acquisition of First Savings,
including the amount, form and value of the potential consideration
Comparable Transactions Analysis. RP Financial compared the merger on
the basis of multiples or ratios of reported earnings, tangible book value,
assets and core deposit premium of First Savings implied by the merger
consideration to be paid to the First Savings shareholders with the same
multiples or ratios in pending acquisitions and acquisitions completed 1998 to
date of: (a) all publicly traded savings and loan associations, savings banks,
and savings and loan holding companies meeting the following criteria - assets
less than $150 million, equity/assets less than 12 percent, profitable and with
ample deal data (10 pending and 23 completed); and (b) all Mid-Atlantic savings
and loan associations, savings banks, and savings and loan holding companies
meeting the following criteria - assets under $250 million, profitable and with
ample deal data (4 pending and 11 completed). The median acquisition pricing
multiples or ratios of the groups were:
<TABLE>
<CAPTION>
National Group Mid-Atlantic Group
-------------- ------------------
Pending Pending
All Only All Only
--- ---- --- ----
<S> <C> <C> <C> <C>
Price/earnings 25.60x 25.66x 28.95x 34.59x
Price/book 187.93% 163.09% 150.79% 158.27%
Price/tangible book 188.80% 163.09% 150.79% 158.27%
Price/assets 14.68% 13.69% 17.71% 14.88%
Tangible book premium/ 9.08% 8.02% 8.36% 8.76%
Core deposits
</TABLE>
In comparison to these groups, First Savings was generally similarly
sized, less capitalized and similarly profitable, and maintained a higher return
on equity. First Savings' acquisition pricing multiples or ratios for
price/earnings, price/tangible book, price/assets and core deposits premium, as
of the March 31, 2000 fairness opinion, based on financial statements as of or
for the 12 months ended December 31, 1999, were: 15.95 times earnings; 123.01%
of reported tangible book value; 8.42% of assets; and 2.82% tangible book
premium to core deposits. In each pricing ratio, First Savings' indicated ratios
fell within the range of the pricing ratios for national and Mid-Atlantic
groups.
Discounted Cash Flow Analysis. Using discounted cash flow analyses, RP
Financial estimated the present value of future dividends and the terminal value
based on alternative capital management and operating strategies over a
five-year period. Alternative strategies analyzed included a base case scenario,
a faster growth scenario and an assumed regular dividend scenario. The terminal
value multipliers incorporated in RP Financial's analysis were derived from the
comparable transaction analysis discussed above pertaining to financially
comparable transactions, specifically, the price/tangible book ratio and
price/earnings multiple. The dividend streams and terminal values were then
discounted to present value based on a discount rate derived from the earnings
capitalization rate of publicly traded thrifts, the
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Treasury yield curve (i.e., the risk-free rate) and perceived investment risks
in the First Savings shares. The merger consideration exceeds the upper end of
the range of the sum of the present values of the future dividends and terminal
values derived from the individual strategic scenarios. For example, the present
values derived from the individual strategic scenarios ranged from roughly $4.88
to $5.49 per share.
Pro Forma Impact Analysis. RP Financial's analysis considered the
financial condition and operations of Southern Financial on a stand-alone basis
at December 31, 1999, versus the pro forma impact resulting from the merger. RP
Financial considered that the merger is estimated to (1) be accretive to
Southern Financial's pro forma earnings per share incorporating anticipated
synergies and (2) leverage Southern Financial's tangible capital while resulting
in a small amount of book value per share dilution and (3) the resulting
increase to Southern Financial's return on equity. RP Financial considered the
potential impact of the merger on Southern Financial's key financial
characteristics, per share data, resulting pricing ratios and comparison to
other regional bank pricing ratios, as well as Southern Financial's longer run
strategic objectives. RF Financial evaluated the estimated financial impact of
the merger on the potential for increased liquidity of First Savings common
stock, the receipt of dividends by First Savings, the enhanced ability to pursue
growth without an additional capital issuance and expanded market share.
As described above, RP Financial's opinion and presentation to the
First Savings board was one of many factors taken into consideration by the
First Savings board in making its determination to approve the merger agreement.
Although the foregoing summary describes, the material components of the
analyses presented by RP Financial to the First Savings board on March 31, 2000,
and updated as of July 17, 2000, in connection with its opinion as of those
dates, it does not purport to be a complete description of all the analyses
performed by RP Financial and is qualified by reference to the written opinion
of RP Financial set forth as Appendix D, which First Savings shareholders are
urged to read in its entirety.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Certain members of First Savings' management, as well as the members of
the First Savings board of directors, have interests in the merger in addition
to their interests as shareholders of First Savings. These interests are
described below. In each case, the First Savings board was aware of these
potential interests, and considered them, among other matters, in approving the
merger agreement and the transactions contemplated thereby.
Indemnification. Southern Financial has generally agreed to indemnify
the officers and directors of First Savings to the extent permitted by Virginia
law following the closing of the merger. Southern Financial also has agreed to
provide directors' and officers' liability insurance for the three years
following the merger for the present officers and directors of First Savings.
Chairman of First Savings. Barbara J. Fried, who will serve on the
Southern Financial board, initially will receive annual retainers and monthly
fees for service on Southern Financial's board. Based on the existing schedule
utilized by Southern Financial, these individuals will receive an annual fee of
$4,000, $500 for attendance at each board meeting and $150 for attendance at
each board committee meeting.
Payments to Officers of First Savings. On the effective date of the
merger, Mr. Jeffrey C. Constantz, President and Chief Executive Officer of First
Savings, will receive an aggregate of $125,000 under the terms of his employment
agreement with First Savings, which provides for such payment in
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connection with termination of Mr. Constantz' employment in connection with a
change in control of First Savings. Mr. Constantz will also receive a payment of
$100,000 pursuant to a "pay to stay" incentive program adopted by First Savings
as a means of retaining key management through the date of the merger. Mr. Glenn
Rhodes, First Savings' Controller, will receive a payment of $37,500 as of the
effective date of the merger under his employment agreement with First Savings.
Mr. Rhodes and Ms. Patricia Bhatia, Vice President of First Savings, will also
receive payments of $37,500 and $21,500, respectively, under the pay to stay
program.
Employee and Benefit Plans. As soon as practicable upon completion of
the merger and subject to Southern Financial's best efforts, employees of First
Savings will be entitled to participate in Southern Financial's benefit plans
and programs on the same terms as employees of Southern Financial, without
waiting period or exceptions for pre-existing conditions and giving effect to
years of service with First Savings as if such service were with Southern
Financial. Southern Financial will also honor First Savings' obligations for all
accrued and unused vacation, sick leave and personal leave and all employment,
severance, consulting and other compensation contracts and agreements that First
Savings has previously disclosed to Southern Financial.
Conversion of Stock Options. All outstanding options for shares of
common stock of First Savings issued to employees and directors of First Savings
under its stock option plans will be converted as of the close of the merger to
options for common stock of Southern Financial having equivalent values.
CERTAIN DIFFERENCES IN RIGHTS OF SHAREHOLDERS
Both Southern Financial and First Savings are corporations subject to
the provisions of the Virginia Stock Corporation Act. First Savings'
shareholders' rights are presently governed by First Savings' articles of
incorporation and bylaws. Upon consummation of the merger and First Savings'
shareholders becoming shareholders of Southern Financial, shareholders' rights
will be governed by the articles of incorporation and bylaws of Southern
Financial.
There are a few material differences between the rights of a First
Savings shareholder under First Savings' articles of incorporation and bylaws,
on the one hand, and the rights of a Southern Financial shareholder under the
articles of incorporation and bylaws of Southern Financial, on the other hand,
which are disclosed in the section "Comparative Rights of Shareholders" on page
89.
TERMS OF THE MERGER AGREEMENT
The following is a summary description in the material aspects of the
merger agreement. This description does not purport to be complete and is
qualified in its entirety by reference to Appendix A that contains the full
merger agreement. We urge you to read Appendix A in its entirety.
Representations and Warranties; Conditions to the Merger
The merger agreement contains representations and warranties by
Southern Financial and First Savings, including representations and warranties
with respect to their individual organizations, authorizations to enter into the
merger agreement, capitalization, financial statements and pending and
threatened litigation. These representations and warranties, except as otherwise
provided in the merger agreement, will not survive the effective date of the
merger.
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The obligations of Southern Financial and First Savings to consummate
the merger are subject to the following conditions, among others:
o approval of the merger agreement by the requisite shareholder vote
of the First Savings shareholders;
o receipt of all necessary regulatory approvals not conditioned or
restricted in a manner that, in the judgment of the boards of
directors of Southern Financial or First Savings, materially
adversely affects the economic or business benefits of the merger
so as to render inadvisable or unduly burdensome consummation of
the merger;
o the absence of certain actual or threatened proceedings before a
court or other governmental body relating to the merger;
o the receipt of an opinion of counsel as to certain federal income
tax consequences of the merger;
o performance by the other company of its obligations under the
merger agreement;
o the accuracy, in all material respects, of the representations and
warranties of the other company contained in the merger agreement;
and
o the receipt of certain opinions and certificates from the other
company.
Regulatory Approvals
As indicated above, the merger is conditioned on the prior approval of
the merger by the Board of Governors of the Federal Reserve System and the
Virginia State Corporation Commission. Southern Financial has filed applications
with the Federal Reserve and the Virginia State Corporation Commission. While we
cannot predict whether or when Southern Financial will obtain all required
regulatory approvals, we see no reason why the approvals will not be obtained in
a timely manner. However, there can be no assurance that the necessary approvals
will be obtained, or that any approval will not be conditioned in a manner which
makes consummation of the merger, in the judgment of the board of directors of
Southern Financial or First Savings, inadvisable or unduly burdensome.
Business Pending the Merger
Until the effective date of the merger, each of Southern Financial and
First Savings has agreed that it will operate its business substantially as
presently operated, in the ordinary course of business, and will use its best
efforts to preserve intact its relationships with persons having business
dealings with it. In addition, until the effective date, First Savings has
agreed not to take, without Southern Financial's consent, certain specific
actions in connection with the ongoing operation of its business. Specifically,
First Savings may not:
o declare or pay dividends on its capital stock, except in accordance
with past practice;
o enter into any material transactions out of the ordinary course of
business;
o amend or repeal its charter or bylaws;
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o issue any capital stock, except upon exercise of rights, warrants
or options issued pursuant to existing employee benefits plans,
programs or arrangements or effect any stock split or otherwise
change its capitalization;
o purchase or redeem any of its capital stock;
o voluntarily alter or change the composition of any director,
officer or other key management personnel;
o make any change in the compensation or title of any officer,
director or key management employee other than in the ordinary
course of business;
o enter into any new benefit plans or employment agreements;
o incur any liability outside the ordinary course of business; or
o knowingly waive any right of substantial value.
No Solicitation; Board Action
First Savings has agreed not to (i) knowingly encourage, solicit or
initiate discussions or negotiations with any person other than Southern
Financial concerning any merger, share exchange, sale of substantial assets,
tender offer, sale of shares of capital stock or similar transaction involving
First Savings, (ii) enter into any agreement with any third party providing for
a business combination transaction, equity investment or sale of a significant
amount of assets not in the ordinary course of business, or (iii) furnish any
information to any other person relating to or in support of such transaction.
First Savings also has agreed that it will promptly communicate to
Southern Financial the terms of any proposal which it may receive in respect to
any of the foregoing transactions.
First Savings would be required to pay Southern Financial $100,000 if
the merger agreement is terminated and before the date of termination First
Savings receives a merger or acquisition proposal or initiates merger or
acquisition discussions with a third party and within 12 months after the date
of termination the First Savings board determines by vote that a merger or
acquisition by the third party is in the best interests of First Savings and its
shareholders. Additionally, no fee is payable, however, if Southern Financial
wrongfully terminates the merger agreement. Similarly, no fee is payable if, at
the time the merger agreement terminates, First Savings is entitled to terminate
on the basis of a breach by Southern Financial or there has been a failure to
satisfy certain closing conditions (other than approval by First Savings'
shareholders). See "- Expenses of the Merger and Termination Fee" on page 27.
Effective Date
If the merger is approved by the shareholders of First Savings, all
required governmental and other consents are obtained and the other conditions
to the merger are satisfied or waived, the merger will be consummated and made
effective on the date and at the time indicated on the certificate of merger
issued by the Virginia State Corporation Commission pursuant to the Virginia
Stock Corporation Act. See "- Representations and Warranties; Conditions to the
Merger" on page 23.
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<PAGE>
It is anticipated that the effective date of the merger will occur in
the third quarter of 2000.
Surrender of Stock Certificates
As soon as practicable after the merger, Southern Financial will cause
Chase Mellon Shareholder Services, its exchange agent, to mail to each First
Savings shareholder a letter of transmittal and instructions for use to
surrender the certificates representing shares of First Savings common stock in
exchange for certificates representing shares of Southern Financial common
stock.
First Savings shareholders should not send in their certificates until
they receive such instructions.
Promptly after surrender of one or more certificates for First Savings
common stock, together with a properly completed letter of transmittal, each
First Savings shareholder will receive a certificate or certificates
representing the number of shares of Southern Financial common stock to which he
or she is entitled and, where applicable, a check for the amount payable in cash
instead of issuing a fractional share. Lost, stolen, mutilated or destroyed
certificates will be treated in accordance with the existing procedures of
Southern Financial.
After the merger, each First Savings shareholder will be entitled to
vote the number of shares of Southern Financial common stock into which your
First Savings common stock has been converted, regardless of whether you have
surrendered your First Savings certificates. The merger agreement provides,
however, that no dividend or distribution payable to the holders of record of
Southern Financial common stock at or as of any time after the effective date of
the merger will be paid to the holder of any First Savings certificate until
such holder physically surrenders such certificate, promptly after which time
all such dividends or distributions will be paid, without interest.
Waiver, Amendment and Termination
At any time on or before the effective date of the merger, any term or
condition of the merger may be waived by the party which is entitled to the
benefits thereof and without shareholder approval. The merger agreement may be
amended at any time before the merger by agreement of the parties whether before
or after the shareholder meeting. Any material change in a material term of the
merger agreement would require a resolicitation of First Savings' shareholders.
Such a material change would include, but not be limited to, a decrease in the
exchange ratio or a change in the tax consequences to First Savings'
shareholders.
The merger agreement may be terminated by Southern Financial or First
Savings, whether before or after the approval of the merger by the shareholders
of First Savings:
o by mutual consent of First Savings and Southern Financial;
o unilaterally by First Savings or Southern Financial, if the merger
has not occurred on or before February 28, 2001; or
o unilaterally by First Savings or Southern Financial if the
satisfaction in any material respect of one or more conditions to
the obligation of that party is rendered impossible of
satisfaction. In the event of termination, the merger agreement
shall become null and void, except that certain provisions thereof
relating to expenses and confidentiality of information exchanged
between the parties shall survive any such termination.
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Resales of Southern Financial Common Stock
All shares of Southern Financial common stock received by First Savings
shareholders in connection with the merger will be freely transferable, except
that Southern Financial common stock received by persons who are deemed to be
"affiliates" of First Savings for purposes of Rule 145 under the Securities Act
of 1933, as amended (the "Securities Act"). To the best knowledge of First
Savings and Southern Financial, the only persons who may be deemed to be
affiliates of First Savings subject to these limitations are the directors and
executive officers of First Savings.
Expenses of the Merger and Termination Fee
In general, whether or not the merger is consummated, First Savings and
Southern Financial will pay their own expenses incident to preparing, entering
into and carrying out the merger agreement, and preparing and filing the
registration statement of which this proxy statement/prospectus is a part.
If the merger agreement terminates and, prior to the date of
termination First Savings solicits or receives a business combination inquiry or
proposal from a third party and, within 12 months after the merger agreement
terminates the First Savings board determines by vote that a business
combination with the third party is in the best interests of First Savings and
its shareholders, First Savings shall pay Southern Financial $100,000.
Additionally, no payment will be due if Southern Financial wrongfully terminates
the merger agreement or, if at the time the merger agreement terminates, First
Savings is entitled to terminate or refuse to close on the grounds that Southern
Financial has breached any representation or warranty in the merger agreement.
Finally, no payment will be due if there has been a failure to satisfy certain
closing conditions; a failure to obtain regulatory approval; if the Securities
and Exchange Commission issues a stop order or threatens to issue a stop order
concerning this proxy statement/prospectus; or if counsel to Southern Financial
does not issue an opinion that the merger is tax free to the shareholders of
First Savings.
This provision is intended to discourage another party from interfering
with the merger agreement between Southern Financial and First Savings.
If either party willfully and materially breaches the merger agreement,
that party must pay the costs associated with this transaction incurred by the
non-breaching party. If the merger agreement is terminated because First Savings
shareholders did not approve the merger agreement, then First Savings will pay
50% of the costs and expenses of Southern Financial, except that such
reimbursement will not exceed a total of $100,000.
MARKET PRICES AND DIVIDENDS
Market Prices
First Savings common stock is traded on a quarterly basis in private
transactions by matching prospective buyers and sellers. To First Savings
management's knowledge, the last sales of First Savings common stock took place
in the first quarter of 2000 at a price of $5.25 per share.
Southern Financial common stock is listed and traded on The Nasdaq
National Market under the symbol "SFFB."
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The following table sets forth the high, low, and closing sales prices
of the common stock as reported by The Nasdaq National Market for the periods
listed.
Southern Financial
<TABLE>
<CAPTION>
---------------------------------------- ------------- ------------- -------------
High Low Closing
---------------------------------------- ------------- ------------- -------------
<S> <C> <C> <C>
2000
---------------------------------------- ------------- ------------- -------------
3rd Quarter (through July 10, 2000) $13.63 $13.00 $13.25
---------------------------------------- ------------- ------------- -------------
2nd Quarter 15.88 12.50 13.00
---------------------------------------- ------------- ------------- -------------
1st Quarter 17.38 13.50 14.19
---------------------------------------- ------------- ------------- -------------
---------------------------------------- ------------- ------------- -------------
1999
---------------------------------------- ------------- ------------- -------------
4th Quarter 20.00 16.50 16.50
---------------------------------------- ------------- ------------- -------------
3rd Quarter 20.63 19.75 19.75
---------------------------------------- ------------- ------------- -------------
2nd Quarter 22.25 19.75 20.38
---------------------------------------- ------------- ------------- -------------
1st Quarter 22.00 19.50 20.31
---------------------------------------- ------------- ------------- -------------
---------------------------------------- ------------- ------------- -------------
1998
---------------------------------------- ------------- ------------- -------------
4th Quarter 24.75 21.00 21.00
---------------------------------------- ------------- ------------- -------------
3rd Quarter 27.00 24.00 24.50
---------------------------------------- ------------- ------------- -------------
2nd Quarter 27.25 25.25 26.13
---------------------------------------- ------------- ------------- -------------
1st Quarter 30.00 20.00 25.50
---------------------------------------- ------------- ------------- -------------
</TABLE>
The closing price of Southern Financial common stock on The Nasdaq
National Market on March 30, 2000, the last full trading day preceding the
public announcement of the proposed merger, was $14.19 per share. The closing
price of Southern Financial common stock on The Nasdaq National Market on July
10, 2000, the latest practicable date before the date of this proxy
statement/prospectus, was $13.25 per share.
Dividends
The following table reflects the cash dividends declared per share
during each quarter on Southern Financial common stock for the periods
indicated. First Savings has not paid cash dividends.
Southern Financial
------------------
----------------------------- ---------------- ---------------- ----------------
2000 1999 1998
----------------------------- ---------------- ---------------- ----------------
Fourth Quarter n/a $ .12 $ .10
----------------------------- ---------------- ---------------- ----------------
Third Quarter n/a .12 .095
----------------------------- ---------------- ---------------- ----------------
Second Quarter n/a .115 .09
----------------------------- ---------------- ---------------- ----------------
First Quarter .12 .11 .08
----------------------------- ---------------- ---------------- ----------------
Certain state law restrictions are imposed on distributions of
dividends to shareholders of Southern Financial. Southern Financial shareholders
are entitled to receive dividends as declared by the Southern Financial board of
directors. However, no such distribution may be made if, after giving effect to
the distribution, it would not be able to pay its debts as they become due in
the usual course of business or its total assets would be less than its total
liabilities. There are similar restrictions with respect to stock repurchases
and redemptions.
Banks have limitations imposed upon all "capital distributions,"
including cash dividends, payments to repurchase or otherwise acquire its
shares, payments to shareholders of another institution in
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a cash-out merger, and other distributions charged against capital. As
of March 31, 2000, Southern Financial Bank had the capacity to pay no more than
$3.8 million in total dividends to its sole shareholder, Southern Financial, and
First Savings had the capacity to pay $650,000 in total dividends to its
shareholders.
Similarly, Southern Financial Bank and First Savings each are subject
to legal limitations on capital distributions including the payment of
dividends, if, after making such distribution, the institution would become
"undercapitalized" (as such term is used in the statute). For all state member
banks of the Federal Reserve seeking to pay dividends, the prior approval of the
applicable Federal Reserve Bank is required if the total of all dividends
declared in any calendar year will exceed the sum of the bank's net profits for
that year and its retained net profits for the preceding two calendar years.
Federal law also generally prohibits a depository institution from making any
capital distribution (including payment of a dividend or payment of a management
fee to its holding company) if the depository institution would thereafter fail
to maintain capital above regulatory minimums. Federal Reserve Banks are also
authorized to limit the payment of dividends by any state member bank if such
payment may be deemed to constitute an unsafe or unsound practice. In addition,
under Virginia law no dividend may be declared or paid that would impair a
Virginia chartered bank's paid-in capital. The Virginia State Corporation
Commission has general authority to prohibit payment of dividends by a Virginia
chartered bank if it determines that the limitation is in the public interest
and is necessary to ensure the bank's financial soundness.
Following the consummation of the merger, most of the revenues of
Southern Financial and Southern Financial's ability to pay dividends to its
shareholders will depend on dividends paid to it by Southern Financial Bank and
First Savings. Based on the current financial condition of Southern Financial
Bank and First Savings, Southern Financial expects that the above-described
provisions will have no impact on Southern Financial's ability to obtain
dividends from Southern Financial Bank and First Savings or on Southern
Financial's ability to pay dividends to its shareholders.
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<PAGE>
CHAPTER II
INFORMATION ABOUT THE MEETING AND VOTING
General
We are furnishing this document in connection with the solicitation of
proxies by the board of directors of First Savings for use at the special
meeting of First Savings shareholders including any adjournments or
postponements thereof, to be held on August 11, 2000, at the time and place set
forth in the accompanying notice.
The purpose of the meeting is to consider and vote upon the Agreement
and Plan of Reorganization, dated March 31, 2000, among First Savings, Southern
Financial and Southern Financial Bank, a Virginia corporation and a wholly owned
subsidiary of Southern Financial. The merger agreement is attached to this
document as Appendix A. For a description of the merger agreement, see "Terms of
the Merger Agreement" on page 23.
The merger agreement provides that First Savings will merge with and
into Southern Financial Bank. In the merger, each share of common stock, par
value $1.00 per share, of First Savings then outstanding will be converted into
the right to receive 0.44 shares (the "exchange ratio") of common stock, par
value $0.01 per share, of Southern Financial. Southern Financial will pay cash
in lieu of fractional shares.
First Savings Meeting
General. The First Savings meeting will be held on August 11, 2000 at
10:00 a.m., local time, at First Savings' Springfield branch, 6551 Loisdale
Court, Suite 150, Springfield, Virginia. At the First Savings meeting, holders
of First Savings common stock will be asked to consider and vote upon a proposal
to approve the merger agreement. First Savings shareholders may also be asked to
vote upon a proposal to adjourn or postpone the First Savings meeting for the
purpose of, among other things, allowing additional time for the solicitation of
proxies from First Savings shareholders to approve the merger agreement.
Record Date; Voting Power. Only holders of record of shares of First
Savings common stock at the close of business on July 3, 2000 are entitled to
notice of and to vote at the First Savings meeting. As of such date, there were
931,605 issued and outstanding shares of First Savings common stock held by
approximately 180 holders of record. Holders of record of First Savings common
stock on the First Savings record date are entitled to one vote per share on any
matter that may properly come before the First Savings meeting. Brokers who hold
shares of First Savings common stock as nominees will not have discretionary
authority to vote such shares in the absence of instructions from the beneficial
owners thereof. Any such shares of First Savings common stock for which a broker
has submitted an executed proxy but for which the beneficial owner thereof has
not given instructions on voting to such broker are referred to as "broker
non-votes."
Vote Required. The presence in person or by proxy of the holders of
one-third of the shares of First Savings common stock outstanding on the First
Savings record date will constitute a quorum for the transaction of business at
the First Savings meeting. Abstentions and broker non-votes will be counted for
purposes of establishing the presence of a quorum at the First Savings meeting.
The approval of the proposal to approve the merger agreement requires the
affirmative vote of holders of more than two-thirds of the shares of First
Savings common stock outstanding on the record date. Broker non-votes and
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<PAGE>
abstentions will be counted and will have the effect of a vote against the
proposal to approve the merger agreement.
On the record date, the executive officers and directors of First
Savings, including their affiliates, had voting power with respect to an
aggregate of 408,787 shares of First Savings common stock or approximately 43.9%
of the shares of First Savings common stock then outstanding. We expect that
such directors and officers will vote all of such shares in favor of the
proposal to approve the merger agreement. In addition, on the First Savings
record date, the directors and executive officers of Southern Financial did not
beneficially own any shares of First Savings common stock.
Recommendation of the First Savings Board. The First Savings board has
unanimously approved and adopted the merger agreement. The First Savings board
believes that the merger is fair to and in the best interests of First Savings
and the First Savings shareholders and recommends that the First Savings
shareholders vote "FOR" approval of the merger agreement and the transactions
contemplated thereby. See "The Merger - First Savings' Reasons for the Merger"
on page 12.
Solicitation and Revocation of Proxies. A form of proxy is enclosed
with this document. All shares of First Savings common stock represented by
properly executed proxies (whether through the return of the enclosed proxy card
or by telephone) will, unless such proxies have been previously revoked, be
voted in accordance with the instructions indicated on such proxies. If no
instructions are indicated, such shares will be voted FOR approval of the merger
agreement and in the discretion of the proxy holder as to any other matter which
may properly come before the First Savings meeting.
EACH HOLDER OF FIRST SAVINGS COMMON STOCK IS REQUESTED TO VOTE BY
COMPLETING, DATING AND SIGNING THE ACCOMPANYING PROXY CARD AND RETURNING IT
PROMPTLY TO FIRST SAVINGS IN THE ENCLOSED, POSTAGE-PAID ENVELOPE. FIRST SAVINGS
SHAREHOLDERS SHOULD NOT SEND STOCK CERTIFICATES WITH THEIR PROXY CARDS.
Any First Savings shareholder that has previously delivered a properly
executed proxy may revoke such proxy at any time before its exercise. A proxy
may be revoked either by (i) filing with the secretary of First Savings prior to
the First Savings meeting, at First Savings' principal executive offices, either
a written revocation of such proxy or a duly executed proxy bearing a later date
or (ii) attending the First Savings meeting and voting in person. Presence at
the First Savings meeting will not revoke a shareholder's proxy unless such
shareholder votes in person.
The cost of soliciting proxies will be borne by First Savings. Proxies
may be solicited by personal interview, mail or telephone. In addition, First
Savings may reimburse brokerage firms and other persons representing beneficial
owners of shares of First Savings common stock for their expenses in forwarding
solicitation materials to beneficial owners. Proxies may also be solicited by
certain of First Savings' executive officers, directors and regular employees,
without additional compensation, personally or by telephone or facsimile
transmission.
Other Matters. First Savings is unaware of any matter to be presented
at the First Savings meeting other than the proposal to approve the merger
agreement. If other matters are properly presented at the First Savings meeting,
the persons named in the enclosed form of proxy will have authority to vote all
properly executed proxies in accordance with their judgment on any such matter,
including, without limitation, any proposal to adjourn or postpone the First
Savings meeting, provided that no proxy that has been designated to vote against
approval of the merger agreement will be voted in favor of any proposal to
adjourn or postpone the First Savings meeting for the purpose of soliciting
additional proxies to approve the merger agreement.
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<PAGE>
CHAPTER III
DESCRIPTION OF SOUTHERN FINANCIAL
BUSINESS
General
Southern Financial is incorporated in Virginia. On December 1, 1995,
Southern Financial acquired all of the outstanding shares of Southern Financial
Bank. Southern Financial Bank, formerly Southern Financial Federal Savings Bank,
converted from a savings bank to a state chartered commercial bank effective
December 1, 1995. The only material activity of Southern Financial is to own and
control all of the capital stock of Southern Financial Bank. Southern Financial
also owns 70% of the common stock of Southern WebTech.com, Inc., a bank software
systems design company that began operations in October, 1999. References to
Southern Financial include the activities of its subsidiaries.
Headquartered in Warrenton, Virginia, Southern Financial serves the
retail and commercial financial market as a deposit and loan specialist from 17
full service offices located in Warrenton, Herndon, Middleburg, Winchester,
Leesburg, Fairfax, Sterling, Woodbridge, Manassas and Fredericksburg, Virginia.
Southern Financial's defined market area forms a semi-circle to the west of the
metropolitan Washington, D.C. area roughly centered on Warrenton. The counties
included in the defined market area where Southern Financial currently operates
branches include: Loudoun, Fauquier, Fairfax, Frederick and Prince William and
the cities of Fredericksburg and Winchester. Other counties in the defined
market area include: Spotsylvania, Culpeper, Rappahanock, Clarke and the three
counties in the West Virginia panhandle.
The inner ring of the semi-circle that comprises Southern Financial's
market area is the bedroom community for the close-in greater metropolitan
Washington commercial centers that have grown up in northern Virginia in the
past 30 years. As the economy of the metropolitan Washington area has
diversified away from its concentration in government and government-related
employment, the Dulles corridor has developed into a major center for
communication and high-tech activities. In the process, Reston, Herndon, Tysons
Corner and Fairfax have become important employment centers in their own right
much as Stamford, Connecticut and White Plains, New York have done outside
Manhattan. As a consequence, the commutable radius has pushed west out to
Loudoun and Fauquier Counties and south and southwest to Stafford, Spotsylvania
and Prince William Counties. The branch locations in these areas situate
Southern Financial to take advantage of the rapid economic growth of these
communities.
The principal business of Southern Financial is the acquisition of
deposits from the general public through its home and branch offices and use of
these deposits to fund its loan and investment portfolios. Southern Financial
seeks to be a full service community bank which provides a wide variety of
financial services to its small and middle market business clients as well as to
its retail clients. Southern Financial is an active commercial lender that often
lends in conjunction with the Small Business Administration 7(a) and 504 loan
programs. In addition, Southern Financial is an active residential construction
lender and offers its retail clients permanent residential mortgage loan
alternatives. Southern Financial also invests funds in mortgage-backed
securities, securities issued by agencies of the Federal Government, obligations
of counties and municipalities and corporate obligations.
The principal sources of funds for Southern Financial's lending and
investment activities are deposits, amortization and repayment of loans,
proceeds from the sales of loans, prepayments from mortgage-backed securities,
repayments of maturing investment securities, Federal Home Loan Bank advances
and other borrowed money.
32
<PAGE>
Principal sources of revenue are interest and fees on loans and
investment securities and gains from the sale of loans, as well as fee income
derived from the maintenance of deposit accounts. Southern Financial's principal
expenses include interest paid on deposits and advances from the Federal Home
Loan Bank and other borrowings, and operating expenses.
Lending Activities
Southern Financial's lending focus and the composition of its loan
portfolio have changed dramatically over the past five years. The growth of the
loan portfolio and the change in its composition reflects Southern Financial's
growth strategy and the shift in its focus from residential mortgage lending to
small and middle size business lending. On December 31, 1995, residential
mortgage loans represented 32% of gross loans. By March 31, 2000, residential
mortgage loans had declined to 18% of gross loans. In contrast, commercial
business loans and non-residential mortgage loans were 15% and 32% of gross
loans at December 31, 1995. By March 31, 2000, commercial business loans and
non-residential mortgage loans were 21% and 50%, respectively, of gross loans.
Today, the principal lending activity of Southern Financial is the
origination of commercial mortgage and non-mortgage loans to small and
medium-sized businesses, including loans through various lending programs of the
Small Business Administration. Southern Financial is a Preferred Lender in the
Richmond District of Small Business Administration and a Certified Lender in the
Washington, D.C. District of Small Business Administration.
Southern Financial also makes residential mortgage loans, consumer
loans and construction loans.
Commercial Real Estate Lending. At March 31, 2000, commercial real
estate loans totaled $127.5 million, of which $120.4 million were permanent
loans and $7.1 million were construction loans. Of Southern Financial's
permanent commercial real estate loans, $51.1 million were made under the Small
Business Administration 7(a) and 504 loan programs at March 31, 2000. The Small
Business Administration 7(a) and 504 loan programs are economic development
programs. The Small Business Administration in cooperation with banks and other
lending institutions, finances the expansion of small businesses.
The 504 loan program is used to finance long-term fixed assets,
primarily real estate and large/heavy equipment. The 504 loan program is an
economic development program designed to create new jobs or retain existing
jobs. The credit structure of the 504 loan program gives borrowers access to 90%
financing for the project. Fifty percent is provided by the financial
institution in the form of a first lien position. Forty percent is provided by
the certified development company with a second lien position. The borrower
provides the remaining 10% of the funds required for the project. Of Southern
Financial's $120 million in permanent commercial real estate loans at March 31,
2000, $46 million were 504 loans.
Small Business Administration 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 Small
Business Administration guarantees up to 80% of the loan balance under the 7(a)
program. At March 31, 2000, Southern Financial had $5.1 million in Small
Business Administration 7(a) permanent commercial real estate loans.
Southern Financial also offers an extensive array of commercial real
estate loans outside of Small Business Administration programs. These loans,
which totaled $74.9 million at March 31, 2000, serve
33
<PAGE>
both the investor and owner occupied facility market. These loans are secured by
real estate with loan-to-values averaging less than 70%.
Southern Financial is involved in financing the construction phase of
small business projects prior to the project being approved by the Small
Business Administration. To a lesser extent, Southern Financial also provides
commercial construction financing for projects outside of the Small Business
Administration programs.
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 Small Business Administration
7(a) loan program to reduce the inherent risk associated with this type of
lending. At March 31, 2000, Southern Financial had $51.8 million in commercial
business loans, which represent 22% of Southern Financial's total loans
receivable. Of Southern Financial's $51.8 million in commercial business loans,
23% are Small Business Administration 7(a) loans. During the quarter ended March
31, 2000, Southern Financial originated and closed $4.2 million in loans under
the Small Business Administration 7(a) loan program and sold $2.9 million on the
secondary market.
Residential Lending. Southern Financial makes fixed and adjustable
rate, first mortgage loans with terms up to 30 years. It offers second mortgages
in conjunction with its own first mortgages or those of other lenders. Southern
Financial makes construction loans and permanent loans on individual single
family residences and on other residential properties. Construction loans
generally have interest rates of prime plus one to two percent and fees of one
to three points, loan-to-value ratios of 80% or less based on current appraisals
and terms of generally nine months or less. In the case of conventional loans,
Southern Financial typically lends up to 80% of the appraised value of
single-family residences. Southern Financial requires private mortgage insurance
for loans exceeding 80% of the appraised value.
Residential mortgage loans are secured by single-family homes. At March
31, 2000, loans secured by residential property, both permanent and
construction, totaled $51.7 million, which represented approximately 22% of
total loans receivable. Approximately 20% of the total loans receivable
consisted of loans secured by permanent mortgages on one-to-four family
residential property.
Consumer Lending. Southern Financial offers various types of secured
and unsecured consumer loans. These loans are offered as a convenience to its
customer base since these products are not the focus of Southern Financial's
lending activities. At March 31, 2000, Southern Financial had $10.7 million in
consumer loans which represents 4% 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 68% of
Southern Financial's total revenue for the quarter ended March 31, 2000. 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.
34
<PAGE>
Loan Portfolio Composition
The following table sets forth the composition of Southern Financial's
loan portfolio at the dates indicated:
<TABLE>
<CAPTION>
At March 31,
-------------------------------------------------------------
2000 1999
----------------------------- ------------------------------
Amount Percent Amount Percent
-------------- ------------- ------------- --------------
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 43,911 18% $ 52,216 25%
Nonresidential 120,488 50% 89,571 42%
Construction:
Residential 7,785 3% 7,435 4%
Nonresidential 7,056 3% 13,789 6%
-------------- ------------- ------------- --------------
Total mortgage 179,240 74% 163,011 76%
-------------- ------------- ------------- --------------
Nonmortgage:
Business 51,804 22% 39,534 19%
Consumer 10,684 4% 9,961 5%
-------------- ------------- ------------- --------------
Total nonmortgage 62,488 26% 49,495 24%
-------------- ------------- ------------- --------------
Gross loans 241,728 100% 212,506 100%
Less:
Deferred fees 1,387 1,100
Allowance for loan losses 3,601 3,204
-------------- -------------
Total loans receivable, net $ 236,740 $ 208,202
============== =============
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------------------------
1999 1998 1997
------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent
----------- ----------- ----------- ----------- ------------ -----------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage:
Residential $ 48,604 20% $ 54,822 26% $ 61,328 29%
Nonresidential 109,871 47% 85,124 41% 74,104 36%
Construction:
Residential 7,853 3% 6,949 3% 8,766 4%
Nonresidential 8,270 3% 11,214 5% 13,865 7%
------------------------------------------------------------------------------
Total mortgage 174,598 73% 158,109 75% 158,063 76%
------------------------------------------------------------------------------
Nonmortgage:
Business 54,175 23% 40,814 20% 36,578 18%
Consumer 9,995 4% 11,559 5% 13,524 6%
------------------------------------------------------------------------------
Total nonmortgage 64,170 27% 52,373 25% 50,102 24%
------------------------------------------------------------------------------
Gross loans 238,768 100% 210,482 100% 208,165 100%
Less:
Deferred fees 1,230 1,065 862
Allowance for loan losses 3,452 3,062 2,743
----------- ----------- ------------
Total loans receivable, net $234,086 $206,355 $204,560
=========== =========== ============
</TABLE>
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------
1996 1995
--------------------------------------------------------
Amount Percent Amount Percent
--------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 59,986 33% $ 54,000 32%
Nonresidential 64,848 37% 54,696 32%
Construction:
Residential 8,037 4% 9,248 6%
Nonresidential 8,090 4% 11,029 7%
--------------------------------------------------------
Total mortgage 140,961 78% 128,973 77%
--------------------------------------------------------
Nonmortgage:
Business 27,794 15% 25,646 15%
Consumer 12,555 7% 13,220 8%
--------------------------------------------------------
Total nonmortgage 40,349 22% 38,866 23%
--------------------------------------------------------
Gross loans 181,310 100% 167,839 100%
Less:
Deferred fees 674 620
Allowance for loan losses 2,374 2,041
------------ ------------
Total loans receivable, net $ 178,262 $ 165,178
============ ============
</TABLE>
36
<PAGE>
The following table sets forth the scheduled maturity of selected loans
as of March 31, 2000:
<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 $ 7,785 $ - $ - $ - $ - $ 7,785
Nonresidential 7,056 - - - - 7,056
Business 21,032 12,439 4,024 9,237 5,072 51,804
------------ ---------- ---------- ---------- ---------- ----------
Total $ 35,873 $ 12,439 $ 4,024 $ 9,237 $ 5,072 $ 66,645
============ ========== ========== ========== ========== ==========
</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 and leases, real
estate loans, Small Business Administration 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 Southern
Financial.
Detailed loan applications are obtained to determine the borrower's
ability to repay, and the more significant items on these applications are
verified through the use of credit reports, financial statements and
confirmations. All property valuations are performed by independent outside
appraisers who are reviewed by the Vice President of Real Estate Lending who
reports his findings annually to Southern Financial's board of directors.
It is Southern Financial's policy to retain a mortgage creating a valid
lien on real estate and to obtain a title insurance policy that insures the
property is free of encumbrances. Also required from the borrower is hazard
insurance, and flood insurance is required if the property is in a flood plain
as designated by the Department of Housing and Urban Development. Most borrowers
are also required to advance funds on a monthly basis from which Southern
Financial makes disbursements for items such as real estate taxes, private
mortgage insurance and hazard insurance.
The aggregate amount of loans that Southern Financial may make to one
borrower is limited to 15% of Southern Financial's unimpaired capital and
surplus. The maximum amount of loans that Southern Financial could have made to
one borrower as of December 31, 1999 was approximately $4.3 million based on 15%
of its unimpaired capital and surplus. As of December 31, 1999, the largest
aggregate amount of such loans by Southern Financial to any one borrower was
$3.5 million.
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.
37
<PAGE>
The Credit Committee of the board, consisting of three outside members
of the board of directors and the Chief Executive Officer, is responsible for
the qualitative review of the loan portfolio 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.
Southern Financial has a standing credit committee comprised of
officers, in which the members have defined lending authorities as individuals
and in combination. These individual lending authorities are determined by the
Chief Executive Officer and approved by the board based on the individual's
technical ability and must be agreed to by the Credit Committee. All authorities
are reviewed and approved 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.
38
<PAGE>
Past Due Loans and Nonperforming Assets
The following table sets forth information regarding past due loans and
nonperforming assets at the dates indicated:
<TABLE>
<CAPTION>
At March 31,
----------------------------------
2000 1999
-------------- --------------
(amounts in thousands)
<S> <C> <C>
Accruing Loans 90 Days or More (1) Delinquent
Residential $ - $ -
Nonresidential - 82
Business 79 394
Consumer 29 80
-------------- --------------
Total 108 556
============== ==============
Nonperforming Loans
Residential 425 -
Nonresidential 109 1,019
Business - 1,041
Consumer - 4
-------------- --------------
Subtotal 534 2,064
-------------- --------------
Renegotiated Loans:
Nonresidential 63 -
Real Estate Owned:
Residential - 498
Nonresidential 2,296 -
-------------- --------------
Total Nonperforming Assets $ 2,893 $ 2,562
============== ==============
Nonperforming Assets to Total Assets 0.68% 0.64%
============== ==============
</TABLE>
_______________
(1) Includes portion guaranteed by the Small Business Administration.
39
<PAGE>
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ------------ ------------ ------------ ------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Accruing Loans 90 Days or More (1)
Delinquent
Residential $ - $ - $ - $ - $ 878
Nonresidential - 372 - 194 -
Business 226 283 71 11 -
Consumer 9 231 6 2 3
----------- ------------ ------------ ------------ ------------
Total 235 886 77 207 881
=========== ============ ============ ============ ============
Nonperforming Loans
Residential 413 291 443 321 541
Nonresidential 109 1,033 1,002 1,257 -
Business - 1,576 889 721 605
Consumer - 6 74 532 85
----------- ------------ ------------ ------------ ------------
Subtotal 522 2,906 2,408 2,831 1,231
----------- ------------ ------------ ------------ ------------
Renegotiated Loans:
Nonresidential 68 - - - -
Real Estate Owned:
Nonresidential 2,296 498 722 1,307 1,382
----------- ------------ ------------ ------------ ------------
Total Nonperforming Assets $ 2,886 $ 3,404 $ 3,130 $ 4,138 $ 2,613
=========== ============ ============ ============ ============
Nonperforming Assets to Total
Assets 0.71% 0.84% 0.88% 1.33% 0.97%
=========== ============ ============ ============ ============
</TABLE>
________________
(1) Includes portion guaranteed by the Small Business Administration.
Southern Financial's loss and delinquency experience on its residential
real estate loan portfolio has been limited by a number of factors, including
its underwriting standards. Whether Southern Financial's loss and delinquency
experience will increase significantly depends upon the value of the real estate
securing its loans, economic factors such as an increase in unemployment as well
as the overall economy of the region. As a result of economic conditions and
other factors beyond its control, Southern Financial's future loss and
delinquency experience cannot be accurately predicted. However, management has
provided an allowance for loan losses which it believes will be adequate to
absorb future losses.
At December 31, 1999, loans totaling $3.0 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, 1999, all of the potential problem loans were
adequately secured in the opinion of management. In 1999 Southern Financial
recorded $6,000 of interest income on nonperforming and renegotiated loans.
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,
40
<PAGE>
management takes into account, among other factors, the estimated value of the
underlying collateral, the borrower's ability to repay, the borrower's payment
history and the current delinquent status. The remaining loan portfolio is
evaluated for potential loss exposure by examining the growth and composition of
the portfolio, previous loss experience, current delinquency levels, industry
concentration and the general economic condition.
The allowance for loan losses represents management's estimate of an
amount adequate to provide for potential losses inherent in the loan portfolio
in the normal course of business. However, there are additional risks of future
losses that cannot be quantified precisely or attributed to particular loans or
classes of loans. Because those risks include general economic trends as well as
conditions affecting individual borrowers, management's judgement of the
allowance necessary is approximate. Southern Financial performs 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.
The following table summarizes activity in Southern Financial's
allowance for loan losses during the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
2000 1999
---------------- -----------------
(amounts in thousands)
<S> <C> <C>
Allowance at Beginning of Period $ 3,452 $ 3,062
Provision for Losses 350 341
Charges-offs:
Mortgage:
Residential - -
Nonresidential (100) (50)
Construction
Residential - -
Nonresidential - -
Nonmortgage:
Business (97) (319)
Consumer (10) (33)
---------------- -----------------
Total Charge-offs (207) (402)
---------------- -----------------
Recoveries:
Mortgage:
Residential - 1
Nonresidential - 200
Construction
Residential - -
Nonresidential - -
Nonmortgage:
Business 3 1
Consumer 3 1
---------------- -----------------
Total Recoveries 6 203
---------------- -----------------
Net Charge-offs (201) (199)
---------------- -----------------
Allowance at End of Period $ 3,601 $ 3,204
================ =================
Loans at End of Period $ 240,341 $ 211,406
Ratio of Allowance to Loans 1.50% 1.52%
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ -------------- ------------- ------------ ------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Allowance at Beginning of
Period $ 3,062 $ 2,743 $ 2,374 $ 2,041 $ 2,005
Provision for Losses 2,130 1,301 1,265 906 383
Charges-offs:
Mortgage:
Residential (775) (140) (65) (8) -
Nonresidential (480) - (200) (300) -
Construction
Residential - (81) - (50) -
Nonresidential - (261) - - -
Nonmortgage:
Business (736) (514) (256) (155) (217)
Consumer (55) (9) (413) (79) (176)
------------ -------------- ------------- ------------ ------------
Total Charge-offs (2,046) (1,005) (934) (592) (393)
------------ -------------- ------------- ------------ ------------
Recoveries:
Mortgage:
Residential 1 - 12 - -
Nonresidential 293 - - - -
Construction
Residential - - - - -
Nonresidential - - - -
Nonmortgage:
Business 6 13 18 11 -
Consumer 6 10 8 8 46
--------------------------------------------------------------------------------
Total Recoveries 306 23 38 19 46
--------------------------------------------------------------------------------
Net Charge-offs (1,740) (982) (896) (573) (347)
--------------------------------------------------------------------------------
Allowance at End of Period $ 3,452 $ 3,062 $ 2,743 $ 2,374 $ 2,041
================================================================================
Loans at End of Period $ 237,539 $ 209,417 $ 207,538 $ 180,898 $ 167,384
Ratio of Allowance to Loans 1.45% 1.46% 1.32% 1.31% 1.22%
</TABLE>
42
<PAGE>
The following table summarizes the composition of the allowance for
loan losses:
<TABLE>
<CAPTION>
At March 31,
-----------------------------------------------------------------------------
2000 1999
--------------------------------------- -----------------------------------
Amount Percent Amount Percent
(amounts in thousands)
<S> <C> <C> <C> <C>
Mortgage:
Residential $ 250 7% $ 313 10%
Nonresidential 1,041 29% 1,093 34%
Construction:
Residential 32 1% 23 1%
Nonresidential 29 1% 56 2%
Nonmortgage:
Business 1,073 30% 888 28%
Consumer 164 4% 154 4%
Unallocated 1,012 28% 677 21%
------------------ ----------------- --------------- -----------------
Allowance for Loan Losses $ 3,601 100% $ 3,204 100%
================== ================= =============== =================
</TABLE>
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------------
1999 1998 1997 1996 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 $ 256 7% $ 361 12% $ 199 7% $ 377 16% $ 488 24%
Nonresidential 1,043 30% 913 30% 1,316 48% 910 38% 325 16%
Construction:
Residential 32 1% 21 1% 55 2% 71 3% 138 7%
Nonresidential 34 1% 46 1% 43 2% 131 6% 133 6%
Nonmortgage:
Business 921 27% 752 24% 524 19% 442 19% 307 15%
Consumer 151 5% 151 5% 75 3% 312 13% 320 16%
Unallocated 1,015 29% 818 27% 531 19% 131 5% 330 16%
-------- -------- ------- ------- -------- ------- -------- ------ ------- --------
Allowance for Loan Losses $3,452 100% $3,062 100% $2,743 100% $2,374 100% $2,041 100%
======== ======== ======= ======= ======== ======= ======== ====== ======= ========
</TABLE>
Southern Financial has allocated the allowance according to the amount
deemed to be reasonably necessary to provide for losses 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.
43
<PAGE>
Investment Activities
The following table sets forth the investment portfolio at the dates
indicated:
<TABLE>
<CAPTION>
March 31, December 31,
----------------------- ---------------------------------------
2000 1999 1999 1998 1997
----------- ----------- ------------ ------------- ------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Available-for-sale securities, at fair value:
FHLMC preferred stock $ - $ - $ - $ 3,889 $ 3,908
FHLMC MBS 16,054 9,739 16,369 12,006 -
GNMA MBS 6,207 3,373 2,589 3,771 -
FNMA MBS 24,181 25,807 25,678 29,814 785
Collateralized mortgage obligations 25,649 19,346 25,303 1,529 -
Commercial MBS 22,440 20,116 22,495 18,246 -
Obligations of counties and municipalities 3,589 3,331 3,572 3,220 -
Corporate obligations 931 969 945 992 -
U.S. Treasury and other Government agency obligations 773 11,591 770 10,608 12,017
----------- ----------- ------------ ------------- ------------
$ 99,824 $ 94,272 $ 97,721 $ 84,075 $ 16,710
=========== =========== ============ ============= ============
Held-to-maturity securities, at amortized cost:
FHLMC MBS $ 6,669 $ 3,663 $ 3,837 $ 4,091 $ 6,078
GNMA MBS 16,315 21,798 17,177 24,305 42,471
FNMA MBS 7,536 6,200 6,764 6,780 27,075
Collateralized mortgage obligations 4,896 83 4,073 1,015 4,203
Commercial MBS 2,037 - 2,865 - -
Obligations of counties and municipalities 2,394 1,959 2,395 1,960 -
U.S. Treasury and other Government agency obligations - 20,737 - 19,532 8,741
----------- ----------- ------------ ------------- ------------
$ 39,847 $ 54,440 $ 37,111 $ 57,683 $ 88,568
=========== =========== ============ ============= ============
</TABLE>
Source of Funds
Deposits. Deposit accounts have been the primary source of funds for
use in lending, making other investments, and for other general business
purposes. In addition to deposits, Southern Financial obtains funds from loan
repayments, maturing investments, loan sales, cash flows generated from
operations and Federal Home Loan Bank advances. Borrowings may be used as an
alternative source of lower costing funds or to fund the origination of certain
assets.
44
<PAGE>
The following tables show the average balances and rates, presented on
a monthly average basis, for Southern Financial's deposits for the periods
indicated:
<TABLE>
<CAPTION>
March 31,
------------------------------------------------
2000
------------------------------------------------
Average Average
Balance Rate
------------------------ ----------------------
(amounts in thousands)
<S> <C> <C>
Demand $ 49,263 0.00%
Interest checking 18,643 1.51%
Money market and savings 76,817 2.78%
Certificates of deposit 211,738 5.62%
------------------------
$ 356,461
========================
Weighted average rate 4.01%
======================
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------
1999 1998 1997
----------------------- ---------------------- ----------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
----------- ---------- ----------- --------- ----------- ----------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Demand $ 50,750 0.00% $ 39,369 0.00% $ 30,056 0.00%
Interest checking 33,744 0.96% 34,965 2.36% 28,683 2.07%
Money market and savings 59,743 3.22% 46,883 3.12% 47,552 3.28%
Certificates of deposit 209,993 5.38% 200,902 5.80% 175,779 5.75%
----------- ----------- -----------
$ 354,230 $ 322,119 $ 282,070
=========== =========== ===========
Weighted average rate 3.83% 4.33% 4.36%
========== ========= ==========
</TABLE>
The following table sets forth by time remaining until maturity
Southern Financial's certificates of deposit of $100,000 or more at March 31,
2000:
Time Deposits of
Maturity Period $100,000 or More
------------------------------------------ ----------------------
(amounts in thousands)
Three months or less $ 61,893
Over three months through twelve months 30,644
Over twelve months 20,030
----------------------
Total $ 112,567
======================
45
<PAGE>
Borrowings. Borrowings consist of short-term and long term advances
from the Federal Home Loan Bank of Atlanta. The following table sets forth
information regarding Southern Financial's borrowings for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
---------------------- --------------------------------------
2000 1999 1999 1998 1997
--------- --------- ---------- ---------- ----------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Ending Balance $5,000 $3,000 $5,000 $3,500 $4,000
Average Balance for the Period 18,137 8,383 13,159 4,907 5,979
Maximum Month-end Balance During the Period 29,500 4,500 30,000 13,500 8,500
Average Interest Rate for the Period 5.95% 4.91% 5.56% 5.50% 5.59%
Weighted Average Interest Rate at the End of the 6.32% 5.75% 6.32% 5.15% 5.95%
Period
</TABLE>
Competition
Southern Financial experiences substantial competition in attracting
and retaining savings deposits and in lending funds. The primary factors in
competing for savings deposits are convenient office locations and rates
offered. Direct competition for savings deposits comes from other commercial
banks and thrift institutions. Additional significant competition for savings
deposits comes from money market mutual funds and corporate and government
securities which may yield more attractive interest rates than insured
depository institutions are willing to pay. The primary factors in competing for
loans are interest rate and loan origination fees and the range of services
offered. Competition for origination of real estate loans normally comes from
other commercial banks, thrift institutions, mortgage bankers, mortgage brokers
and insurance companies.
Employees
At December 31, 1999, Southern Financial employed 150 full-time
equivalent persons. Management considers its relations with its employees to be
good. The employees are not covered by a collective bargaining agreement.
Offices and Other Material Properties
At March 31, 2000, Southern Financial conducted its business from its
main office in Warrenton, Virginia and 16 branch offices. The following table
sets forth certain information with respect to the offices of Southern Financial
as of March 31, 2000:
<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
46
<PAGE>
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
-------------------------------------------------------------------------------------------------------------------
101 W. Washington Street Leased June November
Middleburg, VA 2002 1987
33 W. Piccadilly Street Owned N/A November
Winchester, VA 1990
526 E. Market Street Leased June March
Leesburg, VA 2002 1992
4021 University Drive Owned N/A July
Fairfax, VA 1997
322 Lee Highway Leased August August
Warrenton, VA 2001 1994
2545 Q-18 Centreville Road Leased September April
Herndon, VA 2001 1995
13542 Minnieville Road Leased December April
Woodbridge, VA 2003 1995
1095 Millwood Pike Owned N/A July
Winchester, VA 1996
46910 Community Plaza Leased May April
Sterling, VA 2008 1998
2062 Plank Road Leased September January
Fredericksburg, VA 2016 1999
10175 Hastings Drive Leased September March
Manassas, VA 2004 1999
8414 Lee Highway Owned N/A October
Merrifield, VA 1990
527 Maple Avenue Leased January March
Vienna, VA 2005 1995
9720 Lee Highway Leased June July
Fairfax, VA 2006 1996
7857 Heritage Drive Leased April May
Annandale, VA 2008 1998
</TABLE>
47
<PAGE>
Legal Proceedings
Southern Financial is not a party to, nor is any of their property the
subject of, any material pending legal proceedings incidental to its business
other than those arising in the ordinary course of business. Although the amount
of any ultimate liability with respect to such matters cannot be determined, in
the opinion of management, any such liability will not have a material adverse
effect on the consolidated financial position or results of operations of
Southern Financial.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Southern Financial's net income was $1.2 million for the three months
ended March 31, 2000, compared to $887 thousand for the three months ended March
31, 1999, an increase of $289 thousand, or 32.5%. Diluted earnings per share
were $0.44 and $0.32 for the three months ended March 31, 2000 and 1999,
respectively. The weighted average number of diluted shares of common stock
outstanding were 2,688,171 and 2,734,200 for the same respective periods.
Net income for the year ended December 31, 1999, was $961,000 ($0.35
diluted earnings per share), a decrease of 71.3% from earnings of $3.4 million
($1.22 diluted earnings per share) for the year ended December 31, 1998.
Excluding non-recurring special charges and expenses related to the merger on
October 1, 1999 with The Horizon Bank of Virginia, net income totaled $3.8
million ($1.41 diluted earnings per share) for the year ended December 31, 1999,
an increase of 14.3% over the $3.4 million income ($1.22 diluted earnings per
share) in 1998.
Balance Sheet
Total assets increased to $427.7 million at March 31, 2000, an increase
of $21.5 million, or 5.3% from $406.2 million at December 31, 1999. The growth
in total assets is primarily attributable to a $15.4 million increase in
overnight deposits resulting from cash and deposit transactions occurring at the
end of the March. The remaining growth in total assets results from increases of
$4.8 million in investment securities, and $2.6 million in loans receivable.
Total liabilities were $397.8 million at March 31, 2000, an increase of $20.4
million, or 5.4% compared with $377.4 million at December 31, 1999. The increase
in total liabilities results primarily from a $20.5 million increase in deposits
compared with December 31, 1999.
Total assets were $406.2 million at December 31, 1999, a small increase
of $1.9 million from $404.3 million at December 31, 1998. While the increase in
total assets was small, there were significant changes in the composition of the
assets. Cash and overnight deposits declined 59.8% from $42.6 million to $17.1
million as Southern Financial reinvested The Horizon Bank's low yielding
overnight deposits into higher yielding loans. As noted below, loans receivable
increased 13.4% to $234.1 million. Investment securities declined from $141.8
million at December 31, 1998, to $134.8 million at December 31, 1999, a decrease
of 4.9%. Deposits increased to $367.2 million at December 31, 1999, from $366.9
million at December 31, 1998. At December 31, 1999, Southern Financial had
29,021 deposit accounts.
Loans
Total loans receivable increased by $2.6 million to $236.7 million at
March 31, 2000 from $234.1 million at December 31, 1999, as new loan
originations more than offset loan sales and prepayments of
48
<PAGE>
residential mortgage loans during the period. In this period Southern Financial
sold the guaranteed portion of some of the Small Business Administration (SBA)
loans that it held in portfolio. These sales totaled $2.9 million.
Non-residential permanent mortgage loans increased by $10.6 million to $120.5
million at March 31, 2000, from $109.9 million at December 31, 1999.
Non-mortgage business loans decreased $2.4 million to $51.8 million at March 31,
2000, from $54.2 million at December 31, 1999. Non-residential construction
loans decreased $1.2 million from $8.3 million at December 31, 1999, to $7.1
million at March 31, 2000. Residential permanent mortgage loans decreased $4.7
million from $48.6 million at December 31, 1999, to $43.9 million at March 31,
2000.
Loans receivable, net of deferred fees and allowance for losses, were
$234.1 million at December 31, 1999, an increase of $27.7 million, or 13.4%,
from $206.4 million at December 31, 1998. During the year ended December 31,
1999, Southern Financial continued to emphasize loan originations connected with
various lending programs of the U.S. Small Business Administration. In addition,
Southern Financial continued to sell the guaranteed portion of some of its Small
Business Administration loans. These sales totaled $9.1 million. In 1999,
Southern Financial continued to de-emphasize its residential mortgage lending.
During 1999, new residential mortgage loan originations did not fully offset
sales and prepayments of residential mortgage loans, continuing a pattern in
effect for several years. As a consequence, residential mortgage loans
outstanding declined 11.3% to $48.6 million at December 31, 1999 from $54.8
million a year earlier. The growth in the loan portfolio occurred in
non-mortgage business loans, which increased by $13.4 million or 32.7% to $54.2
million, and in loans secured by nonresidential property, which increased by
$24.7 million, or 29.1% over 1998.
Investment Securities
Investment securities available-for-sale increased from $97.7 million
at December 31, 1999, to $99.8 million at March 31, 2000. There were purchases
of $3.9 million of investment securities designated as available-for-sale. There
were repayments and amortization of $1.8 million of investment securities
available-for-sale during the period. There were no sales of investment
securities available-for-sale during the three months ended March 31, 2000.
Investment securities held-to-maturity increased by $2.7 million to $39.8
million at March 31, 2000, from $37.1 million at December 31, 1999. There were
purchases of $4.1 million of investment securities designated as
held-to-maturity. Repayments and amortization of investment securities
held-to-maturity totaled $1.4 million during the period.
After the consummation of the merger with The Horizon Bank on October
1, 1999, Southern Financial sold Horizon's entire investment securities
portfolio and incurred a portfolio restructuring loss of $781,000. Following the
sale, Southern Financial purchased other investment securities with the proceeds
that had a higher yield and were in accordance with its investment policy. The
portfolio of investment securities at December 31, 1999 consisted of $37.1
million in securities classified as held-to-maturity and $97.7 million
classified as available-for-sale. The portfolio of securities held-to-maturity
consisted of Federal National Mortgage Association, Government National Mortgage
Association and Federal Home Loan Mortgage Association mortgage-backed
securities, collateralized mortgage obligations, and obligations of counties and
municipalities. The investment securities classified as available-for-sale
consisted of the same types of mortgage-backed securities, collateralized
mortgage obligations, commercial mortgage-backed securities, obligations of
counties and municipalities, corporate debt securities, and obligations of
government-sponsored agencies.
Liabilities
Total liabilities were $397.8 million at March 31, 2000, an increase of
$20.4 million, or 5.4% compared with $377.4 million at December 31, 1999. The
increase in total liabilities results primarily
49
<PAGE>
from a $20.5 million increase in deposits to $387.8 million at March 31, 2000
compared with December 31, 1999.
Deposits at December 31, 1999 were $367.2 million, an increase of $282
thousand over deposits of $366.9 million at December 31, 1998. The weighted
average interest rate for all accounts increased to 3.99% at December 31, 1999
from 3.93% at December 31, 1998.
Advances from the Federal Home Loan Bank of Atlanta totaled $5.0
million at December 31, 1999, an increase of $1.5 million from $3.5 million at
December 31, 1998.
Results of Operations
Southern Financial's operating results depend primarily on 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 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.
Average Balances, Yields and Rates
(amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
--------------------------------------------------
Average Average Average Average
Balance yield/rate balance yield/rate
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest-earning assets
Loans receivable $ 238,286 9.46 % $ 209,326 9.29 %
Investments 152,435 6.60 167,320 5.91
----------- -----------
Total interest-earning assets 390,721 8.34 376,646 7.79
----------- -----------
Interest-bearing liabilities
Deposits 356,461 4.01 357,583 3.98
Borrowings 18,137 5.95 8,383 4.91
----------- -----------
Total interest-bearing 374,598 4.10 365,966 4.00
liabilities
----------- -----------
Average dollar difference
between interest-earning assets
and interest-bearing liabilities $ 16,123 $ 10,680
=========== ===========
Interest rate spread 4.24 3.79
Interest margin 4.41 3.90
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
----------------------------------------------------------------------------
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 $ 219,286 9.11% $205,208 9.53% $ 193,094 9.63%
Investments 161,517 6.05 137,746 6.03 109,398 6.35
----------- ---------- -----------
Total interest-earning assets 380,803 7.82 342,954 8.12 302,492 8.44
----------- ---------- -----------
Interest-bearing liabilities
Deposits 354,230 3.83 322,119 4.33 282,070 4.36
Borrowings 13,159 5.56 4,907 5.50 5,979 5.59
----------- ---------- -----------
Total interest-bearing liabilities 367,389 3.89 327,026 4.35 288,049 4.39
----------- ---------- -----------
Average dollar difference
between interest-earning assets
and interest-bearing liabilities $ 13,414 $ 15,928 $ 14,443
=========== ========== ===========
Interest rate spread 3.94 3.77 4.05
Interest margin 4.07 3.97 4.26
</TABLE>
The following table presents information regarding changes in interest
income and interest expense for the periods indicated. For each category of
interest-earning asset and interest-bearing liability, information is provided
on changes attributable to changes in volume (changes in volume multiplied by
old rate) and changes in rates (changes in rates multiplied by old volume). The
dollar amount changes in interest income and interest expense attributable to
changes in rate/volume (change in rate multiplied by change in volume) have been
allocated between rate and volume variances based on the percentage relationship
of such variances to each other.
Rate/Volume Analysis
(amounts in thousands)
Three Months Ended March 31, 2000
Compared to
Three Months Ended March 31, 1999
-------------------------------------
Volume Rate Total
------------------------------------------------ ----------- -----------
Interest income
Loans Receivable $ 672 $ 89 $ 761
Investments (227) 272 45
------------- ----------- -----------
Total interest income 445 361 806
------------- ----------- -----------
Interest expense
Deposits (11) 109 98
Borrowings 127 4 131
------------- ----------- -----------
Total interest expense 116 113 229
------------- ----------- -----------
Net interest income $ 329 $ 248 $ 577
============= =========== ===========
51
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31, 1999 Year Ended December 31, 1998
Compared to Compared to
Year Ended December 31, 1998 Year Ended December 31, 1997
-------------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
---------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest income
Loans Receivable $ 1,309 $ (882) $ 427 $ 1,160 $ (195) $ 965
Investments 1,443 28 1,471 1,722 (365) 1,357
---------- ---------- ---------- ---------- ---------- ----------
Total interest income 2,752 (854) 1,898 2,882 (560) 2,322
---------- ---------- ---------- ---------- ---------- ----------
Interest expense
Deposits 1,359 (1,733) (374) 1,743 (85) 1,658
Borrowings 459 3 462 (59) (5) (64)
---------- ---------- ---------- ---------- ---------- ----------
Total interest expense 1,818 (1,730) 88 1,684 (90) 1,594
---------- ---------- ---------- ---------- ---------- ----------
Net interest income $ 934 $ 876 $ 1,810 $ 1,198 $ (470) $ 728
========== ========== ========== ========== ========== ==========
</TABLE>
Comparison of the Quarter Ended March 31, 2000 with the Quarter Ended March 31,
1999
General. Southern Financial's net income was $1.2 million for the three
months ended March 31, 2000, compared to $887 thousand for the three months
ended March 31, 1999, an increase of $289 thousand, or 32.5%. Diluted earnings
per share were $.44 and $.32 for the three months ended March 31, 2000 and 1999,
respectively. The weighted average number of diluted shares of common stock
outstanding were 2,688,171 and 2,734,200 for the same periods in 2000 and 1999,
respectively.
Net interest income. Net interest income before provision for loan
losses for the three months ended March 31, 2000 was $4.2 million, an increase
of $577 thousand, or 15.9%, from $3.6 million for the three months ended March
31, 1999. The increase resulted primarily from growth in average
interest-earning assets, as well as an increase in net interest margin. Total
interest-earning assets in the three months ended March 31, 2000 averaged $390.7
million as compared to $376.6 million for the same period in 1999. For the three
months ended March 31, 2000, the net interest margin was 4.41%, an increase of
51 basis points from 3.90% for the three months ended March 31, 1999. The yield
on interest-earning assets for the three months ended March 31, 2000 was 8.34%,
an increase of 55 basis points from the same period last year. The cost of
interest-bearing liabilities increased by 10 basis points to 4.10% for the three
months ended March 31, 2000 from 4.00% for the three months ended March 31,
1999.
Total interest income. Total interest income increased by $806 thousand
to $8.0 million for the quarter ended March 31, 2000 from $7.2 million for the
three months ended March 31, 1999. This increase was due to an increase of $29
million in average loans receivable to $238.3 million for the three months ended
March 31, 2000 from $209.3 million for the three months ended March 31, 1999,
and an increase in the average yield on loans from 9.29% to 9.46% for the same
periods. The yield on average investment securities for the quarter ended March
31, 2000 was 6.60%, an increase of 69 basis points from 5.91% for the three
months ended March 31, 1999. The increase in yield on investment securities more
than offset the impact of the decrease in average investment securities. Average
investment securities decrease by $14.9 million from $167.3 million in the three
months ended March 31, 1999 to $152.4 million in the three months ended March
31, 2000.
Total interest expense. Total interest expense increased by $229
thousand to $3.8 million for the three months ended March 31, 2000 from $3.6
million for the quarter ended March 31, 1999. This increase was due to a 3 basis
point increase in the average effective rate paid on deposits to 4.01% in the
2000 period from 3.98% in the 1999 period. The increase in total interest
expense was also due to the growth in average borrowings from $8.4 million to
$18.1 million for the quarters ended March 31, 1999 and 2000, respectively.
52
<PAGE>
Provision for loan losses. The provision for loan losses for the three
months ended March 31, 2000 was $350 thousand, as compared to $341 thousand for
the three months ended March 31, 1999. The provision for loan losses is a
current charge to earnings to increase the allowance for loan losses. Southern
Financial has established the allowance for loan losses to absorb the inherent
risk in lending after considering an evaluation of the loan portfolio, current
economic conditions, changes in the nature and volume of lending, past loan
experience and other relevant factors. During the three months ended March 31,
2000, Southern Financial's volume of non-residential mortgage loans has
increased, and these loans tend to carry a higher risk classification. The
increase in the provision for loan losses reflects the growth in the portfolio
of non-residential mortgage loans. It is the opinion of Southern Financial that
the allowance for loan losses at March 31, 2000 remains adequate. Although
Southern Financial believes that the allowance is adequate, there can be no
assurances that additions to such allowance will not be necessary in future
periods, which would adversely affect the results of operations. The allowance
for loan losses at March 31, 2000 was $3.6 million, or 1.50% of total loans
receivable including deferred fees, versus $3.5 million at December 31, 1999,
which was 1.45% of total loans receivable including deferred fees.
During the three months ended March 31, 2000 charge-offs amounted to
$207 thousand compared to $402 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 $6 thousand during the
quarter ended March 31, 2000, which was related to non-mortgage business loans
that were charged off in prior years. Recoveries amounted to $203 thousand
during the three months ended March 31, 1999, most of which was related to one
non-residential mortgage loan that was charged off in 1996.
Other income. Other income for the three months ended March 31, 2000
was $1 million as compared to $933 thousand for the three months ended March 31,
1999, an increase of $90 thousand, or 9.7%. Fee income increased $84 thousand
during the three months ended March 31, 2000, compared to the same period last
year, due to fees earned by Southern WebTech.com.
Other expenses. Other expense increased by $191 thousand, or 6.5%, to
$3.1 million for the three months ended March 31, 2000 from $2.9 million for the
three months ended March 31, 1999. Employee compensation and benefits increased
by $108 thousand, or 6.9%, reflecting normal wage increases for existing
personnel and some additional staffing. Expenses for premises and equipment
increased by $67 thousand, or 12.3%, primarily because of increased rent
expense.
Comparison of the Year Ended December 31, 1999 with the Year Ended December 31,
1998
General. Southern Financial's net income for the year ended December
31, 1999 was $961,000, a decrease of 71.3% over net income of $3.4 million for
the year ended December 31, 1998. The decrease in net income was attributable to
non-recurring special charges and expenses related to Southern Financial's
merger with The Horizon Bank on October 1, 1999. Excluding non-recurring special
charges and expenses related to the merger, net income totaled $3.8 million for
the year ended December 31, 1999, an increase of 14.3% over net income during
the year ended December 31, 1998. Diluted earnings per share for the year ended
December 31, 1999 were $0.35 (or $1.41 excluding non-recurring special charges
and expenses relating to the merger) as compared to $1.22 for the year ended
December 31, 1998. The weighted average number of diluted shares of common stock
outstanding were 2,722,251 for the year ended December 31, 1999 and 2,747,726
for the year ended December 31, 1998.
Net Interest Income. Net interest income before provision for loan
losses was $15.4 million for the year ended December 31, 1999, an increase of
13.3% over $13.6 million for the year ended December 31, 1998. This increase was
due to the growth in the average level of earning assets from $343.0 million
53
<PAGE>
to $380.8 million and an improvement in the interest rate spread to 3.94% in
1999 from 3.77% during the year ended December 31, 1998. In addition, the
interest margin grew from 3.97% in 1998 to 4.07% during 1999.
Total Interest Income. Total interest income was $29.8 million for the
year ended December 31, 1999, an increase of 6.8% over $27.9 million for the
year ended December 31, 1998. This increase resulted from growth in
interest-earning assets. Average loans receivable increased by $14.1 million and
average investment securities increased by $23.8 million over 1998.
The yield on total interest-earning assets was 7.82% for the year ended
December 31, 1999, which decreased from 8.12% for 1998. For the year ended
December 31, 1999, the yield on average loans receivable was 9.11%, down from
9.53% for the year ended December 31, 1998, while the yield on average
investment securities increased from 6.03% during 1998 to 6.05% for the year
ended December 31, 1999.
Total Interest Expense. Total interest expense for the year ended
December 31, 1999 was $14.3 million, an increase of 0.6% over $14.2 million for
the year ended December 31, 1998. This increase was due primarily to growth in
the average balance of deposits, which were $354.2 million for the year ended
December 31, 1999 compared to $322.1 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 3.89% for the year ended
December 31, 1999, a decrease of 46 basis points from 4.35% for the year ended
December 31, 1998.
Provision for Loan Losses. The provision for loan losses amounted to
$2.1 million for the year ended December 31, 1999, an increase over the
provision of $1.3 million for the year ended December 31, 1998. The provision
for 1999 included a special provision of $756,000 taken by The Horizon Bank as a
result of an examination earlier in 1999, and an enhanced approach to setting
their reserves. The provision for loan losses is a current charge to earnings to
increase the allowance for loan losses. Southern Financial has established the
allowance for loan losses to absorb the inherent risk in lending after
considering an evaluation of the loan portfolio, current economic conditions,
changes in the nature and volume of lending and past loan experience. Southern
Financial's opinion is that the allowance for loan losses at December 31, 1999
remains adequate. Although Southern Financial believes that the allowance is
adequate, there can be no assurances that additions to the allowance will not be
necessary in future periods, which would adversely affect its results of
operations. The allowance for loan losses at December 31, 1999 was $3.5 million,
or 1.45% of total loans receivable compared to $3.1 million, or 1.45% at
December 31, 1998.
Other Income. Other income totaled $2.8 million for the year ended
December 31, 1999, a decrease of 9.9%, from $3.1 million for the year ended
December 31, 1998. The decline was attributable to the sale of the investments
formerly held by The Horizon Bank which resulted in a loss of $781,000.
Other Expenses. Other expenses for the year ended December 31, 1999
were $14.6 million, an increase of 36.5% from $10.7 million for the year ended
December 31, 1998. Other expenses in the year ended December 31, 1999 included
non-recurring restructuring charges and merger expenses of $685,000 and $1.8
million respectively.
Employee compensation and benefits increased 19.9% to $6.4 million for
the year ended December 31, 1999 from $5.4 million for the prior year. The
increase reflects the cost of staffing the two new branches opened in early
1999, normal wage increases for existing personnel and the costs of the human
infrastructure necessary to operate a larger and more complex institution.
54
<PAGE>
Expenses for premises and equipment increased $641 thousand to $3.4
million during the year ended December 31, 1999 compared to the prior year. This
increase in expenses is primarily attributable to opening branches in
Fredericksburg and Manassas during the first quarter of 1999.
Other expenses decreased to $2.3 million for the year ended December
31, 1999 from $2.6 million for the prior year.
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 $3.4 million, an increase of 19.4% over net income of $2.8 million for the
year ended December 31, 1997. The increase in net income was primarily due to an
increase in net interest income of 5.6% and an increase of 39.3% in other
income. Diluted earnings per share for the year ended December 31, 1998
increased 15.1% to $1.22 from $1.06 for the year ended December 31, 1997. The
weighted average number of diluted shares of common stock outstanding were
2,747,726 for the year ended December 31, 1998 and 2,647,717 for the year ended
December 31, 1997
Net Interest Income. Net interest income before provision for loan
losses was $13.6 million for the year ended December 31, 1998, an increase of
5.6% over $12.9 million for the year ended December 31, 1997. This increase was
due to the growth in the average level of earning assets from $302.5 million to
$343.0 million, offset partly by declines in the interest rate spread from 4.05%
to 3.77%, and the interest margin from 4.26% to 3.97% when comparing the year
ended December 31, 1997 to the year ended December 31, 1998.
Total Interest Income. Total interest income was $27.9 million for the
year ended December 31, 1998, an increase of 9.1% over $25.5 million for the
year ended December 31, 1997. This increase resulted primarily from growth in
interest-earning assets. Average loans receivable increased by $12.1 million,
and average investment securities increased by $28.3 million over 1997.
The yield on total interest-earning assets was 8.12% for the year ended
December 31, 1998, down from 8.44% in 1997. For the year ended December 31,
1998, the yield on average loans receivable was 9.53%, down from 9.63% for the
year ended December 31, 1997, while the yield on average investment securities
decreased from 6.35% during 1997 to 6.03% for the year ended December 31, 1998.
Total Interest Expense. Total interest expense for the year ended
December 31, 1998 was $14.2 million, an increase of 12.6% over $12.6 million for
the year ended December 31, 1997. This increase was due primarily to growth in
the average balance of deposits, which were $322.1 million for the year ended
December 31, 1998 compared to $282.1 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.35% for the year ended
December 31, 1998, a decrease of 4 basis points from 4.39% for the year ended
December 31, 1997.
Provision for Loan Losses. The provision for loan losses amounted to
$1.3 million for the year ended December 31, 1998, approximately the same as the
provision for the year ended December 31, 1997.
Other Income. Other income totaled $3.1 million for the year ended
December 31, 1998, an increase of 39.3%, from $2.3 million for the year ended
December 31, 1997. The increase was attributable primarily to an increased gain
on sale of loans which increased 278.3% to $1.1 million for the year ended
December 31, 1998 from $268 thousand for the year ended December 31, 1997,
reflecting the decision to sell the guaranteed portion of Small Business
Administration loans rather than holding them in portfolio.
55
<PAGE>
Other Expenses. Other expenses for the year ended December 31, 1998
were $10.7 million, an increase of 9.5% from $9.8 million for the year ended
December 31, 1997, primarily reflecting an increase in employee compensation and
benefits which increased 12.4% to $5.4 million for the year ended December 31,
1998 from $4.8 million for the prior year. The increase reflects the cost of
staffing the new branch opened in July 1997 for a full year, as well as
increased staffing levels to accommodate growth in Southern Financial's customer
base and normal wage increases for existing personnel.
Expenses for premises and equipment decreased 1.3% to $2.7 million for
the year ended December 31, 1998 from $2.8 million for the year ended December
31, 1997.
Other expenses increased 16.5% from $2.2 million in 1997 to $2.6
million in 1998, due partially to a branch operating loss, write off of
repossessed assets, and other increases associated with normal growth.
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 the interest income on loans and investments and the interest
expense on deposits and borrowings. Southern Financial, to the extent that its
interest-bearing liabilities do not reprice or mature at the same time as its
interest-bearing assets, is subject to interest rate risk and corresponding
fluctuations in its net interest income. Asset/liability management policies
have been employed in an effort to manage Southern Financial's interest-earning
assets and interest-bearing liabilities, thereby controlling the volatility of
net interest income, without having to incur unacceptable levels of credit risk.
With respect to the residential mortgage loan portfolio, it is Southern
Financial's policy to keep those mortgage loans which have an adjustable
interest rate and to sell most fixed rate mortgage loans originated to the
secondary market. In addition, commercial loans generally have rates that are
tied to the prime rate, the one-year constant maturity treasury rate, or the
three-year constant maturity treasury rate. Both of these policies help control
Southern Financial's exposure to rising interest rates.
Southern Financial's interest rate sensitivity is primarily monitored
by management through the use of a model which generates estimates of the change
in its market value of portfolio equity over a range of interest rate scenarios.
That analysis was prepared by a third party for Southern Financial. Market value
of portfolio equity is the present value of expected cash flows from assets,
liabilities, and off-balance sheet contracts using standard industry assumptions
about estimated loan prepayment rates, reinvestment rates, and deposit decay
rates. The following table sets forth an analysis of Southern Financial's
interest rate risk as measured by the estimated change in market value of
portfolio equity 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, 2000.
56
<PAGE>
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
<TABLE>
<CAPTION>
Market Value of Market Value of
Portfolio Equity Portfolio Equity as a % of
---------------------------------------- -----------------------------------
Change in
Interest Rates
In Basis Points $ Change % Change Total Portfolio Equity
(Rate Shock) Amount From Base From Base Assets Book Value
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Up 300 34,465 (10,587) -23.50% 8.06% 115.39%
Up 200 38,380 (6,672) -14.81% 8.97% 128.50%
Up 100 41,659 (3,393) -7.53% 9.74% 139.48%
Base 45,052 - 0.00% 10.53% 150.84%
Down 100 48,009 2,957 6.56% 11.22% 160.74%
Down 200 50,803 5,751 12.77% 11.88% 170.10%
Down 300 54,772 9,720 21.58% 12.80% 183.39%
</TABLE>
Southern Financial's interest rate sensitivity is also monitored by
management through the use of a model that generates estimates of the change in
the adjusted net interest income over a range of interest rate scenarios. That
analysis was also prepared by a third party. 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 Southern Financial's interest sensitive assets and liabilities 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 14,305 -4,79% 3.34% -4.84%
Up 200 14,597 -2.84% 3.41% -2.85%
Up 100 14,862 -1.08% 3.47% -1.14%
Base 15,024 0.00% 3.51% 0.00%
Down 100 15,026 0.01% 3.51% 0.00%
Down 200 15,033 0.06% 3.51% 0.00%
Down 300 15,133 0.73% 3.54% 0.85%
</TABLE>
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in market value of portfolio
equity and in sensitivity of net interest income require Southern Financial to
make 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
market value of portfolio equity table and sensitivity of net interest income
table provide an indication of
57
<PAGE>
Southern Financial's interest rate risk exposure at a particular point in time,
those measurements are not intended to and do not provide a precise forecast of
the effect of changes in market interest rates on its worth and net interest
income.
Liquidity and Capital Resources
Southern Financial's principal sources of funds are deposits, loan
repayments, proceeds from the sale of securities and loans, repayments from
mortgage-backed securities, Federal Home Loan Bank advances, other borrowings
and retained income.
Southern Financial'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
approximately $85 million at March 31, 2000.
At March 31, 2000, Southern Financial had $31 million of unfunded lines
of credit and undisbursed construction loan funds of $10.3 million. Approved
loan commitments were $6.4 million at March 31, 2000, and Southern Financial had
commitments from investors to purchase loans in the amount of $841 thousand. It
is anticipated that funding requirements for these commitments can be met from
the normal sources of funds.
Southern Financial is subject to regulations of the Federal Reserve
Board that impose 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 1 capital of 4% of risk-weighted
assets; (c) tier 1 and 2 capital of 8% of risk-weighted assets. At March 31,
2000, Southern Financial Bank's capital ratios were 7.6% leverage capital; 11.1%
tier 1 capital; and 12.3% tier 1 and 2 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 changes have a more significant impact on its
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.
58
<PAGE>
CHAPTER IV
DESCRIPTION OF FIRST SAVINGS
BUSINESS
General
First Savings' business consists of attracting deposits from the
general public and originating loans for the purchase and construction of one-
to four-family residential properties and, to a lesser extent, commercial
business and consumer loans. In recent years, First Savings has expanded its
consumer, commercial real estate and small business lending in an effort to
maintain a profitable spread between its average loan yield and its cost of
funds.
Lending Activities
The following table sets forth information concerning the types of
loans held by First Savings at the dates indicated.
<TABLE>
<CAPTION>
At March 31, At December 31,
------------------------------------------- -------------------------------------------
2000 1999 1999 1998
-------------------- -------------------- -------------------- -------------------
Amount % Amount % Amount % Amount %
------ - ------ - ------ - ------ -
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residential... $ 15,929 33% $ 11,810 27% $ 13,745 28% $ 11,669 29%
Other properties.................. 7,926 16 8,581 20 8,890 18 7,945 19
Construction...................... 13,046 27 13,287 31 14,828 31 12,329 30
Commercial.......................... 10,991 22 8,487 20 9,894 21 8,065 20
Consumer............................ 996 2 998 2 906 2 832 2
---------- ------- ---------- ------- ---------- ------- ---------- ------
Total loans.................... $ 48,888 100% $ 43,163 100% $ 48,263 100% $ 40,840 100%
========== ======= ========== ======= ========== ======= ========== ======
</TABLE>
The following table sets forth the estimated maturity of First Savings'
loan portfolio at December 31, 1999. The table does not include any estimate of
prepayments which significantly shorten the average life of all mortgage loans
and may cause First Savings' repayment experience to differ from that shown
below.
<TABLE>
<CAPTION>
Due After
Due Within One Through Due After
One Year Five Years Five Years Total
-------- ---------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
Real Estate:
One- to four-family residential. $ 5 $ 178 $ 13,562 $ 13,745
Other properties................ 2,198 3,623 3,069 8,890
Construction.................... 14,517 311 -- 14,828
Commercial........................ 6,230 2,106 1,558 9,894
Consumer.......................... 335 559 12 906
--------- ----------- --------- ---------
Total........................ $ 23,285 $ 6,777 $ 18,201 $ 48,263
========= =========== ========= =========
</TABLE>
59
<PAGE>
The following table sets forth at December 31, 1999, the dollar amount
of all loans due one year or more after December 31, 1999 which have
predetermined interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- -----
(In thousands)
<S> <C> <C> <C>
Real Estate:
One- to four-family residential............ $ 7,430 $ 6,310 $ 13,740
Other properties........................... 3,771 2,921 6,692
Construction............................... -- 311 311
Commercial................................... 792 2,872 3,664
Consumer..................................... 547 24 571
---------- ---------- -----------
Total................................... $ 12,540 $ 12,438 $ 24,978
========== ========== ===========
</TABLE>
Single-Family Residential Real Estate Lending. First Savings
historically has been and continues to be an originator of single-family,
residential real estate loans in its market area. At March 31, 2000,
single-family residential mortgage loans, totaled approximately $15.9 million,
or 32.6% of its gross loan portfolio. All such loans originated by First Savings
are maintained in its portfolio rather than sold in the secondary market.
First Savings emphasizes several forms of adjustable-rate loans with
interest rates and payment adjustments made at regular intervals. The retention
of adjustable-rate mortgage loans in its loan portfolio helps reduce First
Savings' exposure to increases in interest rates. Adjustments are generally
based upon movements in the Prime Rate and CMT Mortgage Indices. At March 31,
2000, approximately $24.0 million, or 49.2%, of the loan portfolio consisted of
adjustable-rate mortgage loans. There are unquantifiable credit risks resulting
from potential increased costs to the borrower as a result of repricing of
adjustable-rate mortgage loans. It is possible therefore that during periods of
rising interest rates, the risk of default on adjustable-rate mortgage loans may
increase due to the upward adjustment of interest cost to the borrower. Further,
these loans are subject to increased risk of delinquency or default as the
higher, fully indexed rate of interest subsequently comes into effect, replacing
the lower initial rate.
First Savings also originates, to a limited extent, fixed-rate loans
for terms of 15 years to 30 years. In each case, such loans are secured by first
mortgages on single-family, owner-occupied residential real property located in
its market area. Because of First Savings' policy to mitigate its exposure to
interest rate risk through the use of adjustable-rate rather than fixed-rate
products, First Savings does not emphasize fixed-rate mortgage loans. At March
31, 2000, $12.8 million, or 26.3%, of First Savings' loan portfolio consisted of
fixed-rate mortgage loans.
Construction Lending. First Savings actively engages in lending for the
construction of one- to four-family residential properties. At March 31, 2000,
First Savings had $13.0 million of construction loans outstanding, representing
26.7% of its loan portfolio. All construction loans are secured by a first lien
on the property under construction. Construction financing generally is
considered to involve a higher degree of risk of loss than long-term financing
on improved, occupied real estate. First Savings' risk of loss on a construction
loan is dependent largely upon the accuracy of the initial estimate of the
property's value at completion of construction or development and the estimated
cost (including interest) of construction. First Savings' policy is to minimize
risk of loss by limiting construction lending to qualified borrowers in its
market area and by limiting the aggregate amount of outstanding construction
loans.
60
<PAGE>
Commercial Real Estate and Multi-Family Lending. As of March 31, 2000,
First Savings held $7.9 million in commercial real estate loans which
represented approximately 16.2% of its loan portfolio. These loans are secured
by multi-family units, single proprietor businesses, office buildings, nursing
homes and motels. Before originating such loans, First Savings considers, among
other things, the creditworthiness of the borrower, the location of the real
estate, the condition and occupancy levels of the security and the quality of
the organization managing the property. First Savings also obtains appraisals of
each property in accordance with applicable federal regulations.
Consumer and Commercial Lending. At March 31, 2000, First Savings'
consumer loan portfolio totaled approximately $1.0 million, which represented
2.0% of its total loan portfolio. Consumer loans are both secured and unsecured.
Secured loans include loans secured by automobiles and deposits. Consumer loan
collections depend on the borrower's continuing financial stability, and thus
are more likely to be adversely affected by job loss, illness or personal
bankruptcy. The application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may also limit the amount which can be
recovered on such loans.
First Savings had approximately $11.0 million of commercial business
loans outstanding at March 31, 2000 which were not collateralized by real
estate. First Savings' commercial business lending activities encompass loans
with a variety of purposes and forms of security, including loans to finance
accounts receivable, inventory and equipment. Commercial business loans are of
higher risk and typically are made on the basis of the borrower's ability to
make repayment from the cash flow of the borrower's business. As a result, the
availability of funds for the repayment of commercial business loans may be
substantially dependent on the success of the business itself. Further, the
collateral securing the loans may depreciate over time, may be difficult to
appraise and may fluctuate in value based on the success of the business.
Loan Commitments. First Savings makes commitments to extend credit and
standby letters of credit. Written commitments are given to prospective
borrowers on all approved real estate loans. At March 31, 2000, commitments to
cover originations of mortgage loans were $3.1 million, standby letters of
credit totaled $834,000 and unfunded loan commitments totaled $11.5 million.
With certain limited exceptions, the maximum amount that a savings
institution may lend to any borrower (including certain related entities of the
borrower) at one time may not exceed 15% of the unimpaired capital and surplus
of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully secured by readily marketable collateral. Savings institutions are
additionally authorized to make loans to one borrower, for any purpose, in an
amount not to exceed $500,000 or, by order of the Director of the OTS, in an
amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and
surplus to develop residential housing, provided: (i) the purchase price of each
single-family dwelling in the development does not exceed $500,000; (ii) the
institution is in compliance with its regulatory capital requirements; (iii) the
loans comply with applicable loan-to-value requirements, and; (iv) the aggregate
amount of loans made under this authority does not exceed 150% of unimpaired
capital and surplus. At March 31, 2000, First Savings did use the alternative
30% of unimpaired capital and surplus to provide loans to certain residential
construction borrowers. These borrowers are currently developing residential
housing which meet the above requirements. At such date, the largest aggregate
amount of loans that First Savings had outstanding to any one borrower was $1.0
million.
Nonperforming and Problem Assets
Loan Delinquencies. Generally when a mortgage loan becomes 30 days past
due, a notice of nonpayment is sent to the borrower. Additional notices and
letters from Southern Financial are sent if the
61
<PAGE>
loan remains delinquent after 45, 60 and 75 days. If the loan continues in a
delinquent status for 90 days past due and no repayment plan is in effect, a
notice of right to cure default is sent to the borrower giving 30 additional
days to bring the loan current before foreclosure is commenced. The board meets
regularly to determine when foreclosure proceedings should be initiated. The
customer will be notified when foreclosure is commenced. At March 31, 2000,
First Savings' loans past due between 30 and 89 days totaled $1.7 million.
Nonperforming Assets. The following table sets forth information with
respect to First Savings' nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
At March 31, At December 31,
------------ ---------------
2000 1999 1999 1998
---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate:
One- to four-family residence............ $ 387 $ 552 $ -- $ 422
Commercial............................... 78 553 78 461
Construction............................. 927 -- 818 218
Commercial.................................. 323 306 323 289
Other....................................... -- 5 -- 5
--------- --------- --------- ---------
Total.................................... $ 1,715 $ 1,416 $ 1,219 $ 1,395
========= ========= ========= =========
Accruing loans which are contractually
past due 90 days or more:
Real estate:
One- to four-family residence............ $ -- -- $ 163 $ --
Construction............................. 47 -- -- --
Commercial.................................. 155 -- 112 --
Other....................................... -- -- -- --
--------- --------- --------- ---------
Total.................................... $ 202 $ -- $ 275 $ --
========= ========= ========= =========
Total nonperforming loans................ $ 1,917 $ 1,416 $ 1,494 $ 1,395
========= ========= ========= =========
Percentage of nonperforming to total assets.... 2.70% 1.96% 2.16% 2.14%
========= ========= ========= =========
Other non-performing assets (2)................ $ 8 $ 172 $ 157 $ 10
========= ========= ========= =========
Loans modified in troubled debt restructurings. $ -- $ -- $ -- $ --
========= ========= ========= =========
</TABLE>
(1) Non-accrual status denotes loans which, in the opinion of management,
the collection of additional interest is uncertain. Payments received
on a nonaccrual loan are either applied to the outstanding principal
balance or recorded as interest income, depending on management's
assessment of the collectibility of the loan.
(2) Other nonperforming assets represent property acquired by the First
Savings through foreclosure or repossession. This property is carried
at the lower of its fair market value or the principal balance of the
related loan.
During the three months ended March 31, 2000 and the year ended
December 31, 1999, gross interest income of $139,000 and $272,000, respectively,
would have been recorded on loans accounted for on a nonaccrual basis if the
loans had been current throughout the respective periods. Interest on such loans
included in income during such respective periods amounted to $5,000 and
$162,000, respectively.
62
<PAGE>
Loans are generally placed on a nonaccrual status when in management's
opinion the borrower may be unable to meet payments as they become due. Loans
which are not currently classified as non-accrual, 90 days past due or
restructured, but where known information about possible credit problems of
borrowers causes management to have serious concerns as to the ability of the
borrowers to comply with present loan repayment terms and may result in future
disclosure as non-accrual, 90 days past due or restructured amounted to $604,000
at March 31, 2000.
Classified Assets. OTS regulations provide for a classification system
for problem assets of savings associations which covers all problem assets.
Under this classification system, problem assets of savings associations such as
ours are classified as "substandard," "doubtful," or "loss." When a savings
association classifies problem assets as either substandard or doubtful, it may
establish general allowances for loan losses in an amount deemed prudent by
management. General allowances represent loss allowances which have been
established to recognize the inherent risk associated with lending activities,
but which, unlike specific allowances, have not been allocated to particular
problem assets. When a savings association classifies problem assets as loss, it
is required either to establish a specific allowance for losses equal to 100% of
that portion of the asset so classified or to charge off such amount. A savings
association's determination as to the classification of its assets and the
amount of its valuation allowances is subject to review by the OTS, which may
order the establishment of additional general or specific loss allowances. A
portion of general loss allowances established to cover possible losses related
to assets classified as substandard or doubtful may be included in determining a
savings association's regulatory capital. Specific valuation allowances for loan
losses generally do not qualify as regulatory capital.
At March 31, 2000, First Savings had $73,000 of its assets classified
as special mention, $1.9 million classified as substandard and no assets
classified as doubtful or loss.
Foreclosed Real Estate. Real estate acquired by First Savings as a
result of foreclosure is recorded as "real estate owned" until such time as it
is sold. When real estate owned is acquired, it is initially recorded at the
lower of its fair market value or the principal balance of the related loan at
the date of foreclosure. Management periodically performs valuations and an
allowance is charged to operations if the carrying value of the property exceeds
its fair value. At March 31, 2000, First Savings had one vacant lot with a value
of $7,500 in real estate owned.
Allowance for Loan Losses. First Savings' policy is to provide for
losses on unidentified loans in its loan portfolio. A provision for loan losses
is charged to operations based on management's evaluation of the losses that may
be incurred in the loan portfolio. The evaluation, including a review of all
loans on which full collectibility of interest and principal may not be
reasonably assured, considers: (i) First Savings' past loan loss experience,
(ii) known and inherent risks in the loan, (iii) adverse situations that may
affect the borrower's ability to repay, (iv) the estimated value of any
underlying collateral, and (v) current economic conditions.
Management monitors the allowance for loan losses and makes additions
to the allowance as economic conditions dictate. Although First Savings
maintains its allowance for loan losses at a level that management considers
adequate for the inherent risk of loss in the loan portfolio, actual losses
could exceed the balance of the allowance for loan losses and additional
provisions for loan losses could be required. In addition, the determination as
to the amount of its allowance for loan losses is subject to review by the OTS,
as part of its examination process. After a review of the information available,
the OTS might require the establishment of an additional allowance.
63
<PAGE>
The following table sets forth an analysis of First Savings' allowance
for possible loan losses for the period indicated.
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
---------------------- -----------------------
2000 1999 1999 1998
------ ------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period..................... $ 481 $ 459 $ 459 $ 401
Loans charged off:
Real estate mortgage:
One- to four-family residential............. -- -- (5) --
Other properties............................ -- -- (3) (9)
Commercial..................................... (6) -- (113) --
Consumer....................................... (9) (9) (52) (29)
------- ------ ------- ------
Total charge-offs................................. (15) (9) (173) (38)
------- ------ ------- ------
Recoveries:
Real estate mortgage:
One- to four-family residential............. -- -- 4 --
Other properties............................ -- -- -- --
Commercial..................................... -- -- 41 --
Consumer....................................... 6 1 20 11
------- ------ ------- ------
Total recoveries.................................. 6 1 65 11
------- ------ ------- ------
Net loans charged off............................. (9) (8) (108) (27)
------- ------ ------- ------
Provision for loan losses......................... 225 10 130 85
------- ------ ------- ------
Balance at end of period.......................... $ 697 $ 461 $ 481 $ 459
======= ====== ======= ======
Ratio of net charge-offs to average
loans outstanding during the period............ .02% .02% .23% .07%
======= ====== ======= ======
</TABLE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At March 31, At December 31,
------------ ---------------
2000 1999 1999 1998
---- ---- ---- ----
Percent of Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each Loans in Each
Category to Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage:
One- to four-family residential $ 92 33% $ 45 27% $ 78 28% $ 48 29%
Other properties 135 16 134 20 87 18 128 19
Construction 209 27 92 31 174 31 100 30
Commercial 247 22 177 20 132 21 173 20
Consumer 14 2 13 2 10 2 10 2
------ --- ------ --- ------ --- ------ ---
Total allowance for loan losses $ 697 100% $ 461 100% $ 481 100% $ 459 100%
====== === ====== === ====== === ====== ===
</TABLE>
64
<PAGE>
Investment Securities
Investment Securities. First Savings is required under federal
regulations to maintain a minimum amount of liquid assets which may be invested
in specified short-term securities and certain other investments. Investment
securities are classified as "held to maturity" or "available-for-sale" in
accordance with SFAS No. 115. At March 31, 2000, the investment portfolio policy
of First Savings allowed investments in instruments such as: (i) U.S. Treasury
obligations, (ii) U.S. federal agency or federally-sponsored agency obligations,
(iii) mortgage-backed securities, (iv) certificates of deposit, and (v) federal
funds, including FHLB overnight and term deposits.
Mortgage-Backed Securities. To supplement lending activities, First
Savings has invested in residential mortgage-backed securities, which can serve
as collateral for borrowings and, through repayments, as a source of liquidity.
The mortgage-backed securities portfolio consists of participations or
pass-through certificates issued by the Federal Home Loan Mortgage Corporation,
the Federal National Mortgage Association and the Government National Mortgage
Association.
The following table sets forth the carrying value of First Savings'
investment securities portfolio (excluding certificates of deposit and federal
funds) at the dates indicated.
<TABLE>
<CAPTION>
At March 31, At December 31,
------------ ---------------
2000 1999 1999 1998
---- ---- ----- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Securities available for sale:
Mortgage-backed securities........................ $ 1,040 $ 3,724 $ 1,244 $ 4,398
Securities held to maturity:
U.S. government securities........................ 6,003 4,782 5,515 455
Mortgage-backed securities........................ 5,189 6,330 5,466 7,648
-------- --------- --------- --------
Total investments.............................. $ 12,232 $ 14,836 $ 12,225 $ 12,501
======== ========= ========= ========
</TABLE>
65
<PAGE>
The following table sets forth the scheduled maturities, carrying
values, market values and average yields for First Savings' investment
securities portfolio at March 31, 2000.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------- ------------------- ------------------- --------------------
Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
--------- ------- --------- ------- --------- ------- --------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities held to maturity:
U.S. government and
agency securities.............. $ -- --% $ -- --% $ 500 6.50% $ 5,503 5.81%
Mortgage-backed securities........ -- -- 122 8.57 135 7.99 4,932 6.35
--------- --------- --------- ---------
Total.......................... $ -- -- $ 122 8.57 $ 635 6.82 $ 10,435 6.07
========= ========= ========= =========
Securities available for sale:
Other investments................ $ -- --% $ -- --% $ -- --% $ -- --%
Mortgage-backed securities........ -- -- -- -- -- -- 1,040 6.73
--------- --------- --------- ---------
Total.......................... $ -- -- $ -- -- $ -- -- $ 1,040 6.73
========= ========= ========= =========
</TABLE>
Total Investment Portfolio
----------------------------
Weighted
Carrying Market Average
Value Value Yield
-------- --------- ------
(Dollars in thousands)
Securities held to maturity:
U.S. government and
agency securities.............. $ 6,003 $ 5,859 5.86%
Mortgage-backed securities........ 5,189 5,144 6.45
-------- ---------
Total.......................... $ 11,192 $ 11,003 6.13
======== =========
Securities available for sale:
Other investments................ $ -- $ -- --%
Mortgage-backed securities........ 1,040 1,040 6.73
-------- ---------
Total.......................... $ 1,040 $ 1,040 6.73
======== =========
66
<PAGE>
Sources of Funds
Deposit instruments, including regular savings accounts, money market
accounts, and term certificate accounts and FHLB borrowings and securities sold
under agreements to repurchase are First Savings major external source of funds
for lending and other investment purposes. Consumer and commercial deposits are
attracted principally from within its primary market area. Interest rates are
determined based on current liquidity requirements, interest rates paid by
competitors and applicable regulatory restrictions and requirements.
The following tables set forth the average balances and interest rates
based on month-end balances for interest-bearing demand deposits and time
deposits as of the dates indicated.
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
----------------------------------------- ------------------------------------------
2000 1999 1999 1998
------------------ ------------------- ------------------- -------------------
Average Average Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate Balance Rate
------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Savings deposits............. $ 3,973 3.61% $ 4,279 4.48% $ 3,795 4.16% $ 1,958 2.93%
Interest-bearing demand
deposits.................. 7,524 2.97 5,973 3.26 6,950 3.09 4,442 3.24
Noninterest-bearing demand
deposits.................. 7,104 -- 10,745 -- 7,781 -- 10,362 --
Time deposits................ 35,809 5.49 39,306 5.39 38,471 5.35 38,858 5.77
-------- -------- -------- --------
Total................... $ 54,410 4.29% $ 60,303 4.16% $ 56,997 4.26% $ 55,620 4.39%
======== ======== ======== ========
</TABLE>
The following table indicates the amount of the certificates of deposit
of $100,000 or more held by First Savings by time remaining until maturity as of
March 31, 2000.
Certificates
Maturity Period of Deposits
--------------- -----------
(In thousands)
Three months or less....................... $ 1,354
Over three through six months.............. 1,869
Over six through 12 months................. 2,001
Over 12 months............................. 1,880
----------
Total.................................. $ 7,104
==========
67
<PAGE>
First Savings' borrowings consist of a floating rate note payable to
the FHLB of Atlanta collateralized by mortgage loans. In addition, First Savings
also borrows from First Union under a floating rate repurchase agreement with
the borrowings collateralized by investment securities. Set forth below is
certain information regarding First Savings' borrowings.
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
------------------------------ ------------------------------
2000 1999 1999 1998
--------------- -------------- --------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Amounts outstanding at end of period:
Securities sold under repurchase agreements $8,861 $6,486 $5,861 $2,516
FHLB borrowings 3,000 -- 3,000 --
Weighted average rate paid on:
Securities sold under agreements to repurchase 6.46% 5.26% 6.00% 5.30%
FHLB borrowings 6.59% -- 5.95% --
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
------------------------------ ------------------------------
2000 1999 1999 1998
--------------- -------------- --------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Maximum amount of borrowings outstanding at
any month end:
Securities sold under repurchase agreements $8,861 $6,486 $9,989 $7,824
FHLB borrowings 3,000 -- 3,000 200
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, December 31,
------------------------------ ------------------------------
2000 1999 1999 1998
--------------- -------------- --------------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Approximate average short-term borrowings
outstanding with respect to:
Securities sold under repurchase agreements $7,750 $3,951 $7,302 $2,031
FHLB borrowings 3,000 -- 900 49
Approximate weighted average rate paid on: (1)
Securities sold under agreements to repurchase 6.18 5.29 5.46 5.36
FHLB borrowings 6.06 -- 5.95 5.29
______________
(1) Calculated on average daily balances.
</TABLE>
Competition
First Savings' market area for lending and deposit activities is highly
competitive. First Savings encounters strong competition from a wide range of
financial institutions, including local and regional commercial banks and thrift
institutions, credit unions, finance companies and multi-state regional banks in
its market area. Many of these institutions, particularly the larger banking
firms that have enhanced their local presence through interstate mergers in
recent years, have substantially greater resources than First Savings. First
Savings competes with these institutions primarily on the basis of the quality
of personal service provided to customers.
68
<PAGE>
Employees
First Savings currently has 22 full-time and four part-time employees.
Properties
Currently, First Savings operates from its main office in Springfield,
Virginia and one branch office located in Fredericksburg, Virginia. First
Savings leases both of its locations. Annual rent for the year 2000 under the
leases are $127,000. The lease agreement for the Springfield location provides
for a rent escalation beginning in 2001. The total net book value of First
Savings' investment in premises and equipment at March 31, 2000, was
approximately $490,000.
First Savings is permitted to invest in real estate (improved or
unimproved) to be used for office and related facilities, or for such facilities
and for sale or rental if such investment is made and maintained under a prudent
program of property acquisition to meet its present needs and reasonable future
needs for office space. First Savings may also hold real estate acquired through
foreclosure of loans or via deeds in lieu of foreclosure. First Savings is not
permitted to directly acquire real estate for the purpose of development and
resale. However, First Savings is permitted to invest in service corporations
which may acquire real estate for prompt development, subdivision or for rental
or resale provided that the aggregate amount of First Savings' investments in
such service corporations does not exceed 3.0% of its assets and any investment
in excess of 2.0% must be to serve primarily community, inner-city or community
development purposes. At March 31, 2000, First Savings owns FSB Financial
Corporation, an inactive service corporation.
At March 31, 2000, no property of First Savings had a book value equal
to or greater than 10.0% of First Savings' total assets at that date.
Analysis of First Savings' Regulatory Capital Compliance
The table below represents First Savings' historical capital position
relative to its various regulatory capital requirements at March 31, 2000.
Percent of
Amount Assets (1)
------ ----------
(Dollars in thousands)
Tier 1/leverage capital............................ $ 4,795 6.75%
Tier 1/leverage capital requirement................ 2,843 4.00
---------- -----
Excess........................................... $ 1,952 2.75%
========== =====
Tier 1 Risk-based capital.......................... $ 4,795 11.98%
Tier 1 Risk-based capital requirement.............. 1,601 4.00
---------- -----
Excess........................................... $ 3,194 7.98%
========== =====
Risk-based capital................................. $ 5,298 13.24%
Risk-based capital requirement..................... 3,202 8.00
---------- -----
Excess........................................... $ 2,096 5.24%
========== =====
69
<PAGE>
Key Operating Ratios
The table below sets forth certain performance ratios of First Savings
at the dates or for the periods indicated.
<TABLE>
<CAPTION>
At or for the
Three months Ended At or for the Year
March 31, Ended December 31,
------------------------ -----------------------
2000 1999 1999 1998
------ ------ ------ -----
<S> <C> <C> <C> <C>
Return on assets (net income divided by average
total assets).......................................... 0.44% 0.50% 0.54% 0.76%
Return on average equity earnings (net
income divided by average equity earnings)............. 6.42 7.87 8.03 11.58
Average equity earnings to average assets................ 6.80 6.39 6.76 6.58
Average loans to average deposits........................ 87.72 69.52 77.74 77.13
</TABLE>
70
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
The operating results of First Savings 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.
Asset and Liability Management
First Savings, 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, First Savings' 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 borrowings. First Savings, 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 First Savings' 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 First Savings' residential mortgage loan portfolio, it
is First Savings' policy to keep those mortgage loans which have an adjustable
interest rate in its portfolio and to sell certain fixed rate residential
mortgage loans originated to the secondary market. In addition, First Savings'
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 First Savings' exposure to rising interest rates.
Interest Rate Sensitivity Analysis
First Savings' interest rate sensitivity is primarily monitored by
management through the use of a model which generates estimates of the change in
First Savings' market value of portfolio equity ("MVPE") over a range of
interest rate scenarios. Such analysis was prepared by a third party for First
Savings. 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 First Savings' 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 December 31,
1999.
71
<PAGE>
Net Portfolio Value
Change -----------------------------------------
in Rates $ Amount $ Change % Change
-------- -------- -------- --------
(Dollars in thousands)
+ 300 bp $ 4,550 $ (1,061) (18.91)%
+ 200 bp 5,020 (591) (10.53)
+ 100 bp 5,387 (223) (3.97)
0 bp 5,611 -- --
- 100 bp 5,679 68 1.21
- 200 bp 5,675 65 1.16
- 300 bp 5,674 64 1.14
Certain shortcomings are inherent in the methodology used in the above
interest rate risk measurements. Modeling changes in MVPE 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 provides an indication of First Savings' 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 First Savings' net worth.
The following table sets forth the amounts of interest-earning assets
and interest-bearing liabilities outstanding at March 31, 2000 which are
expected to mature or reprice in each of the time periods shown.
<TABLE>
<CAPTION>
Over One
One Year Through Due After
or Less Five Years Five Years Total
------- ---------- ---------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans.............................. $ 29,055 $ 9,094 $ 10,834 $ 48,983
Investments (1).................... 17,578 123 1,135 18,836
--------- -------- --------- ---------
Total........................... 46,633 9,217 11,969 67,819
--------- -------- --------- ---------
Interest-bearing liabilities:
Deposits........................... 43,145 10,799 100 54,044
Borrowings......................... 11,861 -- -- 11,861
--------- -------- --------- ---------
Total........................... 55,006 10,799 100 65,905
--------- -------- --------- ---------
Interest sensitivity gap.............. $ (8,373) $ (1,582) $ 11,869 $ 1,914
========= ======== ========= =========
Cumulative interest sensitivity gap... $ (8,373) $ (9,955) $ 1,914
========= ======== =========
Ratio of cumulative gap to interest-
earning assets..................... (12.35)% (14.68)% 2.82%
======== ======== =========
</TABLE>
_______________
(1) Excludes Federal Home Loan Bank stock.
72
<PAGE>
Average Balances, Interest and Average Yields
The following table sets forth certain information relating to First
Savings' average balance sheet and reflects (i) the average yield on assets and
average cost of liabilities for the periods indicated and (ii) the average
yields earned and rates paid at the date and for the periods indicated. Such
yields and costs are derived by dividing income or expense by the average
balance of assets or liabilities, respectively, for the periods presented.
Average balances are derived from month-end balances.
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------------------------
2000 1999
-------------------------- ------------------------
Average Average
Average Yield/ Average Yield/
Balance Rate Balance Rate
------- ---- ------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans (1)............................................ $ 48,521 9.47% $ 41,308 8.84%
Investments (2)...................................... 17,519 6.04 22,718 5.07
---------- ------ --------- ------
Total interest-earning assets.................... 66,040 8.56 64,026 7.50
Interest-bearing liabilities:
Deposits............................................ $ 54,410 4.29 $ 60,303 4.16
Borrowings.......................................... 10,861 6.09 4,496 4.65
---------- ------- --------- ------
Total interest-bearing liabilities............... 65,271 4.59 64,799 4.19
Average dollar difference between
interest-earning assets and interest-
bearing liabilities.................................. $ 769 $ (773)
========== =========
Interest rate spread................................... 3.97% 3.31%
====== =====
Interest margin........................................ 4.02% 3.26%
====== ======
</TABLE>
(1) Non-accrual loans are included in average balances, less allowance for loan
losses and deferred fees.
(2) Excludes Federal Home Loan Bank stock.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1999 1998
--------------------------- -------------------------
Average Average
Average Yield/ Average Yield/
Balance Rate Balance Rate
------- ---- ------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans (1).............................................. $ 46,425 8.92% $ 40,322 9.10%
Investments (2)........................................ 19,604 5.47 17,069 4.51
---------- ------- --------- ------
Total interest-earning assets..................... 66,029 7.90 57,391 7.74
Interest-bearing liabilities:
Deposits............................................... 56,997 4.26 55,620 4.39
Borrowings............................................. 8,313 5.44 2,309 4.79
---------- ------- --------- ------
Total interest-bearing liabilities..................... 65,310 4.41 57,929 4.41
Average dollar difference between interest-earning
assets and interest-bearing liabilities.............. $ 719 $ (538)
========== =========
Interest rate spread................................... 3.49% 3.33%
======= =======
Interest margin........................................ 3.53% 3.29%
======= =======
</TABLE>
(1) Non-accrual loans are included in average balances, less allowance for loan
losses and deferred fees.
(2) Excludes Federal Home Loan Bank stock.
73
<PAGE>
Rate/Volume Analysis
The table below 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 and 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.
<TABLE>
<CAPTION>
Three Months Ended March 31, Year Ended December 31,
-------------------------------------- -----------------------------------------
2000 vs. 1999 1999 vs. 1998
-------------------------------------- -----------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
Volume Rate Total Volume Rate Total
------ ------ ----- ------ ------ -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans..................................... $ 168 $ 68 $ 236 $ 543 $ (71) $ 472
Investments............................... (73) 49 (24) 124 177 301
------- -------- -------- -------- --------- ---------
Total interest-earning assets.......... 95 117 212 667 106 773
------- -------- -------- -------- --------- ---------
Interest expense:
Deposits.................................. (63) 20 (43) 59 (72) (13)
Borrowings................................ 93 20 113 324 17 341
------- -------- -------- -------- --------- ---------
Total interest-bearing liabilities... 30 40 70 383 (55) 328
------- -------- -------- -------- --------- ---------
Change in net interest income................ $ 65 $ 77 $ 142 $ 284 $ 161 $ 445
======= ======== ======== ======== ========= =========
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1998 vs. 1997
---------------------------------------------
Increase (Decrease)
Due to
Volume Rate Total
------ ---- -----
(In thousands)
<S> <C> <C> <C>
Interest income:
Loans..................................... $ 203 $ 17 $ 220
Investments............................... 548 (134) 414
--------- ---------- ---------
Total interest-earning assets.......... 751 (117) 634
--------- ---------- ---------
Interest expense:
Deposits.................................. 693 (217) 476
Borrowings................................ (79) (53) (132)
--------- ---------- ---------
Total interest-bearing liabilities... 614 (270) 344
--------- ---------- ---------
Change in net interest income................ $ 137 $ 153 $ 290
========= ========== =========
</TABLE>
74
<PAGE>
Comparison of Financial Condition at December 31, 1999 and December 31, 1998
Total assets were $69.0 million at December 31, 1999, a small increase
of $3.9 million from $65.1 million at December 31, 1998. While the increase in
total assets was small, there were significant changes in the composition of the
assets. Cash and overnight deposits declined 28.4% from $10.6 million to $7.6
million. As noted below, net loans receivable increased 18.4% to $47.7 million.
Deposits decreased to $55.1 million at December 31, 1999, from $58.0 million at
December 31, 1998. Borrowings increased by 252.2% from $2.5 million at December
31, 1998 to $8.9 million at December 31, 1999. These additional funds were used
to fund the increase in loans.
Net income for the year ended December 31, 1999, was $365,000 ($0.39
diluted earnings per share), a decrease of 16.8% from earnings of $438,000 ($.51
diluted earnings per share) for the year ended December 31, 1998. Loans
receivable, net of deferred fees, and allowance for loan losses were $47.7
million at December 31, 1999, an increase of $7.4 million, or 18.4%, from $40.3
million at December 31, 1998. During the year ended December 31. 1999, First
Savings continued to emphasize construction and small business loans.
Deposits at December 31, 1999 were $55.1 million, a decrease of $2.9
million over deposits of $58.0 million at December 31, 1998. Advances from the
FHLB of Atlanta totaled $3.0 million at December 31, 1999, compared with no
outstanding balance of advances at December 31, 1998. Securities sold under
agreement to repurchase increased by 132.9% from $2.5 million to $5.9 million as
of December 31, 1999.
Comparison of Results of Operations for the Quarters Ended March 31, 2000 and
1999
Net Income. First Savings' net income for the quarter ended March 31,
2000 was $76,000, a decrease of 11.5% over net income of $86,000 for the quarter
ended March 31, 1999. Diluted earnings per share for the quarter ended March 31,
2000 was $0.08 as compared to $0.09 for the quarter ended March 31, 1999. The
weighted average number of diluted shares of common stock outstanding was
934,214 for the quarter ended March 31, 2000 and 939,186 for the quarter ended
March 31, 1999.
Net Interest Income. Net interest income before provision for loan
losses was $664,000 for the quarter ended March 31, 2000, an increase of 27.2%
over $523,000 for the quarter ended March 31, 1999. This increase was due to the
growth in the average level of earning assets from $64.0 million to $66.0
million, and an improvement in the interest rate spread to 3.97% in 2000 from
3.31% in 1999. In addition, the interest margin grew from 3.26% in 1999 to 4.02%
in 2000.
Total Interest Income. Total interest income was $1.4 million for the
quarter ended March 31, 2000, an increase of 17.6% over $1.2 million for the
quarter ended March 31, 1999. This increase resulted from growth in
interest-earning assets and an increase in yield. Average loans receivable
increased by $7.2 million, which offset the decrease in average investment
securities of $5.2 million over March 31, 1999.
The yield on total interest-earning assets was 8.56% for the quarter
ended March 31, 2000, which increased from 7.50% for the same quarter in 1999.
For the quarter ended March 31, 2000, the yield on average loans receivable was
9.47%, up from 8.84% for the quarter ended March 31, 1999, while the yield on
average investment securities increased from 5.07% during the first quarter of
1999 to 6.04% for the quarter ended March 31, 2000.
Total Interest Expense. Total interest expense for the quarter ended
March 31, 2000 was $748,000, an increase of 10.3% over $679,000 for the quarter
ended March 31, 1999. This increase was
75
<PAGE>
due primarily to growth in the average balance of borrowings, which were $10.8
million for the quarter ended March 31, 2000 compared to $4.5 million for the
same quarter in the prior year. The average effective rate paid on
interest-bearing liabilities was 4.59% for the quarter ended March 31, 2000,
compared to 4.19% for the quarter ended March 31, 1999.
Provision For Loan Losses. The provision for loan losses amounted to
$225,000 for the quarter ended March 31, 2000, an increase over the provision of
$10,000 for the quarter ended March 31, 1999. The provision for loan losses is a
current charge to earnings to increase the allowance for loan losses. First
Savings has established the allowance for loan losses to absorb the inherent
risk in lending after considering an evaluation of the loan portfolio, current
economic conditions, changes in the nature and volume of lending and past loan
experience. The increase in provision expense during the first quarter of 2000
is consistent with increases in non-performing assets during the period.
Management's opinion is that the allowance for loan losses at March 31, 2000 is
adequate. Although management believes that the allowance is adequate, there can
be no assurance that additions to such allowance will not be necessary in future
periods, which would adversely affect First Savings' results of operations. The
allowance for loan losses at March 31, 2000 was $697,000, or 1.42% of gross
loans receivable compared to $461,000, or 1.07% at March 31, 1999.
Other Income. Other income totaled $266,000 for the quarter ended March
31, 2000, an increase of 84.8%, from $144,000 for the quarter ended March 31,
1999. The increase was primarily the result of increased gains on the sale of
loans.
Other Expenses. Other expenses for the quarter ended March 31, 2000
were $582,000, an increase of 12.6% from $517,000 for the quarter ended March
31, 1999.
Employee compensation and benefits increased 10.2% to $279,000 for the
quarter ended March 31, 2000 from $253,000 for the quarter ended March 31, 1999.
The increase reflects the cost of staffing our expanded lending operation and
normal wage increases for existing personnel.
Professional fees increased to $66,000 for the quarter ended March 31,
2000 compared to $25,000 for the quarter ended March 31, 1999. This is the
result of external consultants being used to assist management in evaluating its
loan portfolio.
Comparison of Results of Operations for the Years Ended December 31, 1999 and
1998
Net Income. First Savings' net income for the year ended December 31,
1999 was $365,000, a decrease of 16.8% over net income of $438,000 for the year
ended December 31, 1998. The decrease in net income was primarily attributable
to First Savings incurring an increased income tax expense in 1999 versus 1998
when First Savings utilized a significant portion of its net operating loss
carryover to reduce income taxes. Pre-tax income increased to $588,000, an
increase of 17.4% over pretax income of $501,000 in 1998. Diluted earnings per
share for the year ended December 31, 1999 was $0.39 as compared to $.51 for the
year ended December 31, 1998. The weighted average number of diluted shares of
common stock outstanding were 939,360 for the year ended December 31, 1999 and
866,376 for the year ended December 31, 1998.
Net Interest Income. Net interest income before provision for loan
losses was $2.3 million for the year ended December 31, 1999, an increase of
23.6% over $1.9 million for the year ended December 31, 1998. This increase was
due to the growth in the average level of earning assets from $57.4 million to
$66.0 million, and an improvement in the interest rate spread to 3.49% in 1999
from 3.33% in 1998. In addition, the interest margin grew from 3.29% in 1998 to
3.53% in 1999.
76
<PAGE>
Total Interest Income. Total interest income was $5.2 million for the
year ended December 31, 1999, an increase of 17.4% over $4.4 million for the
year ended December 31, 1998. This increase resulted from growth in
interest-earning assets. Average loans receivable increased by $6.1 million and
average investment securities increased by $2.5 million over 1998.
The yield on total interest-earning assets was 7.90% for the year ended
December 31, 1999, which increased from 7.74% for 1998. For the year ended
December 31, 1999, the yield on average loans receivable was 8.92%, down from
9.10% for the year ended December 31. 1998, while the yield on average
investment securities increased from 4.51% during 1998 to 5.47% for the year
ended December 31, 1999.
Total Interest Expense. Total interest expense for the year ended
December 31, 1999 was $2.9 million, an increase of 12.9% over $2.6 million for
the year ended December 31, 1998. This increase was due primarily to growth in
the average balance of borrowings, which were $8.3 million for the year ended
December 31, 1999 compared to $2.3 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.41% for the years
ended December 31, 1999 and December 31, 1998.
Provision For Loan Losses. The provision for loan losses amounted to
$130,000 for the year ended December 31, 1999, an increase over the provision of
$85,000 for the year ended December 31, 1998. The provision for loan losses is a
current charge to earnings to increase the allowance for loan losses. First
Savings has established the allowance for loan losses to absorb the inherent
risk in lending after considering an evaluation of the loan portfolio, current
economic conditions, changes in the nature and volume of lending and past loan
experience. The increase in the provision expense is consistent with an increase
experienced in non-performing construction loans. Management's opinion is that
the allowance for loan losses at December 31, 1999 is adequate. Although
management believes that the allowance is adequate, there can be no assurance
that additions to such allowance will not be necessary in future periods, which
would adversely affect First Savings' results of operations. The allowance for
loan losses at December 31, 1999 was $481,000, or 1.00% of net loans receivable
compared to $459,000, or 1.12% at December 31, 1998.
Other Income. Other income totaled $678,000 for the year ended December
31, 1999, an increase of 16.29%, from $583,000 for the year ended December 31,
1998. The increase was primarily the result of increased revenue related to
service charges on loan and deposit accounts.
Other Expenses. Other expenses for the year ended December 31, 1999
were $2.3 million, an increase of 21.6% from $1.9 million for the year ended
December 31, 1998.
Employee compensation and benefits increased 20.0% to $1.1 million for
the year ended December 31, 1999 from $915,000 for the prior year. The increase
reflects the cost of staffing our expanded lending operation and normal wage
increases for existing personnel.
Expenses for premises and equipment increased to $257,000 during the
year ended December 31, 1999 compared to $189,000 in the prior year. This
increase is the result of the installation, testing and maintenance of equipment
that is year 2000 compliant.
Income Taxes. Income tax expense increased by 254% to $223,000 for the
year ended December 31, 1999. This results primarily from First Savings
utilizing a significant portion of its net operating loss carryover to offset
taxes in 1998.
77
<PAGE>
Comparison of Results of Operations for the Years Ended December 31, 1998 and
1997
Net Income. First Savings' net income for the year ended December 31,
1998 was $438,000, an increase of 3.0% over net income of $425,000 for the year
ended December 31, 1997. The increase in net income was primarily due to an
increase in net interest income of 16.7% and a decrease of 63.8% in provision
for loan losses. Diluted earnings per share for the year ended December 31, 1998
decreased to $.51 from $.64 for the year ended December 31, 1997. The weighted
average number of diluted shares of common stock outstanding were 866,376 for
the year ended December 31, 1998 and 666,475 for the year ended December 31,
1997.
Net Interest Income. Net interest income before provision for loan
losses was $1.9 million for the year ended December 31, 1998, an increase of
18.2% over $1.6 million for the year ended December 31, 1997. This increase was
due to the growth in the average level of earning assets from $43.6 million to
$57.4 million, offset partly by declines in the interest rate spread from 3.70%
to 3.33%, when comparing the year ended December 31. 1997 to the year ended
December 31, 1998.
Total Interest Income. Total interest income was $4.4 million for the
year ended December 31, 1998, an increase of 16.7% over $3.8 million for the
year ended December 31, 1997. This increase resulted primarily from growth in
interest-earning assets. Average loans receivable increased by $2.2 million, and
average investment securities increased by $11.5 million over 1997.
The yield on total interest-earning assets was 7.74% for the year ended
December 31, 1998, down from 8.72% in 1997. For the year ended December 31,
1998, the yield on average loans receivable was 9.10%, up from 9.06% for the
year ended December 31. 1997, while the yield on average investment securities
decreased from 6.43% during 1997 to 4.51% for the year ended December 31, 1998.
Total Interest Expense. Total interest expense for the year ended
December 31. 1998 was $2.6 million, an increase of 15.6% over $2.2 million for
the year ended December 31, 1997. This increase was due primarily to growth in
the average balance of deposits, which were $55.6 million for the year ended
December 31, 1998 compared to $40.2 million for the prior year. The average
effective rate paid on interest-bearing liabilities was 4.41% for the year ended
December 31, 1998, a decrease of 62 basis points from 5.03% for the year ended
December 31, 1997.
Provision for Loan Losses. The provision for loan losses amounted to
$85,000 for the year ended December 31, 1998, a decrease of $150,000 from a
$235,000 provision for the year ended December 31, 1997. The decrease is due to
fewer charge-offs experienced in 1998 than management anticipated in estimating
the allowance for loan losses at December 31, 1997.
Other Income. Other income totaled $583,000 for the year ended December
31, 1998, a decrease of 17.7 %, from $708,000 for the year ended December 31,
1997. The decrease was attributable primarily to a decrease in gain on sale of
loans which decreased 63.9 % to $63,000 for the year ended December 31, 1998
from $175,000 for the year ended December 31, 1997.
Other Expenses. Other expenses for the year ended December 31, 1998
were $1.9 million, an increase of 9.6% from $1.7 million for the year ended
December 31, 1997, primarily reflecting an increase in employee compensation and
benefits which increased 12.7% to $915,000 for the year ended December 31, 1998
from $812,000 for the prior year. The increase reflects the cost of increased
staffing levels to accommodate growth in First Savings' customer base and normal
wage increases for existing personnel.
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<PAGE>
Expenses for premises and equipment increased 23.5% to $189,000 for the
year ended December 31, 1998 from $153,000 for the year ended December 31, 1997.
Other expenses increased 8.7% from $449,000 in 1997 to $488,000 in
1998, due to increases associated with the normal growth of First Savings.
Liquidity and Capital Resources
First Savings' principal sources of funds are deposits, loan
repayments, proceeds from the sale of securities and loans, repayments from
mortgage-backed securities, FHLB advances, other borrowings and retained income.
At December 31, 1999, First Savings had $11.6 million of undisbursed
loan funds. The amount of certificate of deposit accounts maturing in calendar
year 2000 is $28.3 million. It is anticipated that funding requirements for
these commitments can be met from the normal sources of funds previously
described.
First Savings is subject to regulations of the Office of Thrift
Supervision that impose certain minimum regulatory capital requirements. Under
current Office of Thrift Supervision regulations, these requirements are (a)
leverage capital of 4.0% of adjusted tangible assets; (b) tier I capital of 4%
of risk-weighted assets; (c) tier I and II capital of 8% of risk-weighted
assets. At December 31, 1999, First Savings' capital ratios were 6.8% leverage
capital, 11.7% tier I capital, and 13.0% 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 First Savings are monetary in nature. As a
result, interest rates have a more significant impact on First Savings'
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.
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CHAPTER V
MANAGEMENT FOLLOWING THE MERGER
The Board of Directors
The Southern Financial board of directors currently is comprised of 12
members. The board of directors is divided into three classes, each of which
consists of three members. These directors serve, and will continue to serve
following the merger, for the terms of their respective classes, which expire in
2001, 2002 and 2003.
The merger agreement requires that Southern Financial increase the size
of the board to 13 members and appoint Barbara J. Fried, Chairman of First
Savings, to the board of Southern Financial.
The following table sets forth the composition of the board of
directors following the merger.
<TABLE>
<CAPTION>
Class I Class II Class III
(Term Expiring in 2002) (Term Expiring in 2003) (Term Expiring in 2001)
<S> <C> <C>
Alfonso G. Finocchiaro John C. Belotti Fred L. Bollerer
Virginia Jenkins Neil J. Call Georgia S. Derrico
Michael P. Rucker David de Give John L. Marcellus, Jr.
Robert P. Warhurst R. Roderick Porter Richard E. Smith
Barbara J. Fried*
</TABLE>
_____________________
* First Savings director
The following paragraphs set forth certain information, as of April 30,
2000, for the 13 individuals who are expected to serve as directors of Southern
Financial following the consummation of the merger. Unless otherwise indicated,
each director has held his or her current position for more than five years.
Class I
(Term Expiring in 2002)
Alfonso G. Finocchiaro, 67, was Executive Vice President, Regional
General Manager and CEO (Americas) of Banco Portugues do Atlantico from 1978 to
until his retirement in 1997. Mr. Finocchiaro has served as a director of
Southern Financial since April 1999.
Virginia Jenkins, 52, is the owner of V. Jenkins Interiors and Antiques
in Middleburg, Virginia. Ms. Jenkins has served as a director of Southern
Financial since 1988.
Michael P. Rucker, 59, is an executive with Caterpillar, Inc., a
manufacturing company in Peoria, Illinois and serves as Chairman of the Board of
George H. Rucker Realty Corp., a real estate development company in Fairfax,
Virginia. Mr. Rucker has served as a director of Southern Financial since 1991.
Robert P. Warhurst, 61, is President and co-owner of Merrifield Garden
Center in Merrifield and Fairfax, Virginia. Previously he was a founding
director of the former Horizon Bank of Virginia which merged to join Southern
Financial Bank on October 1, 1999.
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Class II
(Term Expiring in 2003)
John C. Belotti, 63, is President and co-owner of Bee & H Electric
Company in Fairfax, Virginia. Previously he was a founding director of the
former Horizon Bank of Virginia, also serving as Vice Chairman of the Board
since 1998, which merged to join Southern Financial Bank on October 1, 1999.
Neil J. Call, 66, has been Executive Vice President of MacKenzie
Partners, Inc., a New York financial consulting company, since 1990. Mr. Call
has served as a director of Southern Financial since 1986.
David de Give, 57, has been Senior Vice President of Southern Financial
since 1992. Mr. de Give has served as a director of Southern Financial since
1986.
R. Roderick Porter, 55, has been President and Chief Operating Officer
of Southern Financial since April 1998. From 1994 to 1998, he was President of
FX Concepts, Ltd., an international money management firm in New York, New York.
Mr. Porter has served as a director of Southern Financial since 1986.
Class III
(Term Expiring in 2001)
Fred L. Bollerer, 58, has been President and Chief Executive Officer of
the Potomac Knowledge Way Project, a not for profit leadership organization
company in Herndon, Virginia, since January 1998. From 1993 to 1997, he was
President and Chief Executive Officer of Riggs Bank, N.A. in Washington, D.C.
Mr. Bollerer has served as a director of Southern Financial since April 1999.
Georgia S. Derrico, 55, has been Chairman of the Board and Chief
Executive Officer of Southern Financial since 1986. Ms. Derrico has also served
as a director of Southern Financial since 1986.
John L. Marcellus, Jr., 77, is the retired President and Chairman of
the Board of Oneida, Ltd., a silverware manufacturing company in Oneida, New
York. Mr. Marcellus has served as a director of Southern Financial since 1986.
Richard E. Smith, 74, Retired Colonel U.S. Marine Corps, is CEO and
Chairman MANNA Financial Services, which he founded in 1961. Previously he was a
founding director and Chairman of the Board for the former Horizon Bank of
Virginia which merged to join Southern Financial on October 1, 1999. Mr. Smith,
a former director with Guaranty Bank & Trust Co. and Riggs National Bank of
Virginia is also owner of Reed Insurance Agency.
Barbara J. Fried, 65, has been Chairman of the Fried Companies, Inc., a
real estate development and management company based in Springfield, Virginia,
since 1985. Ms. Fried is also Chairman of the Board of First Savings.
Senior Officers of Southern Financial Who Are Not Directors
William H. Stevens, 55, joined Southern Financial in 1999 as Executive
Vice President, Risk Management. From 1991 to 1999, Mr. Stevens served as a
Senior Analyst in the Office of the Inspector General of The Federal Deposit
Insurance Corporation. Prior to that he was an Executive Vice President at Riggs
Bank, N.A. in Washington, D.C. where he managed the bank's commercial real
estate and single
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family lending activities. Before that, Mr. Stevens was President and COO of
Anchor Mortgage Services and he was a Senior Vice President at Chemical Bank
from 1983 to 1987.
Patricia A. Ferrick, 37, joined Southern Financial in 2000 as Senior
Vice President/Chief Financial Officer. Ms. Ferrick recently served as Managing
Director, Controller of National Cooperative Bank. Prior to that, she was Vice
President/ Controller for First Commonwealth Savings Bank and its subsidiary,
James Madison Mortgage. Before that she served as Vice President, Controller for
NVR Savings Bank and she was an auditor at KPMG LLP from 1985 to 1989.
Richard P. Steele, 53, joined Southern Financial in 1999 as Senior Vice
President, Special Projects. From 1993 to 1999, Mr. Steele was Senior Vice
President of FX Concepts, Inc., an international money management firm based in
New York. Prior to that, Mr. Steele was Director of Finance, Eli Lilly and
Company, Geneva from 1989 to 1993.
Security Ownership of Management
The following table sets forth, based on information as of April 30,
2000, the beneficial ownership of Southern Financial common stock, the
beneficial ownership of First Savings common stock and the anticipated
beneficial ownership, after giving effect to the merger, of Southern Financial
common stock by each director of Southern Financial and First Savings and by
each person named in the "Summary Compensation Table" on page 85.
<TABLE>
<CAPTION>
Ownership Before Ownership After
the Merger the Merger
---------- ----------
Southern Financial
Common Stock
------------
Southern Financial First Savings Number Percent
Common Stock (1) Common Stock of Shares of Class (%)
---------------- ------------ --------- ------------
Southern Financial Directors:
<S> <C> <C>
Fred L. Bollerer * 3,000 -- 3,000 **
Neil J. Call * 43,297 (2) -- 43,297 1.4
David de Give * 86,187 (3) -- 86,187 2.8
Georgia S. Derrico * 269,630 (4) -- 269,630 8.5
Alfonso G. Finocchiaro * 7,292 -- 7,292 **
Virginia Jenkins * 2,275 -- 2,275 **
John L. Marcellus, Jr. * 15,808 (5) -- 15,808 **
R. Roderick Porter * 269,630 (4) -- 269,630 8.5
Michael P. Rucker * 45,871 (6) -- 45,871 1.5
John C. Belotti * 26,370 -- 26,370 **
Robert P. Warhurst * 15,606 (7) -- 15,606 **
Richard E. Smith * 28,974 -- 28,974 **
All current Southern Financial
Directors and Executive
Officers as a group (12 Persons) 544,310 -- 544,310 16.8
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Ownership Before Ownership After
the Merger the Merger
---------- ----------
Southern Financial
Common Stock
------------
Southern Financial First Savings Number Percent
Common Stock (1) Common Stock of Shares of Class (%)
---------------- ------------ --------- ------------
First Savings Directors:
<S> <C> <C> <C> <C>
William A. Beverly -- 100 44 **
Thomas W. Bradford -- 100 44 **
Jeffrey C. Constantz -- 27,650 (8) 12,166 **
Barbara J. Fried * -- 353,778 (9) 155,662 5.1
Steven I. Nadler -- 400 (10) 176 **
Fred B. Rankin -- 3,500 (11) 1,540 **
Adam M. Fried -- 15,000 6,600 **
Edward N. Frye -- 200 88 **
All current First Savings Directors
and Executive Officers as a
group (9 persons) -- 408,787 179,865 5.8
All post-merger Southern Financial
Directors and Executive Officers as
a group (13 persons) 699,972 21.6
</TABLE>
__________________
* Director of Southern Financial following the consummation of the merger.
** Percentage of ownership will be less than one percent of the outstanding
shares of Southern Financial common stock.
(1) The amounts in this column include shares of Southern Financial common
stock with respect to which certain persons have the right to acquire
beneficial ownership within sixty days after April 30, 2000, pursuant to
Southern Financial's 1993 Stock Option and Incentive Plan, as amended: Mr.
de Give: 46,403 shares; Ms. Derrico: 97,176 shares; Mr. Porter: 25,000; and
the directors and officers as a group: 168,579 shares.
(2) Includes 36,331 shares of Southern Financial common stock and 4,354 shares
of Southern Financial convertible preferred stock.
(3) Includes 2,412 shares owned by Mr. de Give's spouse over which she has sole
voting and investment power.
(4) Includes (a) 85,188 shares owned individually by Ms. Derrico over which she
has sole voting and investment power and 109,676 shares that Ms. Derrico
may acquire pursuant to the exercise of stock options; (b) 25,404 shares of
Southern Financial common stock and 4,039 shares of Southern Financial
convertible preferred stock owned individually by Mr. Porter over which he
has sole investment power and 37,500 shares that Mr. Porter may acquire
pursuant to the exercise of stock options; and (c) 5,400 shares owned
jointly by Ms. Derrico and Mr. Porter over which they have joint investment
power. Ms. Derrico and Mr. Porter disclaim beneficial ownership of each
other's shares.
(5) Includes 13,427 shares of Southern Financial common stock and 2,221 shares
of Southern Financial convertible preferred stock.
(6) Includes 12,155 shares of Southern Financial common stock and 991 shares of
Southern Financial convertible preferred stock owned by Michael Rucker,
5,973 shares of Southern Financial common stock and 2,402 shares of
convertible preferred stock owned by Derek Rucker, 2,000 shares of Southern
Financial common stock owned by David Dodrill, 200 shares of Southern
Financial common stock owned by Helen M. Jones and 20,115 shares of
Southern Financial common stock owned by Rucker Realty Corp. and persons
associated with Rucker Realty Corp. and Rucker Realty Retirement Trust.
Southern Financial makes no representation as to whether any of these
persons, individually or in any combination, share voting or investment
power with any other or with Rucker Realty with respect to their shares.
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<PAGE>
(7) Includes 7,512 shares owned individually by Robert P. Warhurst, 6,694
shares owned jointly by Robert R. Warhurst and Billie S. Warhurst, and
1,400 shares owned by Merrifield Garden Center 401K Plan. Robert P.
Warhurst is co-owner of Merrifield Garden Center.
(8) Includes options to purchase 10,000 shares of First Savings common stock.
(9) Includes 295,465 shares of First Savings common stock owned by Ms. Fried's
spouse over which he has sole voting and investment power.
(10) Includes 300 shares of First Savings common stock owned jointly with his
spouse.
(11) Includes 3,400 shares of First Savings common stock held in the Fred B.
Rankin Trust.
Security Ownership of Certain Beneficial Owners
The following table sets forth, to the knowledge of Southern Financial
and First Savings and based on information as of April 30, 2000, (i) the
beneficial ownership of each person who owns more than five percent of the
outstanding shares of Southern Financial common stock or First Savings common
stock and (ii) the anticipated beneficial ownership of each person expected to
own more than five percent of the outstanding shares of Southern Financial
common stock after giving effect to the merger.
<TABLE>
<CAPTION>
Ownership of Southern Financial Ownership of Southern Financial
Common Stock Before the Merger Common Stock After the Merger
------------------------------ -----------------------------
Number Percent Number Percent
of Shares (1) Of Class (%) of Shares of Class (%)
------------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Georgia S. Derrico (2), (3) 269,630 9.7 269,630 8.5
R. Roderick Porter
2954 Burrland Lane
The Plains, Virginia 20171
Financial Institution Partners II, L.P. (4) 255,350 9.6 255,350 8.3
Hovde Capital, L.L.C.
Eric D. Hovde
Steven D. Hovde
1824 Jefferson Place, N.W.
Washington, D.C. 20036
</TABLE>
<TABLE>
<CAPTION>
Ownership of First Savings Ownership of Southern Financial
Common Stock Before the Merger Common Stock After the Merger
------------------------------ -----------------------------
Number Percent Number Percent
of Shares (1) Of Class (%) of Shares of Class (%)
------------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Barbara J. Fried (5) 353,778 38.0 155,662 5.1
6551 Loisdale Court, Suite 900
Springfield, Virginia 22150
</TABLE>
_________________
(1) Except as otherwise indicated, includes shares held directly, as well as
shares held in retirement accounts or by certain family members or
corporations over which the named individuals may be deemed to have voting
or investment power.
(2) Georgia S. Derrico and R. Roderick Porter are married to each other.
(3) Includes (a) 85,188 shares owned individually by Ms. Derrico over which she
has sole voting and investment power and 109,676 shares that Ms. Derrico
may acquire pursuant to the exercise of stock options; (b) 25,404 shares of
Southern Financial common stock and 4,039 shares of Southern Financial
convertible preferred stock owned individually by Mr. Porter over which he
has sole investment power and
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37,500 shares that Mr. Porter may acquire pursuant to the exercise of stock
options; and (c) 5,400 shares owned jointly by Ms. Derrico and Mr. Porter
over which they have joint investment power. Ms. Derrico and Mr. Porter
disclaim beneficial ownership of each other's shares.
(4) As reported in a Schedule 13D filed with the Securities and Exchange
Commission on May 26, 2000 by Financial Institution Partners II, L.P.,
Hovde Capital, L.L.C., Eric D. Hovde and Steven D. Hovde. According to the
Schedule 13D, Hovde Capital, L.L.C., as General Partner of Financial
Institution Partners II, L.P., and Eric D. Hovde and Steven D. Hovde, as
managing members of Hovde Capital, L.L.C., may be deemed to have shared
voting and investment powers over all such shares.
(5) Includes 295,465 shares of First Savings common stock owned by Ms. Fried's
spouse over which he has sole voting and investment power.
Director Compensation
Each member of the board who was not an employee of Southern Financial
or any of its subsidiaries is paid $500 for attendance at each board meeting and
$150 for attendance at each meeting of a committee of the board of which he or
she is a member. Directors are not compensated for meetings conducted by
teleconference. In addition, each director is paid an annual fee of $4,000.
Employee members of the board are not paid separately for their service on the
board or its committees.
Executive Officer Compensation
The following table presents information concerning the compensation of
Ms. Derrico and Mr. Porter. This table presents compensation for services
rendered in all capacities to Southern Financial by Ms. Derrico and Mr. Porter
in 1999, 1998 and 1997.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------- ----------------------
Securities
Name and Other Annual Underlying All Other
Principal Position Year Salary Bonus Compensation (1) Options (#) Compensation (2)
------------------ ---- ------ ----- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 1999 $195,000 $240,000 -- 10,000 $4,800
Chairman of the Board and 1998 193,226 200,000 -- 10,000 4,800
Chief Executive Officer 1997 175,000 175,000 -- 10,000 4,500
R. Roderick Porter (3) 1999 $175,000 $72,000 -- 15,000 $4,800
President and Chief 1998 100,000 -- -- 10,000 2,505
Operating Officer
</TABLE>
_______________
(1) None of the named executive officers received Other Annual Compensation in
excess of the lesser of $50,000 or 10% of combined salary and bonus for the
years indicated.
(2) The amounts set forth in this column constitute matching contributions by
Southern Financial to Southern Financial's 401(k) plan.
(3) Mr. Porter joined Southern Financial on April 1, 1998.
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<PAGE>
Stock Options
Option Grants in Last Fiscal Year. The following table sets forth for
the year ended December 31, 1999, the grants of stock options to each of the
executive officers named in the "Summary Compensation Table."
Option Grants in Year Ended December 31, 1999
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants(1) Option Term
-------------------------------------------------------------------- ------------------------
Percent of
Number of Total Options
Securities Granted to
Underlying Employees in Exercise or
Options Fiscal Year Base Price Expiration
Name Granted (#) (%)(2) ($/Share) Date 5% ($) 10% ($)
---- ----------- ------ --------- ---- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 10,000 10.87 21.00 2/2/09 342,068 544,686
R. Roderick Porter 15,000 16.30 21.00 2/2/09 513,102 817,029
</TABLE>
______________
(1) Stock options were awarded at the fair market value of the shares of
Southern Financial common stock at the date of award and are exercisable
after February 2, 2000.
(2) Options to purchase 92,000 shares of Southern Financial common stock were
granted to Southern Financial's employees during the year ended December
31, 1999.
Option Exercises in Last Fiscal Year. The following table sets forth
information concerning each exercise of stock option during the fiscal year
ended December 31, 1999 by each of the executive officers named in the "Summary
Compensation Table" and the year end value of unexercised options.
Aggregated Option Exercises in Year Ended December 31, 1999
and Fiscal Year End Option Values
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options In-The-Money Options
at December 31, 1999 (#)(1) at December 31, 1999 ($)(2)
--------------------------- ---------------------------
Shares
Acquired on Value
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 4,840 34,848 87,176 10,000 368,786 (3)
R. Roderick Porter -- -- 10,000 15,000 (3) (3)
</TABLE>
______________
(1) Each of these options relates to Southern Financial common stock.
(2) These values are based on $16.50, the closing price of Southern Financial
common stock on December 31, 1999.
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<PAGE>
(3) None of the indicated options held by the named executive officers were
in-the-money as of December 31, 1999.
Employment Agreements
Ms. Derrico has an employment agreement with Southern Financial. The
agreement has a term of five years and will be extended for an additional year
three times, beginning on December 31, 2000. Ms. Derrico's employment agreement
provides that she will serve as the Chairman and Chief Executive Officer of
Southern Financial at an annual base salary of $195,000. Base salary increases
and bonuses will be in the discretion of the Board of Directors. Under the
employment agreement, Ms. Derrico will be entitled to participate in employee
benefit plans, including Southern Financial's stock option plans, on the same
basis as other employees of senior executive status. If Southern Financial
terminates Ms. Derrico's employment without cause, or if Ms. Derrico resigns for
"good reason" during the contract term, she will be entitled to salary and
benefits for the remainder of the contract term and an amount equal to three
times the highest bonus paid to her during the three calendar years that precede
the date her employment terminates. Under the employment agreement, "good
reason" entitling Ms. Derrico to resign includes a change or reduction in Ms.
Derrico's authority; a reduction in base salary, as the same may have been
increased from time to time; the failure of Southern Financial to provide her
with substantially the same fringe benefits that have been provided heretofore;
the failure of a successor corporation to assume Southern Financial's
obligations under the employment agreement; a failure to nominate her for
re-election to the Board of Directors; or a material breach of the Employment
Agreement by Southern Financial. No additional compensation is payable to Ms.
Derrico if there is a change of control of Southern Financial.
At any time after December 31, 2002, Ms. Derrico may resign and
continue to receive her salary for sixty months, provided she agrees to remain
Chairman of the Board of Directors and does not engage in any competitive
business.
Under the employment agreement, Ms. Derrico would not be entitled to
any further compensation or benefits if Southern Financial terminated the
employment agreement for cause. Cause includes personal dishonesty,
incompetence, willful misconduct, breach of fiduciary duty involving personal
profit, intentional failure to perform stated duties, willful violation of any
law, rule or regulation (other than traffic violations or similar offenses that
have no material detrimental effect on Southern Financial) or final cease and
desist order, or a material breach of any provision of the employment agreement.
Certain Relationships and Related Transactions
Georgia S. Derrico, Chairman of the Board and Chief Executive Officer
and a director of Southern Financial, and R. Roderick Porter, President and
Chief Operating Officer and a director of Southern Financial, are married to
each other.
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<PAGE>
CHAPTER VI
LEGAL MATTERS
DESCRIPTION OF SOUTHERN FINANCIAL CAPITAL STOCK
Common Stock
Voting Rights. Each share of Southern Financial common stock entitles
the holder thereof to one vote on all matters voted on by shareholders. The
shares of Southern Financial common stock do not have cumulative voting rights,
which means that the holders of more than 50% of the shares of Southern
Financial common stock voting for the election of directors can elect all of the
directors, in which event the holders of the remaining shares of Southern
Financial common stock will not be able to elect any of the directors.
Dividend Rights. Holders of Southern Financial common stock are
entitled to receive dividends when, as and if declared by the board of directors
out of funds legally available for the payment of dividends.
Liquidation Rights. Subject to the rights of holders of Southern
Financial preferred stock, upon any liquidation, dissolution or winding up of
the affairs of the Southern Financial, holders of Southern Financial common
stock are entitled to receive pro rata all of the assets of the Southern
Financial for distribution to shareholders.
Assessment and Redemption. Shares of Southern Financial common stock
presently outstanding are validly issued, fully paid and nonassessable. There is
no provision for any voluntary redemption of the Southern Financial common
stock.
Other. Holders of Southern Financial common stock have no subscription,
sinking fund, conversion or preemptive rights.
Preferred Stock
Each share of Southern Financial preferred stock has a liquidation
preference over junior shares of Southern Financial stock, including the
Southern Financial common stock, of $14.50 plus any accrued and unpaid dividends
and bears an annual dividend at the rate of six percent. Dividends are
cumulative and payable quarterly if, as and when declared by the board of
directors from funds legally available therefore. Southern Financial preferred
stock is convertible, at the option of the holder, into 1.466 shares of Southern
Financial common stock, subject to adjustment in certain events.
Except as indicated below or as provided by applicable law, the holders
of the Southern Financial preferred stock are not entitled to vote. Such holders
do have the right as a class to elect two directors whenever dividends payable
on the Southern Financial preferred stock are in arrears in an aggregate amount
equal to six quarterly dividends. Currently, there are no preferred stock
dividends in arrears. Such right continues until such time as the dividends
accumulated on the preferred stock have been paid in full, at which time such
right terminates (subject to renewal and divestment from time to time upon the
same terms and conditions), and the directors so elected by the holders of the
preferred stock shall cease to be directors. In addition, Southern Financial may
not, directly or indirectly or through merger or consolidation with any other
corporation, without the consent of the holders of at least two-thirds of the
holders of preferred stock then outstanding (voting separately as a class) (i)
create any class of stock ranking prior to the preferred stock in rights and
preferences or (ii) amend, alter or repeal any of the
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<PAGE>
specific terms of the Southern Financial preferred stock so as to materially and
adversely affect such specific terms.
COMPARATIVE RIGHTS OF SHAREHOLDERS
General
Southern Financial and First Savings are corporations subject to the
provisions of the Virginia Stock Corporation Act. Rights as a shareholder of
First Savings are governed by First Savings' articles of incorporation and
bylaws and by the Virginia Stock Corporation Act. Upon consummation of the
merger, First Savings shareholders will become shareholders of Southern
Financial, and as such shareholder rights will then be governed by the articles
of incorporation and bylaws of Southern Financial and by the Virginia Stock
Corporation Act.
The following is a summary of the material differences in the rights of
shareholders of First Savings and Southern Financial. This summary is qualified
in its entirety by reference to the articles of incorporation and bylaws of
Southern Financial and First Savings and to the Virginia Stock Corporation Act.
Authorized Capital
First Savings. First Savings' articles of incorporation authorize the
issuance of up to 12,000,000 shares of First Savings common stock, par value
$1.00 per share, of which 931,605 shares were issued and outstanding as of April
30, 2000.
Southern Financial. Southern Financial's articles of incorporation
authorize the issuance of up to 5,000,000 shares of Southern Financial common
stock, par value $0.01 per share, of which 2,656,196 shares were issued and
outstanding as of April 30, 2000, and 500,000 shares of preferred stock, $0.01
par value, of which 13,621 shares were issued and outstanding as of April 30,
2000. Southern Financial's articles of incorporation authorize the Southern
Financial board, without shareholder approval, to fix the preferences,
limitations and relative rights of the preferred stock and to establish series
of such preferred stock and determine the variations between each series. If any
additional shares of preferred stock are issued, the rights of holders of
Southern Financial common stock would be subject to the rights and preferences
conferred to holders of such preferred stock.
The authority to create and issue separate classes and series of
preferred stock allows a corporation greater flexibility in structuring
financings and acquisitions. While such issuances could, under certain
circumstances, be considered to have the effect of making a change in control
more difficult, any issuance of such stock would be subject to applicable law,
including, without limitation, the duty of the board of directors of Southern
Financial to exercise its good faith business judgment in the best interests of
Southern Financial and its shareholders. Under Southern Financial's articles of
incorporation, the board of directors of Southern Financial would be authorized
to issue a series of preferred stock with more than one vote, less than one
vote, no vote or one vote per share.
Southern Financial's ability to pay dividends is limited by
restrictions imposed by the Virginia Stock Corporation Act on Virginia
corporations. In general, dividends paid by a Virginia corporation may be paid
only if, after giving effect to the distribution, (i) the corporation is still
able to pay its debts as they become due in the usual course of business, or
(ii) the corporation's total assets are greater than or equal to the sum of its
total liabilities plus (unless the corporation's articles of incorporation
permit otherwise) the amount that would be needed, if the corporation were to be
dissolved at the time of the
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distribution, to satisfy the preferential rights, upon the dissolution, of
shareholders whose preferential rights are superior to those receiving the
distribution.
Dividends on the Southern Financial preferred stock are cumulative,
which means that no dividends may be declared or paid on the common stock unless
all dividends accrued on the preferred stock have been paid, or declared and a
sum sufficient for the payment thereof set apart for such payment. In 1999,
Southern Financial paid $11,852 in preferred stock dividends.
Amendment of Articles of Incorporation or Bylaws
The Virginia Stock Corporation Act provides that an amendment to a
corporation's articles of incorporation must be approved by each voting group
entitled to vote on the proposed amendment. Under Virginia law, an amendment to
the corporation's articles of incorporation must be approved by more than
two-thirds of all votes entitled to be cast by that voting group. However, the
corporation's articles of incorporation may require a greater vote or a lesser
vote, which may not be not less than a majority, by each voting group entitled
to vote on the transaction. A corporation's board of directors may require a
greater vote.
First Savings. The First Savings Articles do not address amendments, so
First Savings is governed by the provisions of the Virginia Stock Corporation
Act. Accordingly, amendments to First Savings' Articles of Incorporation must be
approved by two-thirds of all votes entitled to be cast by each voting group.
First Savings' Bylaws provide that the Bylaws may be amended by
two-thirds of the full Board of Directors or by a majority of the votes cast by
the shareholders at any legal meeting called for that purpose.
Southern Financial. As noted above, amendments to the articles of
incorporation of Virginia corporations, such as Southern Financial, can be
submitted to the shareholders for a vote only by the board of directors.
Additionally, Virginia law provides, as a general rule, that an amendment to the
articles of incorporation must be approved by each voting group entitled to vote
on the proposed amendment by more than two-thirds of all votes entitled to be
cast by such voting group. However, Virginia law also permits the articles of
incorporation to provide for a greater or lesser vote. Southern Financial's
articles of incorporation contain such a provision. Southern Financial's
articles of incorporation provide that amendments must be approved by a majority
of the votes entitled to be cast by each voting group entitled to vote and,
unless such action is approved by at least two-thirds of the Continuing
Directors, by holders of at least two-thirds of the issued and outstanding
shares of Southern Financial common stock. The term "Continuing Director" is
defined in Southern Financial's articles of incorporation to mean (i) any
individual who was an initial director of Southern Financial or (ii) who has
been elected to the board of directors of Southern Financial at an annual
meeting of the shareholders of Southern Financial more than one time or (iii)
who has been elected to fill a vacancy on the board of directors of Southern
Financial and received the affirmative vote of a majority of the Continuing
Directors then on the board of directors and thereafter elected to the board of
directors at an annual meeting of shareholders at least one time.
In the past, the board of directors has acted by a consensus of all
directors on matters of importance and it expects to continue to do so. However,
any significant disagreement among the Continuing Directors on a proposed
amendment to the articles of incorporation likely would indicate that there are
substantial arguments to be made both for and against such amendment. For that
reason, the articles of incorporation effectively require that in such a
situation the matter either receives the support of a large majority of the
shares of Southern Financial common stock, or it would not be adopted. Under
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Virginia law and the articles of incorporation and Southern Financial's bylaws,
a proposed amendment to Southern Financial's articles of incorporation may be
submitted to the shareholders by a vote of a majority of the board of directors.
However, if more than one-third of the Continuing Directors of Southern
Financial did not support a proposed amendment by voting to submit it to the
shareholders, the amendment would fail unless it is approved by a majority of
the votes entitled to be cast by each voting group entitled to vote and by
holders of two-thirds of the issued and outstanding shares of Southern Financial
common stock. At this time all of the directors of Southern Financial, except
Messrs. Bollerer and Finocchiaro, are Continuing Directors.
In the future, a person who is not a director of Southern Financial
today, including each First Savings director who will become a Southern
Financial director, will not become a Continuing Director unless he or she is
elected by the shareholders at an annual meeting more than one time, or is
elected to fill a vacancy on the board of directors by a majority of the
Continuing Directors and thereafter is elected by the shareholders at an annual
meeting at least one time. Continuing Directors are intended to be those
individuals who have been involved with Southern Financial through the years,
and who therefore provide continuity and an in-depth knowledge of the business
affairs of Southern Financial. In the context of a hostile or unfriendly attempt
to acquire or exercise control over Southern Financial, an individual elected to
the board of directors by a person or persons attempting to acquire control
would not become a Continuing Director until he or she is elected to the board
of directors at least twice. While directors elected by a person attempting to
acquire control of Southern Financial might be able to submit a proposed
amendment to the shareholders for a vote, unless at least two-thirds of the
Continuing Directors (who could comprise a minority of the entire board of
directors) approved the action, the additional voting requirement assures that
the action would not be taken if it is opposed by a significant percentage (more
than one-third) of the issued and outstanding shares of Southern Financial
common stock. See "Security Ownership of Management" on page 82 for a
description of the percentage of the outstanding shares of the common stock held
by directors and executive officers.
The provisions that govern the vote required to amend Southern
Financial's articles of incorporation would make it more difficult for a
shareholder, or group of shareholders, who are dissatisfied with incumbent
management to amend the articles of incorporation and after gaining control of
the board of directors, which could discourage such a shareholder or group from
attempting to gain control of the board.
The voting requirements described above are intended to ensure that
amendments to the articles of incorporation and certain bylaw provisions of
Southern Financial are favored by a majority of the outstanding shares of each
voting group entitled to vote and by either two-thirds of Continuing Directors
or holders of a large majority of the shares of Southern Financial common stock.
Southern Financial's bylaws generally may be amended by either the
board of directors or the shareholders by a majority vote.
Mergers, Consolidations and Sales of Assets
First Savings. The Articles of Incorporation of First Savings do not
specify the vote required to enter into a merger, a share exchange or a direct
or indirect sale, lease, exchange or other disposition of all or substantially
all of the property of First Savings. Accordingly, the vote required for such a
transaction is the vote specified in the Virginia Stock Corporation Act, which
is the affirmative vote of holders of more than two-thirds of the issued and
outstanding shares of First Savings common stock.
Southern Financial. Southern Financial's articles of incorporation
provide that a plan of merger or share exchange or a direct or indirect sale,
lease, exchange or other disposition of all or substantially all
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of the property of Southern Financial not in the ordinary course of business may
be approved by the same vote that is required in order to amend the articles of
incorporation. Additionally, consistent with Virginia law, the board of
directors of Southern Financial may condition its submission of such plan of
merger or share exchange or such a sale or disposition of assets to the
shareholders on any basis, including the requirement of a greater vote than the
required vote described above. The reasons that Southern Financial's articles of
incorporation provide for an alternative vote on mergers, share exchanges and
certain sales, leases, exchanges or dispositions of assets are the same reasons
that the articles of incorporation provide for an alternative vote to amend the
articles of incorporation. In many situations, the effect of the provisions in
the articles of incorporation that govern amendments to the articles of
incorporation, mergers and share exchanges and certain dispositions of assets,
would be to make it easier for the board of directors to gain shareholder
approval of such actions than would be the case if a favorable vote of
two-thirds of the outstanding shares were required in all cases.
A proposed merger, share exchange or sale of substantially all assets
of Southern Financial that is favored by two-thirds of the Continuing Directors
could be adopted as long as a majority (rather than two-thirds) of the
outstanding shares entitled to vote in each voting group entitled to vote are
voted in favor of the proposed action. In addition to requiring the affirmative
vote of a majority of the shares entitled to vote in each voting group entitled
to vote, Southern Financial's articles of incorporation would require that,
unless a proposed action is approved by at least two-thirds of the Continuing
Directors, holders of at least two-thirds of the issued and outstanding shares
of Southern Financial common stock must vote in favor of the proposed action.
The purpose of such additional requirement is to ensure that if a proposed major
corporate action does not have the support of a board of directors who can
provide continuity to and an in-depth knowledge of the business of Southern
Financial, the action must be supported by a large majority of the holders of
Southern Financial common stock.
As with amendments to the articles of incorporation, however, if at
least two-thirds of the Continuing Directors of Southern Financial do not
approve such corporate action upon which shareholders are voting, the additional
requirement would permit a minority of the holders of Southern Financial common
stock to defeat the proposed action.
Size and Classification of Board of Directors
First Savings. First Savings' Bylaws provide for a board of directors
consisting of not less than seven or more than fifteen individuals of a single
class. Directors are elected annually and serve until their successors are
elected and qualified.
Southern Financial. Southern Financial's bylaws provide that its board
of directors shall consist of a minimum of five and a maximum of 15 individuals.
Southern Financial's bylaws provide further, subject to the rights of holders of
any series of preferred stock, for the division of the directors into three
classes, consisting, as nearly as may be possible, of one-third of the total
number of directors constituting the entire board of directors. At each annual
meeting of shareholders, successors to the class of directors whose term expires
at that annual meeting are elected for a three-year term. If the number of
directors has changed, any increase or decrease shall be apportioned among the
classes so as to maintain the number of directors in each class as nearly equal
as possible, but in no case will a decrease in the number of directors shorten
the term of any incumbent director. A director shall hold office until the
annual meeting for the year in which his or her term expires and until his or
her successor shall be elected and shall qualify, subject, however, to prior
death, resignation, retirement, disqualification or removal from office.
A classified board of directors makes it more difficult for
shareholders, including those holding a majority of shares, to force an
immediate change in the composition of a majority of the board of directors,
even when the reason for a proposed removal is poor performance. Since the terms
of only
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approximately one-third of Southern Financial's directors expire each year, it
requires at least two annual elections for the shareholders to change a
majority, whereas a majority of a non-classified board may be changed in one
year.
Vacancies and Removal of Directors
First Savings. First Savings' Bylaws provide that shareholders may
remove any Director with or without cause by a vote of the majority of the
shares then entitled to vote in the election of Directors. A director may not be
removed if the number of votes sufficient to elect him or her under cumulative
voting is voted against his or her removal.
Southern Financial. Under Southern Financial's articles of
incorporation, newly created directorships resulting from any increase in the
number of directors and any vacancies on the board of directors resulting from
death, resignation, disqualification, removal or other cause, can be filled only
by the affirmative vote of the majority of the remaining directors then in
office, even if that number is less than a quorum of the board of directors.
This provision would enable incumbent directors to fill vacancies on the board
of directors of Southern Financial to the exclusion of Southern Financial's
shareholders, regardless of the reason for the vacancy.
Southern Financial's articles of incorporation allow removal of
director from office, with or without cause, only if at least two-thirds of the
votes cast are cast in favor of removal. Shareholders of Southern Financial may
not call a special meeting for the purpose of removing a director. In the
context of a takeover attempt these provisions likely would require a hostile
party to prevail at two consecutive annual meetings of Southern Financial in
order to acquire control of the board of directors.
The provisions of Southern Financial's articles of incorporation
relating to the removal of directors and the filling of vacancies would preclude
a holder of a majority of the voting stock from removing incumbent directors and
simultaneously gaining control of the board of directors by filling the
vacancies so created with its own nominees. Accordingly, except with the
concurrence of a majority of the directors remaining in office, persons seeking
representation either by enlarging the board of directors or by filling the
newly created directorships with their own nominees. Since only approximately
one-third of Southern Financial's directors are elected at any one annual
meeting, any hostile bidder, in the context of a takeover attempt, would have to
prevail at two consecutive annual meetings in connection with director elections
in order to replace a majority of the directors of Southern Financial.
Director Liability and Indemnification
The Virginia Stock Corporation Act provides that in any proceeding
brought by or in the right of a corporation or brought by or on behalf of
shareholders of the corporation, the damages assessed against an officer or
director arising out of a single transaction, occurrence or course of conduct
may not exceed the lesser of (1) the monetary amount, including the elimination
of liability, specified in the articles of incorporation or, if approved by the
shareholders, in the bylaws as a limitation on or elimination of the liability
of the officer or director; or (2) the greater of (a) $100,000 or (b) the amount
of cash compensation received by the officer or director from the corporation
during the twelve months immediately preceding the act or omission for which
liability was imposed. The liability of an officer or director is not limited
under the Virginia Stock Corporation Act or a corporation's articles of
incorporation and bylaws if the officer or director engaged in willful
misconduct or a knowing violation of the criminal law or of any federal or state
securities law.
In addition, the Virginia Stock Corporation Act permits a Virginia
corporation to indemnify any director or officer for reasonable expenses
incurred in any legal proceeding in advance of final disposition
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of the proceeding, if the director or officer furnishes the corporation a
written statement of his or her good faith belief that he or she has conducted
himself or herself in good faith and that he or she believed that his or her
conduct was in the best interests of the corporation, and a determination is
made by the board of directors that such standard has been met. In a proceeding
by or in the right of the corporation, no indemnification shall be made in
respect of any matter as to which an officer or director is adjudged to be
liable to the corporation, unless the court in which the proceeding took place
determines that, despite such liability, such person is reasonably entitled to
indemnification in view of all the relevant circumstances. In any other
proceeding, no indemnification shall be made if the director or officer is
adjudged liable to the corporation on the basis that personal benefit was
improperly received by him or her. Corporations are given the power to make any
other or further indemnity, including advancement of expenses, to any director
or officer that may be authorized by the articles of incorporation or any bylaw
made by the shareholders, or by any resolution adopted, before or after the
event, by the shareholders, except an indemnity against willful misconduct or a
knowing violation of the criminal law. Unless limited by its articles of
incorporation, indemnification of a director or officer is mandatory when he or
she entirely prevails in the defense of any proceeding to which he or she is a
party because he or she is or was a director or officer.
First Savings. First Savings' Bylaws provide that each director and
officer shall be indemnified by First Savings against liability (including
amounts paid in settlement) by reason of having been such a director or officer,
whether or not then continuing so to be, and against all expenses (including
counsel fees) reasonably incurred by him or her in connection therewith to the
fullest extent permitted by Virginia law, except such liabilities as are
incurred because of willful misconduct or a knowing violation of the criminal
law. The Bylaws eliminate the liability of First Savings Directors to First
Savings or its shareholders to the fullest extent permitted by Virginia law.
Southern Financial. To the fullest extent permitted by Virginia law,
Southern Financial's articles of incorporation require it to indemnify any
director or officer of Southern Financial who is made a party to any proceeding
because he or she was or is a director or officer of Southern Financial against
any liability, including reasonable expenses and legal fees, incurred in the
proceeding. Under Southern Financial's articles of incorporation, "proceeding"
is broadly defined to include pending, threatened or completed actions of all
types, including actions by or in the right of Southern Financial. Similarly,
"liability" is defined to include, not only judgments, but also settlements,
penalties, fines and certain excise taxes. Southern Financial's articles of
incorporation also provide that Southern Financial may, but is not obligated to,
indemnify its other employees or agents. The Southern Financial must indemnify
any person who is or was serving at the written request of Southern Financial as
a director, officer, employee or agent or agent of another corporation,
partnership, joint venture, trust or other enterprise, to the full extent
provided by Virginia law. The indemnification provisions also require Southern
Financial to pay reasonable expenses incurred by a director or officer of
Southern Financial in a proceeding in advance of the final disposition of any
such proceeding, provided that the indemnified person undertakes to repay
Southern Financial if it is ultimately determined that such person was not
entitled to indemnification. At this time, Virginia law does not permit
indemnification against willful misconduct or a knowing violation of the
criminal law.
The rights of indemnification provided in Southern Financial's articles
of incorporation are not exclusive of any other rights which may be available
under any insurance or other agreement, by vote of shareholders or disinterested
directors or otherwise. In addition, the articles of incorporation authorize
Southern Financial to maintain insurance on behalf of any person who is or was a
director, officer, employee or agent of Southern Financial, whether or not
Southern Financial would have the power to provide indemnification to such
person. The rights of indemnification provided to directors of Southern
Financial could reduce the likelihood of shareholder derivative actions and may
discourage other third
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party claims against the directors, even if such actions otherwise would be
beneficial to shareholders of Southern Financial.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling Southern
Financial pursuant to the foregoing provisions, Southern Financial has been
informed that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is therefor
unenforceable.
Special Meetings of Shareholders
First Savings. First Savings' Bylaws provide that special meetings of
shareholders may be held on the call of the Chairman of the Board, the
President, a majority of the board or holders of at least 20% of First Savings
common stock.
Southern Financial. Southern Financial's bylaws provide that special
meetings of shareholders may be held whenever called by the president, chairman
of the board of directors or by the board of directors, itself, which means that
the shareholders of Southern Financial do not have the right to call special
meetings. The inability of shareholders to call a special meeting could affect
changes in control of Southern Financial by delaying the presentation to
shareholders of proposals relating to, or facilitating, such a change in control
until the annual meeting.
Shareholder Nominations and Proposals
First Savings. First Savings' Bylaws do not prescribe procedures for
directors' nominations. It is the practice of First Savings for the board to
nominate directors for shareholders' consideration.
Southern Financial. Under Southern Financial's bylaws, notice of a
proposed nomination or a shareholder proposal meeting certain specified
requirements must be received by Southern Financial not less than 60 nor more
than 90 days prior to any meeting of shareholders called for the election of
directors, provided in each case that if fewer than 70 days' notice of the
meeting is given to shareholders, such written notice shall be received not
later than the close of the tenth day following the day on which notice of the
meeting was mailed to shareholders.
Southern Financial's bylaws require that the shareholder's notice set
forth as to each nominee (i) the name, age, business address and residence
address of such nominee, (ii) the principal occupation or employment of such
nominee, (iii) the class and number of shares of Southern Financial which are
beneficially owned by such nominee, and (iv) any other information relating to
such nominee that is required under federal securities laws to be disclosed in
solicitations of proxies for the election of directors, or is otherwise required
(including, without limitation, such nominee's written consent to being named in
a proxy statement as nominee and to serving as a director if elected). Southern
Financial's bylaws further require that the shareholder's notice set forth as to
the shareholder giving the notice (i) the name and address of such shareholder
and (ii) the class and amount of such shareholder's beneficial ownership of
Southern Financial capital stock. If the information supplied by a shareholder
is deficient in any material aspect or if the foregoing procedure is not
followed, the chairman of the annual meeting may determine that such
shareholder's nomination should not be brought before the annual meeting and
that such nominee shall not be eligible for election as a director of Southern
Financial.
The advance notice procedure of Southern Financial's bylaws affords the
board of directors the opportunity to consider the qualifications of the
proposed nominees and to inform shareholders about such qualifications. Although
such procedure does not give the board of directors of Southern Financial any
power to approve or disapprove of shareholder nominations for election of
directors, it may have the
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effect of precluding surprise nominations and a contest for the election if
directors if such procedure established by it is not followed. Furthermore, such
procedure may discourage or deter a third party from conducting a solicitation
of proxies to elect its own slate of directors.
The procedures regarding shareholder proposals and nominations provide
the board of directors of Southern Financial with the information which will be
necessary to evaluate a shareholder proposal or nomination and other relevant
information, such as existing shareholder support, as well as the time necessary
to consider and evaluate such information in advance of the applicable meeting.
The proposed procedures, however, will give incumbent directors advance notice
of a business proposal or nomination. This may make it easier for the incumbent
directors to defeat a shareholder proposal or nomination, even when certain
shareholders view such proposal or nomination as in the best interests of
Southern Financial or its shareholders. Southern Financial's articles of
incorporation and bylaws do not prevent shareholders from making proposals under
the Commission's rules and regulations.
Shareholder Voting Rights in General
The Virginia Stock Corporation Act generally provides that shareholders
do not have cumulative voting rights unless those rights are provided in the
corporation's articles of incorporation. The Virginia Stock Corporation Act also
specifies additional voting requirements for Affiliated Transactions which are
discussed below under "State Anti-Takeover Statutes."
First Savings. First Savings' Articles of Incorporation provide
shareholders cumulative voting rights for the election of directors. The holders
of common stock are entitled to one vote per share on all matters submitted to a
vote of shareholders.
The Articles of Incorporation of First Savings eliminate the
pre-emptive right of shareholders to subscribe for and purchase First Savings
common stock.
Southern Financial. Southern Financial's articles of incorporation do
not provide shareholders cumulative rights for the election of directors.
Therefore, the holders of a majority of the shares voted in the election of
directors can elect all of the directors then standing for election. The holders
of Southern Financial common stock are entitled to one vote per share on all
matters submitted to a vote of shareholders. Except to the extent to which the
board of directors shall have specified voting power with respect to any other
class of stock and except as otherwise provided by law, the exclusive voting
power shall be vested in the holders of Southern Financial common stock.
State Anti-Takeover Statutes
The Virginia Stock Corporation Act restricts transactions between a
corporation and its affiliates and potential acquirors. The summary below is
necessarily general and is not intended to be a complete description of all the
features and consequences of those provisions, and is qualified in its entirety
by reference to the statutory provisions contained in the Virginia Stock
Corporation Act. Because both First Savings and Southern Financial are Virginia
corporations, the provisions of the Virginia Stock Corporation Act described
below apply to First Savings and Southern Financial and will continue to apply
to First Savings after the merger.
Affiliated Transactions. The Virginia Stock Corporation Act contains
provisions governing "Affiliated Transactions," found at Sections 13.1-725 -
727.1 of the Virginia Stock Corporation Act. Affiliated Transactions include
certain mergers and share exchanges, certain material dispositions of corporate
assets not in the ordinary course of business, any dissolution of a corporation
proposed by or on behalf of an Interested Shareholder (as defined below), and
reclassifications, including reverse stock
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splits, recapitalizations or mergers of a corporation with its subsidiaries, or
distributions or other transactions which have the effect of increasing the
percentage of voting shares beneficially owned by an Interested Shareholder by
more than 5%. For purposes of the Virginia Stock Corporation Act, an Interested
Shareholder is defined as any beneficial owner of more than 10% of any class of
the voting securities of a Virginia corporation.
Subject to certain exceptions discussed below, the provisions governing
Affiliated Transactions require that, for three years following the date upon
which any shareholder becomes an Interested Shareholder, any Affiliated
Transaction must be approved by the affirmative vote of holders of two-thirds of
the outstanding shares of the corporation entitled to vote, other than the
shares beneficially owned by the Interested Shareholder, and by a majority (but
not less than two) of the Disinterested Directors (as defined below). A
Disinterested Director is defined in the Virginia Stock Corporation Act as a
member of a corporation's board of directors who (i) was a member before the
later of January 1, 1988 or the date on which an Interested Shareholder became
an Interested Shareholder and (ii) was recommended for election by, or was
elected to fill a vacancy and received the affirmative vote of, a majority of
the Disinterested Directors then on the corporation's board of directors. At the
expiration of the three year period after a shareholder becomes an Interested
Shareholder, these provisions require approval of the Affiliated Transaction by
the affirmative vote of the holders of two-thirds of the outstanding shares of
the corporation entitled to vote, other than those beneficially owned by the
Interested Shareholder.
The principal exceptions to the special voting requirement apply to
Affiliated Transactions occurring after the three year period has expired and
require either that the transaction be approved by a majority of the
corporation's Disinterested Directors or that the transaction satisfy certain
fair price requirements of the statute. In general, the fair price requirements
provide that the shareholders must receive the higher of: the highest per share
price for their shares as was paid by the Interested Shareholder for his, her or
its shares, or the fair market value of the shares. The fair price requirements
also require that, during the three years preceding the announcement of the
proposed Affiliated Transaction, all required dividends have been paid and no
special financial accommodations have been accorded the interested Shareholder,
unless approved by a majority of the Disinterested Directors.
None of the foregoing limitations and special voting requirements
applies to a transaction with an Interested Shareholder who has been an
Interested Shareholder continuously since the effective date of the statute
(January 26, 1988) or who became an Interested Shareholder by gift or
inheritance from such a person or whose acquisition of shares making such person
an Interested Shareholder was approved by a majority of the Disinterested
Directors of the corporation.
These provisions were designed to deter certain takeovers of Virginia
corporations. In addition, the Virginia Stock Corporation Act provides that by
affirmative vote of a majority of the voting shares other than shares owned by
any Interested Shareholder, a corporation may adopt by meeting certain voting
requirements, an amendment to its articles of incorporation or bylaws providing
that the Affiliated Transactions provisions shall not apply to the corporation.
Neither First Savings nor Southern Financial has adopted such an amendment.
Control Share Acquisitions. The Virginia Control Share Acquisitions
statute, found at Sections 13.1-728 - 728.8 of the Virginia Stock Corporation
Act, also is designed to afford shareholders of a public company incorporated in
Virginia protection against certain types of non-negotiated acquisitions in
which a person, entity or group ("Acquiring Person") seeks to gain voting
control of that corporation. With certain enumerated exceptions, the statute
applies to acquisitions of shares of a corporation which would result in an
Acquiring Person's ownership of the corporation's shares entitled to vote in the
election of directors falling within any one of the following ranges: 20% to
33-1/3%, 33-1/3% to 50% or 50% or more (a "Control Share Acquisition"). Shares
that are the subject of a Control Share Acquisition
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("Control Shares") will not be entitled to voting rights unless the holders of a
majority of the "Disinterested Shares" vote at an annual or special meeting of
shareholders of the corporation to accord the Control Shares with voting rights.
Disinterested Shares do not include shares owned by the Acquiring Person or by
officers and inside directors of the target company. Under certain
circumstances, the statute permits an Acquiring Person to call a special
shareholders' meeting for the purpose of considering granting voting rights to
the holders of the Control Shares. As a condition to having this matter
considered at either an annual or special meeting, the Acquiring Person must
provide shareholders, among other things, detailed disclosures about his or her
identity, the method and financing of the Control Share Acquisition and any
plans to engage in certain transactions with, or to make fundamental changes to,
the corporation, its management or business. Under certain circumstances, the
statute grants dissenters' rights to shareholders who vote against granting
voting rights to the Control Shares. The Virginia Control Share Acquisitions
Statute also enables a corporation to make provisions for redemption of Control
Shares with no voting rights. A corporation may opt-out of the statute, which
First Savings has not done, by so providing in its articles of incorporation or
bylaws. Southern Financial, however, has opted out of the statute by so
providing in its bylaws. Among the acquisitions specifically excluded from the
statute are acquisitions which are a part of certain negotiated transactions to
which the corporation is a party and which, in the case of mergers or share
exchanges, have been approved by the corporation's shareholders under other
provisions of the Virginia Stock Corporation Act.
REGULATION
Set forth below is a brief description of the material laws and
regulations that affect Southern Financial. The description of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, is not necessarily complete and is qualified in its entirety by
reference to these 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 such, Southern Financial is
supervised by the Board of Governors of the Federal Reserve System. Southern
Financial is also subject to Virginia laws that regulate banks and bank holding
companies. Virginia's banking laws are administered by the Bureau of Financial
Institutions of the State Corporation Commission of Virginia. Southern Financial
is also affected by rules and regulations of the Federal Deposit Insurance
Corporation. Southern Financial is a member of the Federal Reserve System and
the Federal Home Loan Bank of Atlanta. The various laws and regulations
administered by the regulatory agencies affect corporate practices, expansion of
business, and provisions of services. Also, monetary and fiscal policies of the
United States directly affect bank loans and deposits and thus may affect
Southern Financial's earnings. The future impact of these policies and of the
continuing regulatory changes in the financial services industry cannot be
predicted.
The supervision, regulation and examination of Southern Financial Bank
are intended primarily for the protection of depositors rather than holders of
Southern Financial securities.
Bank Holding Company Regulation
Southern Financial is required to file with the Federal Reserve its
periodic reports and any additional information the Federal Reserve may require.
The Federal Reserve examines Southern Financial and may examine its
subsidiaries. The State Corporation Commission also may examine Southern
Financial.
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The Bank Holding Company Act requires prior Federal Reserve approval
for, among other things, the acquisition of direct or indirect ownership or
control of more than 5% of the voting shares or substantially all of the assets
of any bank, or a merger or consolidation of a bank holding company with another
bank holding company. A bank holding company may acquire direct or indirect
ownership or control of voting shares of any company that is engaged directly or
indirectly in banking or managing or controlling banks or performing services
for its authorized subsidiaries. A bank holding company also may engage in or
acquire an interest in a company that engages in activities which the Federal
Reserve has determined by regulation or order to be so closely related to
banking as to be a proper incident thereto.
The activities permissible to bank holding companies and their
affiliates were substantially expanded by the Gramm-Leach-Bliley Act, which the
President signed on November 12, 1999. Gramm-Leach-Bliley repeals the
anti-affiliation provisions of the Glass-Steagall Act to permit the common
ownership of commercial banks, investment banks and insurance companies. Under
Gramm-Leach-Bliley, a bank holding company can elect to be treated as a
financial holding company. A financial holding company may engage in any
activity and acquire and retain any company that the Federal Reserve determines
to be financial in nature. A financial holding company also may engage in any
activity that is complementary to a financial activity and does not pose a
substantial risk to the safety and soundness of depository institutions or the
financial system generally. The Federal Reserve must consult with the Secretary
of the Treasury in determining whether an activity is financial in nature or
incidental to a financial activity.
Southern Financial is a legal entity separate and distinct from
Southern Financial Bank. Section 23A of the Federal Reserve Act restricts loans
from Southern Financial Bank to Southern Financial. Section 23A defines "covered
transactions," which include loans, and limits a bank's covered transactions
with any affiliate to 10% of the bank's capital and surplus. It also requires
that all of a bank's loans to an affiliate be secured by acceptable collateral,
generally United States government or agency securities. Southern Financial and
Southern Financial Bank also are subject to Section 23B of the Federal Reserve
Act, which requires that transactions between Southern Financial Bank and
Southern Financial or its other subsidiaries be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to Southern Financial Bank as those prevailing at the time
for transactions with unaffiliated companies.
Federal Reserve policy requires a bank holding company to act as a
source of financial strength and to take measures to preserve and protect bank
subsidiaries in situations where additional investments in a troubled bank may
not otherwise be warranted. As a result, a bank holding company may be required
to lend money to its subsidiaries in the form of capital notes or other
instruments which qualify as capital under regulatory rules. Any loans from the
holding company to such subsidiary banks likely will be unsecured and
subordinated to such bank's depositors and perhaps to other creditors of its
bank subsidiaries.
Bank Supervision
As a Virginia bank that is a member of the Federal Reserve System,
Southern Financial Bank is regulated and examined by the State Corporation
Commission and by its primary federal regulator, the Federal Reserve. The State
Corporation Commission and the Federal Reserve regulate and monitor all of
Southern Financial Bank's operations, including reserves, loans, mortgages,
payments of dividends and the establishment of branches.
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Various statutes limit the ability of Southern Financial Bank to pay
dividends, extend credit or otherwise supply funds to Southern Financial and its
non-bank subsidiaries. Dividends from Southern Financial Bank are expected to
constitute Southern Financial' major source of funds.
Regulatory Capital Requirements
All banks are required to maintain minimum levels of regulatory
capital. The federal bank regulatory agencies have established substantially
similar risked based and leverage capital standards for banks that they
regulate. These regulatory agencies also may impose capital requirements in
excess of these standards on a case-by-case basis for various reasons, including
financial condition or actual or anticipated growth. Under the risk-based
capital requirements of these regulatory agencies, Southern Financial and
Southern Financial Bank are required to maintain a minimum ratio of total
capital to risk-weighted assets of at least 8%. At least half of the total
capital is required to be tier 1 capital, which consists principally of common
and certain qualifying preferred shareholders' equity, less certain intangibles
and other adjustments. The remainder, tier 2 capital, consists of a limited
amount of subordinated and other qualifying debt and a limited amount of the
general loan loss allowance. Based upon the applicable Federal Reserve
regulations, at December 31, 1999, Southern Financial Bank was considered to be
"well capitalized."
In addition, the federal regulatory agencies have established a minimum
leverage capital ratio, tier 1 capital divided by tangible assets. These
guidelines provide for a minimum leverage capital ratio of 3% for banks and
their respective holding companies that meet certain specified criteria,
including that they have the highest regulatory examination rating and are not
contemplating significant growth or expansion. All other institutions are
expected to maintain a leverage ratio of at least 100 to 200 basis points above
that minimum. The guidelines also provide that banking organizations
experiencing internal growth or making acquisitions will be expected to maintain
strong capital positions substantially above the minimum supervisory levels,
without significant reliance on intangible assets.
Limits on Dividends and Other Payments
Virginia law restricts distributions of dividends to shareholders of
Southern Financial. Southern Financial shareholders are entitled to receive
dividends as declared by the Southern Financial Board of Directors. No
distribution to Southern Financial shareholders may be made if, after giving
effect to the distribution, Southern Financial would not be able to pay its
debts as they become due in the usual course of business or its total assets
would be less than its total liabilities. There are similar restrictions on
stock repurchases and redemptions.
Banks have limits on all capital distributions, including cash
dividends, payments to repurchase or otherwise acquire shares, payments to
shareholders of another institution in a cash-out merger, and other
distributions charged against capital. As of December 31, 1999, Southern
Financial Bank had the capacity to pay no more than $5.2 million in total
dividends to its sole shareholder, Southern Financial.
Southern Financial Bank may not make a capital distribution, including
the payment of a dividend, if, after the distribution, it would become
undercapitalized . The prior approval of the applicable Federal Reserve Bank is
required if the total of all dividends declared in any calendar year will exceed
the sum of the bank's net profits for that year and its retained net profits for
the preceding two calendar years. Federal Reserve Banks also may limit the
payment of dividends by any state member bank if it considers the payment an
unsafe or unsound practice. In addition, under Virginia law no dividend may be
declared or paid that would impair a Virginia chartered bank's paid-in capital.
The State Corporation Commission has general authority to prohibit payment of
dividends by a Virginia chartered
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bank if it determines that the limit is in the public interest and is necessary
to ensure the bank's financial soundness.
FDIC Regulations
The Federal Deposit Insurance Corporation Improvements Act of 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. Each
federal banking agency has issued 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. Those
supervisory actions become increasingly severe for banks that are
under-capitalized or worse.
Under the Federal Reserve's regulations implementing the prompt
corrective action provisions, an institution is considered 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.
An adequately capitalized institution 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.
An undercapitalized institution 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).
Undercapitalized banks are subject to growth limits and are required to submit a
capital restoration plan for approval. For a capital restoration plan to be
acceptable, the bank's parent holding company must guarantee that the bank will
comply with the capital restoration plan. The aggregate liability of the parent
holding company is limited to the lesser of 5% of the bank's total assets at the
time it became undercapitalized and the amount necessary to bring the
institution into compliance with applicable capital standards. If a bank fails
to submit an acceptable plan, it is treated as if it is significantly
undercapitalized. If the controlling holding company fails to fulfill its
obligations and files (or has filed against it) a petition under the federal
Bankruptcy Code, the claim would be entitled to a priority in such bankruptcy
proceeding over third-party creditors of Southern Financial.
A significantly undercapitalized institution 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%. Significantly
undercapitalized depository institutions may be subject to a number of
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized, requirements to reduce total assets, and
cessation of receipt of deposits from correspondent banks.
A critically undercapitalized institution has a ratio of tangible
equity to total assets that is equal to or less than 2%. A critically
undercapitalized bank is likely to be put in receivership and liquidated.
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.
The Federal Deposit Insurance Corporation Improvements Act also
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
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growth, compensation, loan documentation and interest rate exposure. The Federal
Deposit Insurance Corporation Improvements Act 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
undercapitalized banks to borrow from the Federal Reserve's discount window and
required federal banking regulators to perform annual onsite bank examinations.
The 1991 legislation also contains a variety of other provisions that
may affect the operations of Southern Financial and Southern Financial Bank,
including new reporting requirements, regulatory standards for estate lending,
"truth in savings" provisions, the requirement that a depository institution
give 90 days' prior notice to customers and regulatory authorities before
closing any branch, and a prohibition on the acceptance or renewal of brokered
deposits by depository institutions that are not well capitalized or are
adequately capitalized and have not received a waiver from the FDIC.
Deposit Insurance
The deposits of Southern Financial Bank are currently insured to a
maximum of $100,000 per depositor, subject to certain aggregation rules. The
FDIC has implemented a risk-related assessment system for deposit insurance
premiums. All depository institutions have been assigned to one of nine risk
assessment classifications based on certain capital and supervisory measures.
Southern Financial's deposits are subject to the rates of the Savings
Associations Insurance Fund since Southern Financial converted to a commercial
bank from a federal savings bank on December 1, 1995. Based on its current risk
classifications, Southern Financial pays the minimum Savings Associations
Insurance Fund assessment and Bank Insurance Fund assessments.
Community Reinvestment Act
Southern Financial and Southern Financial Bank are subject to the
provisions of the Community Reinvestment Act of 1977, as amended ("CRA"). Under
the Community Reinvestment Act, all banks have an obligation, consistent with
its safe and sound operation, to help meet the credit needs for their entire
communities, including low and moderate-income neighborhoods. The Community
Reinvestment Act does not establish specific lending requirements or programs
for financial institutions, nor does it limit an institution's discretion to
develop the types of products and services that it believes are best suited to
its particular community consistent with the Community Reinvestment Act. A
depository institution's primary federal regulator, in connection with its
examination of the institution, must assess the institution's record in
assessing and meeting the credit needs of the community served by that
institution, including low and moderate-income neighborhoods. The regulatory
agency's assessment of the institution's record is made available to the public.
Further, such assessment is required of any institution which has applied to
charter a national bank, obtain deposit insurance coverage for a newly chartered
institution, establish a new branch office that accepts deposits, relocate an
office or merge or consolidate with, or acquire the assets or assume the
liabilities of, a federally regulated financial institution. If a bank holding
company applies for approval to acquire a bank or other bank holding company,
the Federal Reserve will assess the records of each subsidiary depository
institution of the applicant bank holding company, and such records may be the
basis for denying the application. Following the most recent Community
Reinvestment Act examination in February 1999 Southern Financial Bank received a
"satisfactory" Community Reinvestment Act rating.
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Fiscal and Monetary Policy
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
its other borrowings, and the interest received by a bank on its loans and
securities holdings, constitutes the major portion of a bank's earnings. Thus,
the earnings and growth of Southern Financial and Southern Financial Bank will
be subject to the influence of economic conditions generally, both domestic and
foreign, and also to the monetary and fiscal policies of the United States and
its agencies, particularly the Federal Reserve. The Federal Reserve regulates
the supply of money through various means, including open market dealings in
United States government securities, the discount rate at which banks may borrow
from the Federal Reserve, and the reserve requirements on deposits. The nature
and timing of any changes in such policies and their effect on Southern
Financial and Southern Financial Bank cannot be predicted.
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 with each subject to
supervision and regulation by the Federal Housing Finance Board. The Federal
Home Loan Banks provide a central credit facility for member institutions.
Southern Financial, as a member of the Federal Home Loan Bank of Atlanta, is
required to acquire and hold shares of capital stock in that Federal Home Loan
Bank in an amount equal to at least 1% of the aggregate principal amount of
their unpaid residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each year, or 5% of their borrowings from the
Federal Home Loan Bank of Atlanta, whichever is greater. At December 31, 1999,
Southern Financial had an investment of $1.8 million in the stock of the Federal
Home Loan Bank of Atlanta and was in compliance with these requirements.
Advances from the Federal Home Loan Bank of Atlanta are secured.
Interest rates charged for advances vary depending upon maturity, the cost of
funds to the Federal Home Loan Bank of Atlanta and the purpose of the borrowing.
At December 31, 1999, Southern Financial had $5.0 million outstanding in
borrowings from the Federal Home Loan Bank of Atlanta.
Federal Reserve System
The Federal Reserve Board of Governors requires all depository
institutions to maintain reserves against their transaction 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.
RESALES OF SOUTHERN FINANCIAL COMMON STOCK
The shares of Southern Financial common stock to be issued to First
Savings shareholders in the merger have been registered under the Securities
Act. These shares may be traded freely and without restriction by those
shareholders not deemed to be "affiliates" of First Savings as that term is
defined under the Securities Act. An affiliate of a corporation, as defined by
the rules promulgated under the Securities Act, is a person who directly or
indirectly, through one or more intermediaries, controls, is controlled by, or
is under common control with, that corporation. Any subsequent transfer by an
affiliate of First Savings must be one permitted by the resale provisions of
Rule 145 promulgated under the Securities Act or as otherwise permitted under
the Securities Act.
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First Savings has agreed to deliver to Southern Financial not less than
30 days prior to the effective date, for each of its affiliates, an agreement
that such person will not dispose of any Southern Financial common stock in
violation of the Securities Act.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This proxy statement/prospectus, including information included or
incorporated by reference herein, contains certain forward-looking statements
with respect to the financial condition, results of operations, plans,
objectives, future performance and businesses of each of Southern Financial and
First Savings. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by such forward-looking statements include, among others, the
following possibilities:
o competitive pressure from banks and other financial service
providers increases significantly;
o changes in the interest rate environment reduce margins;
o general economic conditions, either nationally or regionally, are
less favorable than expected, resulting in, among other things, a
deterioration in credit quality;
o changes occur in the regulatory environment;
o changes occur in business conditions and inflation; and o changes
occur in the securities markets
EXPERTS
The consolidated financial statements of Southern Financial as of
December 31, 1999 and 1998 and for each of the years in the three-year period
ended December 31, 1999 have been included herein and in the registration
statement in reliance upon the report of KPMG LLP, independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing. The report of KPMG LLP relies on the report
of Thompson, Greenspon & Co., P.C., independent certified public accountants,
for 1998 and 1997 with respect to The Horizon Bank of Virginia.
The financial statements of First Savings as of December 31, 1999 and
1998 and for each of the years ended December 31, 1999, 1998 and 1997 have been
included herein and in the registration statement in reliance upon the report of
Grant Thornton LLP, independent certified public accountants, appearing
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
LEGAL OPINIONS
The validity of the shares of Southern Financial common stock offered
hereby is being passed upon for Southern Financial by Williams, Mullen, Clark &
Dobbins, Richmond, Virginia. Williams, Mullen, Clark & Dobbins will deliver an
opinion to Southern Financial and First Savings concerning certain federal
income tax consequences of the merger. See "The Merger - Material Federal Income
Tax Consequences of the Merger" on page 12.
Certain matters relating to the merger will be passed upon for First
Savings by Stradley, Ronon, Housley, Kantarian & Bronstein, LLP, Washington,
D.C.
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WHERE YOU CAN FIND MORE INFORMATION
Southern Financial maintains an Internet site at
www.southernfinancialbank.com, which contains information relating to Southern
Financial and its business.
In addition, Southern Financial files annual, quarterly and current
reports, proxy statements and other information with the Securities and Exchange
Commission. You may read and copy any document that Southern Financial files at
the Commission's public reference room facility located at 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the Commission's regional offices at 7 World
Trade Center, 13th Floor, Suite 1300, New York, New York 10048 and Suite 1400,
Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661. Please call
the Commission at 1-800-SEC-0330 for further information on the public reference
room. The Commission maintains an Internet site at www.sec.gov that contains
reports, proxy and information statements and other information regarding
issuers, including Southern Financial, that file documents with the Commission
electronically through the Commission's electronic data gathering, analysis and
retrieval system known as EDGAR. Southern Financial's reports, proxy and
information statements may also be reviewed at the offices of the National
Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington D.C.
20006.
This proxy statement/prospectus is part of a registration statement
filed by Southern Financial with the Commission. Because the rules and
regulations of the Commission allow the omission of certain portions of the
registration statement from this document, this proxy statement/prospectus does
not contain all the information contained in the registration statement. You may
review the registration statement and the exhibits filed with the registration
statement for further information regarding Southern Financial. The registration
statement and its exhibits may be inspected at the public reference facilities
of the Commission at the addresses mentioned above.
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Appendix A
AGREEMENT AND PLAN OF REORGANIZATION
BETWEEN
FIRST SAVINGS BANK OF VIRGINIA
AND
SOUTHERN FINANCIAL BANCORP, INC.
-------------------------
March 31, 2000
A-1
<PAGE>
TABLE OF CONTENTS
ARTICLE 1
The Reorganization and Related Matters
<TABLE>
<CAPTION>
Page
<S> <C> <C>
1.1 The Reorganization ......................................................................... A-6
1.2 Management and Business of FSBV and SFB..................................................... A-6
1.3 The Closing and Effective Date.............................................................. A-6
1.4 Definitions................................................................................. A-7
ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of FSBV Stock.................................................................... A-8
2.2 Manner of Exchange.......................................................................... A-8
2.3 No Fractional Shares........................................................................ A-8
2.4 Dividends................................................................................... A-8
ARTICLE 3
Representations and Warranties
3.1 Representations and Warranties of FSBV...................................................... A-9
(a) Organization, Standing and Power................................................... A-9
(b) Authority.......................................................................... A-9
(c) Capital Structure.................................................................. A-10
(d) Ownership of the FSBV Subsidiaries; Capital Structure
of the FSBV Subsidiaries; and Organization of the FSBV
Subsidiaries....................................................................... A-10
(e) Financial Statements............................................................... A-10
(f) Absence of Undisclosed Liabilities................................................. A-11
(g) Legal Proceedings; Compliance with Laws............................................ A-11
(h) Regulatory Approvals............................................................... A-11
(i) Labor Relations.................................................................... A-11
(j) Tax Matters........................................................................ A-11
(k) Property........................................................................... A-11
(l) Reports............................................................................ A-12
(m) Employee Benefit Plans............................................................. A-12
(n) Investment Securities.............................................................. A-12
(o) Certain Contacts................................................................... A-13
(p) Insurance.......................................................................... A-13
(q) Absence of Material Changes and Events............................................. A-14
A-2
<PAGE>
(r) Loans, OREO and Allowance for Loan Losses.......................................... A-14
(s) Statements True and Correct........................................................ A-15
(t) Brokers and Finders................................................................ A-15
(u) Repurchase Agreements.............................................................. A-15
(v) Administration of Trust Accounts................................................... A-15
(w) Environmental Matters.............................................................. A-16
3.2 Representations and Warranties of SFB....................................................... A-17
(a) Organization, Standing and Power................................................... A-17
(b) Authority.......................................................................... A-18
(c) Capital Structure.................................................................. A-19
(d) Ownership of the SFB Subsidiaries; Capital Structure
of the SFB Subsidiaries; and Organization of the SFB
Subsidiaries....................................................................... A-19
(e) Financial Statements............................................................... A-19
(f) Absence of Undisclosed Liabilities................................................. A-20
(g) Legal Proceedings; Compliance with Laws............................................ A-20
(h) Regulatory Approvals............................................................... A-21
(i) Labor Relations.................................................................... A-21
(j) Tax Matters........................................................................ A-21
(k) Property........................................................................... A-21
(l) Reports............................................................................ A-22
(m) Employee Benefit Plans............................................................. A-22
(n) Investment Securities.............................................................. A-22
(o) Certain Contacts................................................................... A-22
(p) Insurance.......................................................................... A-23
(q) Loans, OREO and Allowance for Loan Losses.......................................... A-23
(r) Absence of Material Changes and Events............................................. A-24
(s) Statements True and Correct........................................................ A-24
(t) Brokers and Finders................................................................ A-25
(u) Administration of Trust Accounts................................................... A-25
(v) Environmental Matters.............................................................. A-25
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties............................................................ A-26
4.2 Confidentiality............................................................................. A-27
4.3 Registration Statement, Proxy Statement and Shareholder Approval............................ A-27
4.4 Operation of the Business of FSBV and SFB................................................... A-28
4.5 Dividends................................................................................... A-29
4.6 No Solicitation............................................................................. A-29
4.7 Regulatory Filings.......................................................................... A-29
4.8 Public Announcements........................................................................ A-29
4.9 Notice of Breach............................................................................ A-29
A-3
<PAGE>
4.10 Accounting Treatment........................................................................ A-29
4.11 Reorganization Consummation................................................................. A-30
ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options................................................................. A-30
5.2 Benefit Plans............................................................................... A-31
5.3 Indemnification............................................................................. A-31
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to Each Party's Obligations to Effect the Reorganization......................... A-31
(a) Shareholder Approval............................................................... A-31
(b) Regulatory Approvals............................................................... A-31
(c) Registration Statement............................................................. A-32
(d) Tax Opinion........................................................................ A-32
(e) Opinions of Counsel................................................................ A-32
(f) Legal Proceedings.................................................................. A-32
6.2 Conditions to Obligations of SFB............................................................ A-32
(a) Representations and Warranties..................................................... A-32
(b) Performance of Obligations......................................................... A-32
(c) Affiliate Letters.................................................................. A-32
(d) Investment Banking Letter.......................................................... A-33
6.3 Conditions to Obligations of FSBV........................................................... A-33
(a) Representations and Warranties..................................................... A-33
(b) Performance of Obligations......................................................... A-33
(c) Investment Banking Letter.......................................................... A-33
ARTICLE 7
Termination
7.1 Termination................................................................................. A-33
7.2 Effect of Termination....................................................................... A-34
7.3 Non-Survival of Representations, Warranties and Covenants................................... A-34
7.4 Expenses.................................................................................... A-34
7.5 Termination Fee............................................................................. A-35
A-4
<PAGE>
ARTICLE 8
General Provisions
8.1 Entire Agreement............................................................................ A-36
8.2 Waiver and Amendment........................................................................ A-36
8.3 Descriptive Headings........................................................................ A-36
8.4 Governing Law............................................................................... A-36
8.5 Notices..................................................................................... A-36
8.6 Counterparts................................................................................ A-37
8.7 Severability................................................................................ A-37
8.8 Subsidiaries................................................................................ A-37
</TABLE>
Exhibit A - Plan of Merger between First Savings Bank of Virginia and Southern
Financial Bancorp, Inc.
A-5
<PAGE>
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made and
entered into as of March 31, 2000 by and between First Savings Bank of Virginia,
a Virginia-chartered savings association with its principal office located in
Springfield, Virginia ("FSBV"), and Southern Financial Bancorp, Inc., a Virginia
corporation with its principal office located in Warrenton, Virginia ("SFB");
and Southern Financial Bank, a Virginia state bank and a wholly owned subsidiary
of SFB (the "Bank").
WITNESSETH:
WHEREAS, FSBV and SFB desire to combine their respective businesses;
and
WHEREAS, FSBV and SFB have agreed to the affiliation of their two
companies through a merger of FSBV with and into the Bank under Virginia law, as
a result of which the shareholders of FSBV would become shareholders of SFB, all
as more specifically provided in this Agreement and the Plan of Merger in the
form attached hereto as Exhibit A (the "Plan"); and
WHEREAS, the respective Boards of Directors of FSBV, the Bank and SFB
have resolved that the transactions described herein are in the best interests
of the parties and their respective shareholders and have authorized and
approved the execution and delivery of this Agreement.
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements set forth herein, the parties hereby agree as follows:
ARTICLE 1
The Reorganization and Related Matters
1.1 The Reorganization. Subject to the terms and conditions of
this Agreement, at the Effective Date as defined in Section 1.3 hereof, FSBV
will be merged with and into the Bank pursuant to the Plan (the
"Reorganization"). The separate corporate existence of FSBV shall thereupon
cease, and the Bank will be the surviving corporation in the Merger. From and
after the Effective Date, the Reorganization will have the effects set forth in
Section 13.1-721 of the Virginia Stock Corporation Act.
1.2 Management and Business of FSBV and SFB. On the Effective
Date, SFB will increase the size of its board of directors by one (1) member,
and Barbara J. Fried will become a director of SFB.
1.3 The Closing and Effective Date. The closing of the
transactions contemplated by this Agreement and the Plan of Reorganization shall
take place at the offices of Williams, Mullen, Clark & Dobbins, 1021 East Cary
Street, Richmond, Virginia or at such other place as may be mutually agreed upon
by the parties. The Reorganization shall become effective on the date shown on
the Certificate of Merger issued by the State Corporation Commission of Virginia
effecting the Reorganization (the "Effective Date"). Unless otherwise agreed
upon in writing by the chief
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executive officers of SFB and FSBV, subject to the conditions to the obligations
of the parties to effect the Reorganization as set forth in Article 6, the
parties shall use their best efforts to cause the Effective Date to occur on the
first day of the month following the month in which the conditions set forth in
Sections 6.1(a) and 6.1(b) are satisfied. All documents required by the terms of
this Agreement to be delivered at or prior to consummation of the Reorganization
will be exchanged by the parties at the closing of the Reorganization (the
"Reorganization Closing"), which shall be held on the Effective Date. Prior to
the Reorganization Closing, SFB and FSBV shall execute and deliver to the
Virginia State Corporation Commission Articles of Merger containing a Plan of
Merger in substantially the form of Exhibit A hereto.
1.4 Definitions. Any term defined anywhere in this Agreement shall
have the meaning ascribed to it for all purposes of this Agreement (unless
expressly noted to the contrary). In addition:
(a) the term "knowledge" when used with respect to a
party shall mean the knowledge, after reasonable investigation, of any
"Executive Officer" of such party, as such term is defined in Regulation O, (12
C.F.R. 215);
(b) the term "Material Adverse Effect", when applied to a
party, shall mean an event, occurrence or circumstance (including without
limitation (i) the making of any provisions for possible loan and lease losses,
write-downs or other real estate and taxes (but specifically excluding any
reserves or accruals recorded by FSBV pursuant to Section 4.10(c) hereof) and
(ii) any breach of a representation or warranty by such party) which (a) has or
is reasonably likely to have a material adverse effect on the financial
position, results of operations or business of the party and its subsidiaries,
taken as a whole, or (b) would materially impair the party's ability to perform
its obligations under this Agreement or the consummation of the Reorganization
and the other transactions contemplated by this Agreement; provided, however,
that solely for purposes of measuring whether an event, occurrence or
circumstance has a material adverse effect on such party's results of
operations, the term "results of operations" shall mean net interest income plus
non-interest income (less securities gains) less gross expenses (excluding
provisions for possible loan and lease losses, write-downs of other real estate
and taxes); and provided further, that material adverse effect and material
impairment shall not be deemed to include the impact of (i) changes in banking
and similar laws of general applicability or interpretations thereof by courts
or governmental authorities, (ii) changes in generally accepted accounting
principles or regulatory accounting requirements applicable to banks and bank
holding companies generally, (iii) actions required to be taken by this
Agreement and (iv) the Reorganization on of the parties to this Agreement; and
(c) the term "Previously Disclosed" by a party shall mean
information set forth in a written disclosure letter that is delivered by that
party to the other party prior to or contemporaneously with the execution of
this Agreement and specifically designated as information "Previously Disclosed"
pursuant to this Agreement.
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ARTICLE 2
Basis and Manner of Exchange
2.1 Conversion of FSBV Stock. At the Effective Date, by virtue of
the Reorganization and without any action on the part of the holders thereof,
each share of common stock, par value $1.00 per share, of FSBV ("FSBV Stock")
issued and outstanding immediately prior to the Effective Date (other than
Dissenting Shares as defined in Section 2.5) shall cease to be outstanding and
shall be converted into and exchanged for 0.44 shares (the "Exchange Ratio") of
common stock, par value $.01 per share, SFB ("SFB Common Stock") plus cash for
fractional shares. Each holder of a certificate representing any shares of FSBV
Common Stock shall thereafter cease to have any rights with respect to such FSBV
Common Stock, except the right to receive any dividends previously declared but
unpaid as to such stock and the consideration described in Sections 2.1 and 2.3
upon the surrender of such certificate in accordance with Section 2.2. In the
event SFB changes the number of shares of SFB Common Stock issued and
outstanding prior to the Effective Date as a result of any stock split, stock
dividend, recapitalization or similar transaction with respect to the
outstanding SFB Common Stock and the record date therefor shall be prior to the
Effective Date, the Exchange Ratio shall be proportionately adjusted.
2.2 Manner of Exchange. As promptly as practicable after the
Effective Date, SFB shall cause Chase Mellon Shareholder Services, acting as the
exchange agent ("Exchange Agent"), to send to each former shareholder of record
of FSBV immediately prior to the Effective Date transmittal materials for use in
exchanging such shareholder's certificates of FSBV Common Stock (other than
shares held by shareholders who perfect their dissenters' rights as provided
under Section 2.5 hereof) for the consideration set forth in Section 2.1 above
and Section 2.3 below. Any fractional share checks which a FSBV shareholder
shall be entitled to receive in exchange for such shareholder's shares of FSBV
Common Stock, and any dividends paid on any shares of SFB Common Stock that such
shareholder shall be entitled to receive prior to the delivery to the Exchange
Agent of such shareholder's certificates representing all of such shareholder's
shares of FSBV Common Stock will be delivered to such shareholder only upon
delivery to the Exchange Agent of the certificates representing all of such
shares (or indemnity satisfactory to SFB and the Exchange Agent, in their
judgement, if any of such certificates are lost, stolen or destroyed). No
interest will be paid on any such fractional share checks or dividends to which
the holder of such shares shall be entitled to receive upon such delivery.
2.3 No Fractional Shares. No certificates or scrip for fractional
shares of SFB Common Stock will be issued. In lieu thereof, SFB will pay the
value of such fractional shares in cash on the basis of the average of the
closing prices of SFB Common Stock as reported by NASDAQ for trades reported
during the ten (10) trading days immediately preceding the Effective Date.
2.4 Dividends. No dividend or other distribution payable to the
holders of record of SFB Common Stock at or as of any time after the Effective
Date shall be paid to the holder of any certificate representing shares of FSBV
Common Stock issued and outstanding at the Effective Date until such holder
physically surrenders such certificate for exchange as provided in Section 2.2
of
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this Agreement, promptly after which time all such dividends or distributions
shall be paid (without interest).
ARTICLE 3
Representation and Warranties
3.1 Representations and Warranties of FSBV. FSBV represents and
warrants to SFB as follows:
(a) Organization, Standing and Power. (1) FSBV is a
corporation and a Virginia savings association, duly organized, validly existing
and in good standing under the laws of Virginia, and it has all requisite
corporate power and authority to carry on its business in Virginia as now being
conducted and to own and operate its assets, properties and business; FSBV has
one subsidiary, FSB Financial Corporation, a Virginia corporation, of which FSBV
holds 100% of the outstanding capital stock; and FSBV has the corporate power
and authority to execute and deliver this Agreement and perform the respective
terms of this Agreement and the Plan of Merger. Except as Previously Disclosed,
FSBV is in compliance in all material respects with all rules and regulations
promulgated by the Office of Thrift Supervision (the "OTS"), the Virginia State
Corporation Commission ("SCC") and any other regulatory authority having
jurisdiction over it, and it has all requisite corporate power and authority to
carry on a banking business as now being conducted and to own and operate its
assets, properties and business.
(2) FSBV is an "insured depository institution" as
defined in the Federal Deposit Insurance Act and applicable regulations
thereunder. All of the shares of capital stock of FSBV are fully paid and
nonassessable.
(b) Authority. (1) The execution and delivery of this
Agreement, the Plan and the consummation of the Reorganization, have been duly
and validly authorized by all necessary corporate action on the part of FSBV,
except the approval of shareholders. The Agreement represents the legal, valid,
and binding obligation of FSBV, enforceable against FSBV in accordance with its
terms (except in all such cases as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally and except that the availability of
the equitable remedy of specific performance or injunctive relief is subject to
the discretion of the court before which any proceeding may be brought).
(2) Neither the execution and delivery of this Agreement,
the consummation of the transactions contemplated herein, nor compliance by FSBV
with any of the provisions hereof will: (i) conflict with or result in a breach
of any provision of FSBV's Articles of Incorporation or Bylaws; (ii) except as
Previously Disclosed, constitute or result in the breach of any term, condition
or provision of, or constitute a default under, or give rise to any right of
termination, cancellation or acceleration with respect to, or result in the
creation of any lien, charge or encumbrance upon, any property or assets of FSBV
pursuant to (A) any note, bond, mortgage, indenture, or (B) any material
license, agreement, lease, or other instrument or obligation, to which FSBV is a
party or by which any of them or any of their properties or assets may be bound,
or (iii) subject to the receipt of the
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requisite approvals referred to in Section 4.7, violate any order, writ,
injunction, decree, statute, rule or regulation applicable to FSBV or any or its
properties or assets.
(c) Capital Structure. The authorized capital stock of
FSBV consists of 12,000,000 shares of common stock, par value $1.00 per share,
of which, as of the date hereof, 931,605 shares are issued, outstanding, fully
paid and nonassessable, not subject to shareholder preemptive rights and were
not issued in violation of any agreement to which FSBV is a party or otherwise
bound, or of any registration or qualification provisions of any federal or
state securities laws; and 1,000,000 shares of preferred stock, par value $1.00
per share, none of which are issued or outstanding. Except as Previously
Disclosed, there are no outstanding options, warrants or other rights to
subscribe for or purchase from FSBV any capital stock of FSBV or securities
convertible into or exchangeable for capital stock of FSBV.
(d) Ownership of the FSBV Subsidiaries; Capital Structure
of the FSBV Subsidiaries; and Organization of the FSBV Subsidiaries. (1) FSBV
does not own, directly or indirectly, 5% or more of the outstanding capital
stock or other voting securities of any corporation, bank or other organization
actively engaged in business except as Previously Disclosed (collectively the
"FSBV Subsidiaries" and each individually a "FSBV Subsidiary"). The outstanding
shares of capital stock of each FSBV Subsidiary have been duly authorized and
are validly issued, and are fully paid and nonassessable and all such shares are
directly or indirectly owned by FSBV free and clear of all liens, claims and
encumbrances. No rights are authorized, issued or outstanding with respect to
the capital stock of any FSBV Subsidiary and there are no agreements,
understandings or commitments relating to the right of FSBV to vote or to
dispose of said shares, except as Previously Disclosed. None of the shares of
capital stock of any FSBV Subsidiary has been issued in violation of the
preemptive rights of any person.
(2) Each FSBV Subsidiary is a duly organized corporation
validly existing and in good standing under applicable laws. Each FSBV
Subsidiary (i) has full corporate power and authority to own, lease and operate
its properties and to carry on its business as now conducted except where the
absence of such power or authority would not have a Material Adverse Effect on
the financial condition, results of operations or business of FSBV on a
consolidated basis, and (ii) is duly qualified to do business in the states of
the United States and foreign jurisdictions where its ownership or leasing of
property or the conduct of its business requires such qualification and where
failure to so qualify would have a Material Adverse Effect on the financial
condition, results of operations or business of FSBV on a consolidated basis.
Each FSBV Subsidiary has all federal, state, local and foreign governmental
authorizations and licenses necessary for it to own or lease its properties and
assets and to carry on its business as it is now being conducted, except where
failure to obtain such authorization or license would not have a Material
Adverse Effect on the business of such FSBV Subsidiary.
(e) Financial Statements. FSBV has previously furnished
to SFB true and complete copies of its audited consolidated balance sheets and
related consolidated statements of income, statements of cash flows, and
statements of stockholders' equity for the three year period ended December 31,
1999 (together with the notes thereto, the "FSBV Financial Statements"). The
FSBV Financial Statements have been prepared in conformity with generally
accepted accounting principles applied on a consistent basis during the periods
presented, and present fairly the financial
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position of FSBV as of the respective dates thereof and the results of its
operations for the three year period then ended.
(f) Absence of Undisclosed Liabilities. At December 31,
1999 FSBV had no obligation or liability (contingent or otherwise) of any nature
which was not reflected in the FSBV Financial Statements, except for those which
in the aggregate are immaterial or have been Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of FSBV's management, threatened against FSBV,
or against any property, asset, interest or right of FSBV, that are reasonably
expected to have, either individually or in the aggregate a Material Adverse
Effect on the financial condition of FSBV or that are reasonably expected to
threaten or impede the consummation of the Reorganization. FSBV is not a party
to any agreement or instrument or subject to any judgment, order, writ,
injunction, decree or rule that might reasonably be expected to have a Material
Adverse Effect on the condition (financial or otherwise), business or prospects
of FSBV. To the best knowledge of FSBV's management, FSBV is in compliance in
all material respects with all laws, ordinances, requirements, regulations or
orders applicable to its business (including environmental laws, ordinances,
requirements, regulations or orders).
(h) Regulatory Approvals. FSBV knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b).
(i) Labor Relations. FSBV is not a party to or bound by
any collective bargaining agreement, contract or other agreement or
understanding with a labor union or labor organization, nor, to its knowledge,
is it the subject of a proceeding asserting that it has committed an unfair
labor practice (within the meaning of the National Labor Relations Act) or
seeking to compel it to bargain with any labor organization as to wages and
conditions of employment, nor is there any strike or other labor dispute
involving it, pending or, to the best of its knowledge, threatened, nor is it
aware of any activity involving its employees seeking to certify a collective
bargaining unit or engaging in any other organization activity.
(j) Tax Matters. FSBV has filed all federal, state and
local tax returns and reports required to be filed, and all taxes shown by such
returns to be due and payable have been paid or are reflected as a liability in
the FSBV Financial Statements or are being contested in good faith and have been
Previously Disclosed. Except to the extent that liabilities therefor are
specifically reflected in the FSBV Financial Statements, there are no federal,
state or local tax liabilities of FSBV other than liabilities that have arisen
since December 31, 1999, all of which have been properly accrued or otherwise
provided for on the books and records of FSBV. Except as Previously Disclosed,
no tax return or report of FSBV is under examination by any taxing authority or
the subject of any administrative or judicial proceeding, and no unpaid tax
deficiency has been asserted against FSBV by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the FSBV Financial Statements, FSBV has good and marketable title free and clear
of all material liens, encumbrances,
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charges, defaults or equities of whatever character to all of the material
properties and assets, tangible or intangible, reflected in the FSBV Financial
Statements as being owned by FSBV as of the dates thereof. To the best knowledge
of FSBV, all buildings, and all fixtures, equipment, and other property and
assets which are material to its business on a consolidated basis, held under
leases or subleases by FSBV are held under valid instruments enforceable in
accordance with their respective terms, subject to bankruptcy, insolvency,
reorganization, moratorium and similar laws. The buildings, structures, and
appurtenances owned, leased, or occupied by FSBV are in good operating condition
and in a state of good maintenance and repair, and to the best knowledge of FSBV
(i) comply with applicable zoning and other municipal laws and regulations, and
(ii) there are no latent defects therein.
(l) Reports. Since January 1, 1996, FSBV has filed all
reports and statements of a material nature, together with any amendments
required to be made with respect thereto, that were required to be filed with
the OTS, the SCC, and to the best knowledge of FSBV, any other governmental or
regulatory authority or agency having jurisdiction over its operations.
(m) Employee Benefit Plans. (1) FSBV has delivered or
will deliver for SFB's review, as soon as practicable, true and complete copies
of all material pension, retirement, profit-sharing, deferred compensation,
stock option, bonus, vacation or other material incentive plans or agreements,
all material medical, dental or other health plans, all life insurance plans and
all other material employee benefit plans or fringe benefit plans, including,
without limitation, all "employee benefit plans" as that term is defined in
Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), currently adopted, maintained by, sponsored in whole or in part by,
or contributed to by FSBV for the benefit of employees, retirees or other
beneficiaries eligible to participate (collectively, the "FSBV Benefit Plans").
Any of the FSBV Benefit Plans which is an "employee pension benefit plan," as
that term is defined in Section (3(2) of ERISA, is referred to herein as a "FSBV
ERISA Plan." No FSBV Benefit Plan is or has been a multi-employer plan within
the meaning of Section 3(37) of ERISA.
(2) Except as Previously Disclosed, all FSBV Benefit
Plans are in material compliance with the applicable terms of ERISA and the
Internal Revenue Code of 1986, as amended (the "IRC") and any other applicable
laws, rules and regulations, the breach or violation of which could result in a
material liability to FSBV on a consolidated basis.
(3) No FSBV ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which
FSBV has sold securities subject to an obligation to repurchase, none of the
investment securities reflected in the FSBV Financial Statements is subject to
any restriction, contractual, statutory, or otherwise, which would impair
materially the ability of the holder of such investment to dispose freely of any
such investment at any time. With respect to any agreements pursuant to which
FSBV has purchased securities subject
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to any agreement to resell, it has a valid, perfected first lien or security
interest in the government securities or other collateral securing such
agreement, and the value of such collateral equals or exceeds the amount of the
debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, neither FSBV nor any FSBV Subsidiary is a party to, or is bound by,
(i) any material agreement, arrangement or commitment, (ii) any agreement,
indenture or other instrument relating to the borrowing of money by FSBV or any
FSBV Subsidiary or the guarantee by FSBV or any FSBV Subsidiary of any such
obligation, (iii) any agreement, arrangement or commitment relating to the
employment of a consultant or the employment, election, retention in office or
severance of any present or former director or officer, (iv) any agreement to
make loans or for the provision, purchase or sale of goods, services or property
between FSBV or any FSBV Subsidiary and any director of officer of FSBV or any
FSBV Subsidiary, or any member of the immediate family or affiliate of any of
the foregoing, or (v) any agreement between FSBV or any FSBV Subsidiary and any
5% or more shareholder of FSBV; in each case other than agreements entered into
in the ordinary course of the banking business of FSBV or any FSBV Subsidiary
consistent with past practice.
(2) Neither FSBV nor any FSBV Subsidiary, nor to the
knowledge of FSBV, the other party thereto, is in default under any material
agreement, commitment, arrangement, lease, insurance policy or, to the knowledge
of FSBV, other instrument whether entered into in the ordinary course of
business or otherwise, nor, to the knowledge of FSBV, has there occurred any
event that, with the lapse of time or giving of notice or both, would constitute
such a default, other than defaults of loan agreement by borrowers from FSBV or
a FSBV Subsidiary in the ordinary course of its business.
(3) Since December 31, 1999 neither FSBV nor any FSBV
Subsidiary has incurred or paid any obligation or liability that is material to
FSBV, except obligations incurred or paid in connection with transactions in the
ordinary course of business of FSBV or a FSBV Subsidiary consistent with its
practice and, except as Previously Disclosed, from December 31, 1999 to the date
hereof, neither FSBV nor any FSBV Subsidiary has taken any action that, if taken
after the date hereof, would breach any of the covenants contained in Section
4.4 hereof.
(p) Insurance. All policies or binders of fire,
liability, product liability, workmen's compensation, vehicular and other
insurance held by or on behalf of FSBV has previously been made available to SFB
and all such policies or binders are valid and enforceable in accordance with
their terms, are in full force and effect, and insure against risks and
liabilities to the extent and in the manner customary for the industry and are
deemed appropriate and sufficient by FSBV. FSBV is not in default with respect
to any provision contained in any such policy or binder and has not failed to
give any notice or present any claim under any such policy or binder in due and
timely fashion. FSBV has not received notice of cancellation or non-renewal of
any such policy or binder. FSBV has no knowledge of any inaccuracy in any
application for such policies or binders, any failure to pay premiums when due
or any similar state of facts or the occurrence of any event that is reasonably
likely to form the basis for any material claim against it not fully covered
(except to the extent of any applicable deductible) by the policies or binders
referred to above. FSBV has not received notice from any of its insurance
carriers that any insurance premiums will be increased
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materially in the future or that any such insurance coverage will not be
available in the future on substantially the same terms as now in effect.
(q) Absence of Material Changes and Events. Since
December 31, 1999, there has not been any material adverse change in the
condition (financial or otherwise), aggregate assets or liabilities, cash flow,
earnings or business of FSBV, and FSBV has conducted its business only in the
ordinary course consistent with past practice.
(r) Loans, OREO and Allowance for Loan Losses. (1) Except
as Previously Disclosed, and except for matters which individually or in the
aggregate do not materially adversely affect the Reorganization or the financial
condition of FSBV, to the best knowledge of FSBV, each loan reflected as an
asset in the FSBV Financial Statements (i) is evidenced by notes, agreements, or
other evidences of indebtedness which are true, genuine and what they purport to
be, (ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
terms, subject to bankruptcy, insolvency and other laws of general applicability
relating to or affecting creditors' rights and to general equity principles. All
loans and extensions of credit which are subject to regulation by the OTS which
have been made by FSBV or the FSBV Subsidiaries comply in all material respects
therewith.
(2) The classification on the books and records of FSBV
and each FSBV Subsidiary of loans and/or non-performing assets as nonaccrual,
troubled debt restructuring, OREO or other similar classification, complies in
all material respects with generally accepted accounting principles and
applicable regulatory accounting principles.
(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the FSBV Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and neither FSBV nor any FSBV
Subsidiary has received any notice of denial of any such claim.
(4) FSBV and each FSBV Subsidiary are in possession of
all of the OREO or, if any of the OREO remains occupied by the mortgagor,
eviction or summary proceedings have been commenced or rental arrangements
providing for market rental rates have been agreed upon and FSBV and/or each
FSBV Subsidiary are diligently pursuing such eviction or summary proceedings or
such rental arrangements. Except as Previously Disclosed and except for ordinary
foreclosure actions, no legal proceeding or quasi-legal proceeding is pending
or, to the knowledge of FSBV and each FSBV Subsidiary, threatened concerning any
OREO or any servicing activity or omission to provide a servicing activity with
respect to any of the OREO.
(5) Except as Previously Disclosed, all loans made by
FSBV to facilitate the disposition of OREO are performing in accordance with
their terms.
(6) The allowance for possible loan losses shown on the
FSBV Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of
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FSBV as of dates subsequent to the execution of this Agreement will be, in each
case as of the dates thereof, adequate in all material respects to provide for
possible losses, net of recoveries relating to loans previously charged off, on
loans outstanding (including accrued interest receivable) of FSBV and other
extensions of credit (including letters of credit and commitments to make loans
or extend credit) by FSBV.
(s) Statements True and Correct. None of the information
supplied or to be supplied by FSBV for inclusion in the Registration Statement
on Form S-4 (the "Registration Statement") to be filed by SFB with the SEC, the
Proxy Statement/Prospectus (as defined in Section 4.3) to be mailed to every
FSBV shareholder or any other document to be filed with the SEC, the SCC, the
Federal Reserve, the OTS or any other regulatory authority in connection with
the transactions contemplated hereby, will, at the respective time such
documents are filed, and, in the case of the Registration Statement, when it
becomes effective and with respect to the Proxy Statement/Prospectus, when first
mailed to FSBV shareholders, be false or misleading with respect to any material
fact or omit to state any material fact necessary in order to make the
statements therein not misleading, or, in the case of the Proxy
Statement/Prospectus or any supplement thereto, at the time of the FSBV
Shareholders' Meeting (as defined in Section 4.3), be false or misleading with
respect to any material fact or omit to state any material fact necessary to
correct any statement in any earlier communication with respect to the
solicitation of any proxy for the FSBV Shareholders' Meeting.
(t) Brokers and Finders. Except as Previously Disclosed,
neither FSBV nor any FSBV Subsidiary, nor any of their respective officers,
directors or employees, has employed any broker, finder or financial advisor or
incurred any liability for any fees or commissions in connection with the
transactions contemplated herein, except for RP Financial LC.
(u) Repurchase Agreements. With respect to all agreements
pursuant to which FSBV or any FSBV Subsidiary has purchased securities subject
to an agreement to resell, if any, FSBV or such FSBV Subsidiary, as the case may
be, has a valid, perfected first lien or security interest in the government
securities or other collateral securing the repurchase agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(v) Administration of Trust Accounts. FSBV and FSBV
Subsidiaries have properly administered, in all respects material and which
could reasonably be expected to be material to the business, operations or
financial condition of FSBV and FSBV Subsidiaries, taken as a whole, all
accounts for which they act as fiduciaries including but not limited to accounts
for which they serve as trustees, agents, custodians, personal representatives,
guardians, conservators or investment advisors, in accordance with the terms of
the governing documents and applicable state and federal law and regulation and
common law. Neither FSBV nor a FSBV Subsidiary, nor any director, officer or
employee of FSBV or a FSBV Subsidiary has committed any breach of trust with
respect to any such fiduciary account which is material to or could reasonably
be expected to be material to the business, operations or financial condition of
FSBV, or a FSBV Subsidiary, taken as a whole, and the accountings for each such
fiduciary account are true and correct in all material respects and accurately
reflect the assets of such fiduciary account in all material respects.
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(w) Environmental Matters. (1) Except as Previously
Disclosed, to the best of FSBV's knowledge, neither FSBV nor any FSBV Subsidiary
owns or leases any properties affected by toxic waste, radon gas or other
hazardous conditions or constructed in part with the use of asbestos. Each of
FSBV and the FSBV Subsidiaries is in substantial compliance with all
Environmental Laws applicable to real or personal properties in which it has a
direct fee ownership or, with respect to a direct interest as lessee, applicable
to the leasehold premises or, to the best knowledge of FSBV and the FSBV
Subsidiary, the premises on which the leasehold is situated. Neither FSBV nor
any FSBV Subsidiary has received any Communication alleging that FSBV or such
FSBV Subsidiary is not in such compliance and, to the best knowledge of FSBV and
the FSBV Subsidiaries, there are no present circumstances (including
Environmental Laws that have been adopted but are not yet effective) that would
prevent or interfere with the continuation of such compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on FSBV and the FSBV
Subsidiaries of any liability arising under any Environmental Laws pending or,
to the best knowledge of FSBV and the FSBV Subsidiaries, threatened against (A)
FSBV or any FSBV Subsidiary, (B) any person or entity whose liability for any
Environmental Claim FSBV or any FSBV Subsidiary has or may have retained or
assumed either contractually or by operation of law, or (C) any real or personal
property which FSBV or any FSBV Subsidiary owns or leases, or has been or is
judged to have managed or to have supervised or participated in the management
of, which liability might have a material adverse effect on the business,
financial condition or results of operations of FSBV. FSBV and the FSBV
Subsidiaries are not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
(3) To the best knowledge of FSBV and the FSBV
Subsidiaries, there are no legal, administrative, arbitral or other proceedings,
or Environmental Claims or other claims, causes of action or governmental
investigations of any nature, seeking to impose, or that could result in the
imposition, on FSBV or any FSBV Subsidiary of any liability arising under any
Environmental Laws pending or threatened against any real or personal property
in which FSBV or any FSBV Subsidiary holds a security interest in connection
with a loan or a loan participation which liability might have a material
adverse effect on the business, financial condition or results of operations of
FSBV. FSBV and the FSBV Subsidiaries are not subject to any agreement, order,
judgment, decree or memorandum by or with any court, governmental authority,
regulatory agency or third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by FSBV or any FSBV Subsidiary, other than OREO, FSBV has made
available to SFB copies of any environmental audits, analyses and surveys that
have been prepared relating to such properties. With respect to all OREO held by
FSBV or any FSBV Subsidiary and all real or personal property which FSBV or any
FSBV Subsidiary has been or is judged to have managed or to have supervised or
participated in the management of, FSBV has made available to SFB the
information relating to such OREO available to FSBV. FSBV and the FSBV
Subsidiaries are in compliance in all material respects with all recommendations
contained in any environmental audits, analyses and surveys relating to any of
the properties, real or personal, described in this subsection (4).
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(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern, that could reasonably form the basis of any Environmental Claim or
other claim or action or governmental investigation that could result in the
imposition of any liability arising under any Environmental Laws currently in
effect or adopted but not yet effective against FSBV or any FSBV Subsidiary or
against any person or entity whose liability for any Environmental Claim FSBV or
any FSBV Subsidiary has or may have retained or assumed either contractually or
by operation of law.
(6) For the purpose of this Agreement, the following
terms shall have the following meanings:
(i) "Communication" means a communication which is of a
substantive nature and which is made (A) in writing to FSBV or any FSBV
Subsidiary on the one hand or to SFB or any SFB Subsidiary on the other hand, or
(B) orally to a senior officer of FSBV or any FSBV Subsidiary or of SFB or any
SFB Subsidiary, whether from a governmental authority or a third party.
(ii) "Environmental Claim" means any Communication from
any governmental authority or third party alleging potential liability
(including, without limitation, potential liability for investigatory costs,
cleanup costs, governmental response costs, natural resources damages, property
damages, personal injuries, or penalties) arising out of, based on or resulting
from the presence, or release into the environment, of any Material of
Environmental Concern.
(iii) "Environmental Laws" means all applicable federal,
state and local laws and regulations, including the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended, that relate to
pollution or protection of human health or the environment (including, without
limitation, ambient air, surface water, ground water, land surface or subsurface
strata). This definition includes, without limitation, laws and regulations
relating to emissions, discharges, releases or threatened releases of Materials
of Environmental Concern, or otherwise relating to the manufacture, processing,
distribution, use, treatment, storage, disposal, transport or handling of
Materials of Environmental Concern.
(iv) "Materials of Environmental Concern" means
pollutants, contaminants, wastes, toxic substances, petroleum and petroleum
products and any other materials regulated under Environmental Laws.
3.2 Representations and Warranties of SFB. SFB represents and
warrants to FSBV as follows:
(a) Organization, Standing and Power. (1) SFB is a
corporation duly organized, validly existing and in good standing under the laws
of Virginia. It has all requisite corporate power and authority to carry on its
business as now being conducted and to own and operate its assets, properties
and business, and SFB has the corporate power and authority to execute and
deliver this Agreement and perform the respective terms of this Agreement and
the Plan. SFB
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is duly registered as a bank holding company under the Bank Holding Company Act
of 1956. Southern Financial Bank, a wholly owned subsidiary of SFB, is a
Virginia corporation and a Virginia state bank, duly organized, validly existing
and in good standing under the laws of Virginia, is in compliance in all
material respects with all rules and regulations promulgated by any relevant
regulatory authority, and it has all requisite corporate power and authority to
carry on a commercial banking business as now being conducted and to own and
operate its assets, properties and business.
(2) SFB has Previously Disclosed its subsidiary
corporations (and the subsidiaries thereof), all of which are duly organized,
validly existing and in good standing in their respective states of
incorporation and which have all requisite corporate power and authority to
carry on their businesses as now being conducted and to own and operate their
assets, properties and business (the "SFB Subsidiaries" and, collectively with
SFB, the "SFB Companies"). Each SFB Subsidiary that is a depository institution
is an "insured bank" as defined in the Federal Deposit Insurance Act and
applicable regulations thereunder. All of the shares of capital stock of the SFB
Subsidiaries held by SFB are duly and validly issued, fully paid and
nonassessable, and all such shares are owned by SFB or a SFB Subsidiary free and
clear of any claim, lien, pledge or encumbrance of any kind, and were not issued
in violation of the preemptive rights of any shareholder or in violation of any
agreement or of any registration or qualification provisions of federal or state
securities laws. Except as Previously Disclosed, none of the SFB Companies owns
any equity securities of any other corporation or entity. Except as Previously
Disclosed, each of the SFB Companies is in good standing as a foreign
corporation in each jurisdiction where the properties owned, leased or operated,
or the business conducted, by it require such qualification and where failure to
so qualify either singly or in the aggregate would have a material adverse
effect on the financial condition, properties, businesses or results of
operations of the SFB Companies.
(b) Authority. (1) The execution and delivery of this
Agreement and the Plan of Merger and the consummation of the Reorganization have
been duly and validly authorized by all necessary corporate action on the part
of SFB, except the approval of shareholders. The Agreement represents the legal,
valid, and binding obligation of SFB, enforceable against SFB in accordance with
its terms (except in all such cases as enforceability may be limited by
applicable bankruptcy, insolvency, reorganization, moratorium or similar laws
affecting the enforcement of creditors' rights generally and except that the
availability of the equitable remedy of specific performance or injunctive
relief is subject to the discretion of the court before which any proceeding may
be brought).
(2) Neither the execution and delivery of the Agreement,
the consummation of the transactions contemplated therein, nor the compliance by
SFB with any of the provisions thereof will (i) conflict with or result in a
breach of any provision of the Articles of Incorporation or Bylaws of SFB, (ii)
except as Previously Disclosed, constitute or result in the breach of any term,
condition or provision of, or constitute default under, or give rise to any
right of termination, cancellation or acceleration with respect to, or result in
the creation of any lien, charge or encumbrance upon, any property or assets of
the SFB Companies pursuant to (A) any note, bond, mortgage, indenture, or (B)
any material license, agreement, lease or other instrument or obligation, to
which any of the SFB Companies is a party or by which any of them or any of
their properties or assets may be bound, or (iii) subject to the receipt of the
requisite approvals referred to in Section 4.7, violate any
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order, writ, injunction, decree, statute, rule or regulation applicable to any
of the SFB Companies or any of their properties or assets.
(c) Capital Structure. The authorized capital stock of
SFB consists of: 5,000,000 shares of common stock, par value $.01 per share
("SFB Common Stock), of which 2,666,196 shares are issued and outstanding, fully
paid and nonassessable, not subject to shareholder preemptive rights, and not
issued in violation of any agreement to which SFB is a party or otherwise bound,
or of any registration or qualification provisions of any federal or state
securities laws; and 500,000 shares of preferred stock, par value $.01 per
share, of which 13,621 are issued and outstanding. The shares of SFB Common
Stock to be issued in exchange for shares of FSBV Common Stock upon consummation
of the Reorganization will have been duly authorized and, when issued in
accordance with the terms of this Agreement, will be validly issued, fully paid
and nonassessable and subject to no preemptive rights. Except as Previously
Disclosed, there are no outstanding understandings or commitments of any
character pursuant to which SFB and any of the SFB Companies could be required
or expected to issue shares of capital stock.
(d) Ownership of the SFB Subsidiaries; Capital Structure
of SFB Subsidiaries; and Organization of the SFB Subsidiaries. (1) SFB does not
own, directly or indirectly, 5% or more of the outstanding capital stock or
other voting securities of any corporation, bank or other organization actively
engaged in business except as Previously Disclosed (collectively the "SFB"
Subsidiaries" and each individually a "SFB Subsidiary"). The outstanding shares
of capital stock of each SFB Subsidiary have been duly authorized and are
validly issued, and are fully paid and nonassessable and all such shares are
directly or indirectly owned by SFB free and clear of all liens, claims and
encumbrances. No Rights are authorized, issued or outstanding with respect to
the capital stock of any SFB Subsidiary and there are no agreements,
understandings or commitments relating to the right of SFB to vote or to dispose
of said shares. None of the shares of capital stock of any SFB Subsidiary has
been issued in violation of the preemptive rights of any person.
(2) Each SFB Subsidiary is a duly organized corporation,
validly existing and in good standing under applicable laws. Each SFB Subsidiary
(i) has full corporate power and authority to own, lease and operate its
properties and to carry on its business as now conducted except where the
absence of such power or authority would not have a material adverse effect on
the financial condition, results of operations or business of SFB on a
consolidated basis, and (ii) is duly qualified to do business in the states of
the United States and foreign jurisdictions where its ownership or leasing of
property or the conduct of its business requires such qualification and where
failure to so qualify would have a material adverse effect on the financial
condition, results of operations or business of SFB on a consolidated basis.
Each SFB Subsidiary has all federal, state, local and foreign governmental
authorizations and licenses necessary for it to own or lease its properties and
assets and to carry on its business as it is now being conducted, except where
failure to obtain such authorization or license would not have a material
adverse effect on the business of such SFB Subsidiary.
(e) Financial Statements. SFB's Annual Report on Form
10-K for the fiscal year ended December 31, 1999, and all other documents filed
or to be filed subsequent to December 31, 1999 under Sections 13(a), 13(c), 14
or 15(d) of the Securities Exchange Act of 1934, as
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amended (together with the rules and regulations thereunder, the "Exchange
Act"), in the form filed with the Securities and Exchange Commission (the "SEC")
(in each such case, the "SFB Financial Statements") did not and will not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements made therein,
in light of the circumstances under which they were made, not misleading; and
each of the balance sheets in or incorporated by reference into the SFB
Financial Statements (including the related notes and schedules thereto) fairly
presents and will fairly present the financial position of the entity or
entities to which it relates as of its date and each of the statements of income
and changes in stockholders' equity and cash flows or equivalent statements in
the SFB Financial Statements (including any related notes and schedules thereto)
fairly presents and will fairly present the results of operations, changes in
stockholders' equity and changes in cash flows, as the case may be, of the
entity or entities to which it relates for the periods set forth therein, in
each case in accordance with generally accepted accounting principles
consistently applied to banks and bank holding companies during the periods
involved, except as may be noted therein, subject to normal and recurring
year-end audit adjustments in the case of unaudited statements.
(f) Absence of Undisclosed Liabilities. At December 31,
1999, none of the SFB Companies had any obligation or liability (contingent or
otherwise) of any nature which were not reflected in the SFB Financial
Statements, except for those which in the aggregate are immaterial or have been
Previously Disclosed.
(g) Legal Proceedings; Compliance with Laws. Except as
Previously Disclosed, there are no actions, suits or proceedings instituted or
pending or, to the best knowledge of SFB's management, threatened or probable of
assertion against any of the SFB Companies, or against any property, asset,
interest or right of any of them, that are reasonably expected to have, either
individually or in the aggregate, a material adverse effect on the financial
condition of SFB on a consolidated basis or that are reasonably expected to
threaten or impede the consummation of the transactions contemplated by this
Agreement. None of the SFB Companies is a party to any agreement or instrument
or subject to any judgment, order, writ, injunction, decree or rule that might
reasonably be expected to have a material adverse effect on the condition
(financial or otherwise), business or prospects of SFB on a consolidated basis.
Except as Previously Disclosed, as of the date of this Agreement, none of the
SFB Companies nor any of their properties is a party to or is subject to any
order, decree, agreement, memorandum of understanding or similar arrangement
with, or a commitment letter or similar submission to, any federal or state
governmental agency or authority charged with the supervision or regulation of
depository institutions or mortgage lenders or engaged in the insurance of
deposits which restricts or purports to restrict in any material respect the
conduct of the business of it or any of its subsidiaries or properties, or in
any manner relates to the capital, liquidity, credit policies or management of
it; and except as Previously Disclosed, none of the SFB Companies has been
advised by any such regulatory authority that such authority is contemplating
issuing or requesting (or is considering the appropriateness of issuing or
requesting) any such order, decree, agreement, memorandum of understanding,
commitment letter or similar submission. To the best knowledge of SFB, the SFB
Companies have complied in all material respects with all laws, ordinances,
requirements, regulations or orders applicable to its business (including
environmental laws, ordinances, requirements, regulations or orders).
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(h) Regulatory Approvals. SFB knows of no reason why the
regulatory approvals referred to in Section 6.1(b) should not be obtained
without the imposition of any condition of the type referred to in Section
6.1(b). SFB has received no advice or information from any regulatory authority
indicating that such approvals will be denied or are doubtful. There has not
been any adverse change in the business or financial condition, operations,
properties, prospects or capitalization of SFB since the end of its most
recently completed fiscal year that is reasonably likely to have a Material
Adverse Effect on its ability to consummate the transactions contemplated by
this Agreement and as of the date of this Agreement, no event, occurrence or
development of any nature is existing or, to the knowledge of SFB, threatened,
which would reasonably be expected to have such an effect on SFB's ability to
consummate such transactions.
(i) Labor Relations. None of the SFB Companies is a party
to, or is bound by any collective bargaining agreement, contract or other
agreement or understanding with a labor union or labor organization, nor is it
the subject of a proceeding asserting that it has committed an unfair labor
practice (within the meaning of the National Labor Relations Act) or seeking to
compel it to bargain with any labor organization as to wages and conditions of
employment, nor is there any strike or other labor dispute involving it, pending
or, to the best of its knowledge, threatened, nor is it aware of any activity
involving its employees seeking to certify a collective bargaining unit or
engaging in any other organizational activity.
(j) Tax Matters. The SFB Companies have filed all
federal, state, and local tax returns and reports required to be filed, and all
taxes shown by such returns to be due and payable have been paid or are
reflected as a liability in the SFB Financial Statements or are being contested
in good faith and have been Previously Disclosed. Except to the extent that
liabilities therefor are specifically reflected in the SFB Financial Statements,
there are no federal, state or local tax liabilities of the SFB Companies other
than liabilities that have arisen since December 31, 1999, all of which have
been properly accrued or otherwise provided for on the books and records of the
SFB Companies. Except as Previously Disclosed, no tax return or report of any of
the SFB Companies is under examination by any taxing authority or the subject of
any administrative or judicial proceeding, and no unpaid tax deficiency has been
asserted against any of the SFB Companies by any taxing authority.
(k) Property. Except as disclosed or reserved against in
the SFB Financial Statements, all of the SFB Companies have good and marketable
title free and clear of all material liens, encumbrances, charges, defaults or
equities of whatever character to all of the material properties and assets,
tangible or intangible, reflected in the SFB Financial Statements as being owned
by the SFB Companies as of the dates thereof. To the best knowledge of SFB, all
buildings, and all fixtures, equipment, and other property and assets which are
material to its business on a consolidated basis, held under leases or subleases
by the SFB Companies are held under valid instruments enforceable in accordance
with their respective terms, subject to bankruptcy, insolvency, reorganization,
moratorium and similar laws. The buildings, structures, and appurtenances owned,
leased, or occupied by the SFB Companies are, to the best knowledge of SFB, in
good operating condition, in a state of good maintenance and repair and (i)
comply with applicable zoning and other municipal laws and regulations, and (ii)
there are no latent defects therein.
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(l) Reports. Since January 1, 1996, the SFB Companies
have filed all reports and statements, together with any amendments required to
be made with respect thereto, that were required to be filed with the SEC, the
Federal Reserve, the SCC, and any other governmental or regulatory authority or
agency having jurisdiction over their operations.
(m) Employee Benefit Plans. (1) SFB will deliver for
FSBV's review, as soon as practicable, true and complete copies of all material
pension, retirement, profit-sharing, deferred compensation, stock option, bonus,
vacation or other material incentive plans or agreements, all material medical,
dental or other health plans, all life insurance plans and all other material
employee benefit plans or fringe benefit plans, including, without limitation,
all "employee benefit plans" as that term is defined in Section 3(3) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"), currently
adopted, maintained by, sponsored in whole or in part by, or contributed to by
SFB for the benefit of employees, retirees or other beneficiaries eligible to
participate (collectively, the "SFB Benefit Plans"). Any of the SFB Benefit
Plans which is an "employee pension benefit plan," as that term is defined in
Section 3(2) of ERISA, is referred to herein as a "SFB ERISA Plan." No SFB
Benefit Plan is or has been a multi-employer plan within the meaning of Section
3(37) of ERISA.
(2) Except as Previously Disclosed, all SFB Benefit Plans
are in compliance with the applicable terms of ERISA and the Internal Revenue
Code of 1986, as amended (the "IRC") and any other applicable laws, rules and
regulations the breach or violation of which could result in a material
liability to SFB on a consolidated basis.
(3) No SFB ERISA Plan which is a defined benefit pension
plan has any "unfunded current liability," as that term is defined in Section
302(d)(8)(A) of ERISA, and the present fair market value of the assets of any
such plan exceeds the plan's "benefit liabilities," as that term is defined in
Section 4001(a)(16) of ERISA, when determined under actuarial factors that would
apply if the plan was terminated in accordance with all applicable legal
requirements.
(n) Investment Securities. Except for pledges to secure
public and trust deposits and obligations under agreements pursuant to which any
of the SFB Companies has sold securities subject to an obligation to repurchase,
none of the investment securities reflected in the SFB Financial Statements is
subject to any restriction, contractual, statutory, or otherwise, which would
impair materially the ability of the holder of such investment to dispose freely
of any such investment at any time. With respect to any agreements pursuant to
which any of the SFB Companies has purchased securities subject to any agreement
to resell, it has a valid, perfected first lien or security interest in the
government securities or other collateral securing such agreement, and the value
of such collateral equals or exceeds the amount of the debt secured thereby.
(o) Certain Contracts. (1) Except as Previously
Disclosed, neither SFB nor any SFB subsidiary is a party to, or is bound by, (i)
any material agreement, arrangement or commitment, (ii) any agreement, indenture
or other instrument relating to the borrowing of money by SFB or any SFB
Subsidiary or the guarantee by SFB or any SFB Subsidiary of any such obligation,
(iii) any agreement, arrangement or commitment relating to the employment of a
consultant or the employment, election, retention in office or severance of any
present or former director or officer, (iv) any agreement to make loans or for
the provision, purchase or sale of goods,
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services or property between SFB or any SFB Subsidiary and any director or
officer of SFB or any SFB Subsidiary, or any member of the immediate family or
affiliate of any of the foregoing, or (v) any agreement between SFB or any SFB
Subsidiary and any 5% or more shareholder of SFB; in each case other than
agreements entered into in the ordinary course of the banking business of SFB or
a SFB Subsidiary consistent with past practice.
(2) Neither SFB or any SFB Subsidiary, nor to the
knowledge of SFB, the other party thereto, is in default under any material
agreement, commitment, arrangement, lease, insurance policy or other instrument
whether entered into in the ordinary course of business or otherwise, nor has
there occurred any event that, with the lapse of time or giving of notice or
both, would constitute such a default, other than defaults of loan agreements by
borrowers from SFB or a SFB Subsidiary in the ordinary course of its business.
(p) Insurance. A complete list of all policies or binders
of fire, liability, product liability, workmen's compensation, vehicular and
other insurance held by or on behalf of the SFB Companies has previously been
furnished to FSBV and all such policies or binders are valid and enforceable in
accordance with their terms, are in full force and effect, and insure against
risks and liabilities to the extent and in the manner customary for the industry
and are deemed appropriate and sufficient by SFB. The SFB Companies are not in
default with respect to any provision contained in any such policy or binder and
have not failed to give any notice or present any claim under any such policy or
binder in due and timely fashion. None of the SFB Companies has received notice
of cancellation or non-renewal of any such policy or binder. None of the SFB
Companies has knowledge of any inaccuracy in any application for such policies
or binders, any failure to pay premiums when due or any similar state of facts
or the occurrence of any event that is reasonably likely to form the basis for
any material claim against it not fully covered (except to the extent of any
applicable deductible) by the policies or binders referred to above. None of the
SFB Companies has received notice from any of its insurance carriers that any
insurance premiums will be increased materially in the future or that any such
insurance coverage will not be available in the future on substantially the same
terms as now in effect.
(q) Loans, OREO, and Allowance for Loan Losses. (1)
Except as Previously Disclosed, and except for matters which individually or in
the aggregate, do not materially adversely affect the Reorganization or the
financial condition of SFB, to SFB's best knowledge each loan reflected as an
asset in the SFB Financial Statements (i) is evidenced by notes, agreements, or
other evidences of indebtedness which are true, genuine and what they purport to
be, (ii) to the extent secured, has been secured by valid liens and security
interests which have been perfected, and (iii) is the legal, valid and binding
obligation of the obligor named therein, enforceable in accordance with its
terms, subject to bankruptcy, insolvency, and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles. All loans and extensions of credit which are subject to regulation
of the Federal Reserve which have been made by SFB and the SFB Subsidiaries
comply therewith.
(2) The classification on the books and records of SFB
and each SFB Subsidiary of loans and/or non-performing assets as nonaccrual,
troubled debt restructuring, OREO or other similar classification, complies in
all material respects with generally accepted accounting principles and
applicable regulatory accounting principles.
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(3) Except for liens, security interests, claims,
charges, or such other encumbrances as have been appropriately reserved for in
the SFB Financial Statements or are not material, title to the OREO is good and
marketable, and there are no adverse claims or encumbrances on the OREO. All
title, hazard and other insurance claims and mortgage guaranty claims with
respect to the OREO have been timely filed and neither SFB nor any SFB
Subsidiary has been received any notice of denial of any such claim.
(4) SFB and each SFB Subsidiary are in possession of all
of the OREO or, if any of the OREO remains occupied by the mortgagor, eviction
or summary proceedings have been commenced or rental arrangements providing for
market rental rates have been agreed upon and SFB and/or each SFB Subsidiary are
diligently pursuing such eviction of summary proceedings or such rental
arrangements. Except as Previously Disclosed, no legal proceeding or quasi-legal
proceeding is pending or, to the knowledge of SFB and each SFB Subsidiary,
threatened concerning any OREO or any servicing activity or omission to provide
a servicing activity with respect to any of the OREO.
(5) Except as Previously Disclosed, all loans made by any
of the SFB Companies to facilitate the disposition of OREO are performing in
accordance with their terms.
(6) The allowance for possible loan losses shown on the
SFB Financial Statements was, and the allowance for possible loan losses shown
on the financial statements of SFB as of dates subsequent to the execution of
this Agreement will be, in each case as of the dates thereof, adequate in all
material respects to provide for possible losses, net of recoveries relating to
loans previously charged off, on loans outstanding (including accrued interest
receivable) of the SFB Companies and other extensions of credit (including
letters of credit and commitments to make loans or extend credit) by SFB.
(r) Absence of Material Changes and Events. Since
December 31, 1999, there has not been any material adverse change in the
condition (financial or otherwise), aggregate assets or liabilities, cash flow,
earnings or business or SFB, and SFB has conducted its business only in the
ordinary course consistent with past practice.
(s) Statements True and Correct. None of the information
supplied or to be supplied by SFB for inclusion in the Registration Statement,
the Proxy Statement/Prospectus or any other document to be filed with the SEC or
any other regulatory authority in connection with the transactions contemplated
hereby, will, at the respective time such documents are filed, and, in the case
of the Registration Statement, when it becomes effective and with respect to the
Proxy Statement/Prospectus, when first mailed to FSBV shareholders, be false or
misleading with respect to any material fact or omit to state any material fact
necessary in order to make the statements therein not misleading, or, in the
case of the Proxy Statement/Prospectus or any supplement thereto, at the time of
the FSBV Shareholders' Meeting, be false or misleading with respect to any
material fact or omit to state any material fact necessary to correct any
statement in any earlier communication with respect to the solicitation of any
proxy for the FSBV Shareholders' Meeting. All documents that SFB is responsible
for filing with the SEC or any other regulatory authority in connection with the
transactions contemplated, hereby will comply as to form in all material
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respects with the provisions of applicable law, including applicable provisions
of federal and state securities law.
(t) Brokers and Finders. Neither SFB nor any SFB
Subsidiary, nor any of their respective officers, directors or employees, has
employed any broker, finder or financial advisor or incurred any liability for
any fees or commissions in connection with the transactions contemplated herein,
except for the McKinnon & Company, Inc..
(u) Administration of Trust Accounts. SFB and SFB
Subsidiaries have properly administered, in all respects material and which
could reasonably be expected to be material to the business, operations or
financial condition of SFB and SFB Subsidiaries, taken as a whole, all accounts
for which they act as fiduciaries including but not limited to accounts for
which they serve as trustees, agents, custodians, personal representatives,
guardians, conservators or investment advisors, in accordance with the terms of
the governing documents and applicable state and federal law and regulation and
common law. Neither SFB nor a SFB Subsidiary, nor any director, officer or
employee of SFB or a SFB Subsidiary has committed any breach of trust with
respect to any such fiduciary account which is material to or could reasonably
be expected to be material to the business, operations or financial condition of
SFB, or a SFB Subsidiary, taken as a whole, and the accountings for each such
fiduciary account are true and correct in all material respects and accurately
reflect the assets of such fiduciary account in all material respects.
(v) Environmental Matters. (1) Except as Previously
Disclosed, to the best of SFB's knowledge, neither SFB nor any SFB Subsidiary
owns or leases any properties affected by toxic waste, radon gas or other
hazardous conditions or constructed in part with the use of asbestos. Each of
SFB and the SFB Subsidiaries is in substantial compliance with all Environmental
Laws applicable to real or personal properties in which it has a direct fee
ownership or, with respect to a direct interest as lessee, applicable to the
leasehold premises or, to the best knowledge of SFB and the SFB Subsidiaries,
the premises on which the leasehold is situated. Neither SFB nor any SFB
Subsidiary has received any Communication alleging that SFB or such SFB
Subsidiary is not in such compliance and, to the best knowledge of SFB and the
SFB Subsidiaries, there are no present circumstances (including Environmental
Laws that have been adopted but are not yet effective) that would prevent or
interfere with the continuation of such compliance.
(2) There are no legal, administrative, arbitral or other
claims, causes of action or governmental investigations of any nature, seeking
to impose, or that could result in the imposition, on SFB and the SFB
Subsidiaries of any liability arising under any Environmental Laws pending or,
to the best knowledge of SFB and the SFB Subsidiaries, threatened against (A)
SFB or any SFB Subsidiary, (B) any person or entity whose liability for any
Environmental Claim, SFB or any SFB Subsidiary has or may have retained or
assumed either contractually or by operation of law, or (C)any real or personal
property which SFB or any SFB Subsidiary owns or leases, or has been or is
judged to have managed or to have supervised or participated in the management
of, which liability might have a material adverse effect on the business,
financial condition or results of operations of SFB. SFB and the SFB
Subsidiaries are not subject to any agreement, order, judgment, decree or
memorandum by or with any court, governmental authority, regulatory agency or
third party imposing any such liability.
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(3) To the best knowledge of SFB and the SFB
Subsidiaries, there are no legal, administrative, arbitral or other proceedings,
or Environmental Claims or other claims, causes of action or governmental
investigations of any nature, seeking to impose, or that could result in the
imposition, on SFB or any SFB Subsidiary of any liability arising under any
Environmental Laws pending or threatened against any real or personal property
in which SFB or any SFB Subsidiary holds a security interest in connection with
a loan or a loan participation which liability might have a material adverse
effect on the business, financial condition or results of operations of SFB. SFB
and the SFB Subsidiaries are not subject to any agreement, order, judgment,
decree or memorandum by or with any court, governmental authority, regulatory
agency or third party imposing any such liability.
(4) With respect to all real and personal property owned
or leased by SFB or any SFB Subsidiary, other than OREO, SFB has made available
to FSBV copies of any environmental audits, analyses and surveys that have been
prepared relating to such properties. With respect to all OREO held by SFB or
any SFB Subsidiary and all real or personal property which SFB or any SFB
Subsidiary has been or is judged to have managed or to have supervised or
participated in the management of, SFB has made available to FSBV the
information relating to such OREO available to SFB. SFB and the SFB Subsidiaries
are in compliance in all material respects with all recommendations contained in
any environmental audits, analyses and surveys relating to any of the
properties, real or personal, described in this subsection (4).
(5) There are no past or present actions, activities,
circumstances, conditions, events or incidents, including, without limitation,
the release, emission, discharge or disposal of any Materials of Environmental
Concern, that could reasonably form the basis of any Environmental Claim or
other claim or action or governmental investigation that could result in the
imposition of any liability arising under any Environmental Laws currently in
effect or adopted but not yet effective against SFB or any SFB Subsidiary or
against any person or entity whose liability for any Environmental Claim SFB or
any SFB Subsidiary has or may have retained or assumed either contractually or
by operation of law.
ARTICLE 4
Conduct Prior to the Effective Date
4.1 Access to Records and Properties. FSBV will keep SFB, and SFB
will keep FSBV advised of all material developments relevant to their respective
businesses prior to consummation of the Reorganization. Prior to the Effective
Date, SFB, on the one hand, and FSBV on the other, agree to give to the other
party reasonable access to all the premises and books and records (including tax
returns filed and those in preparation) of it and its subsidiaries and to cause
its officers to furnish the other with such financial and operating data and
other information with respect to the business and properties as the other shall
from time to time request for the purposes of verifying the warranties and
representations set forth herein; provided, however, that any such investigation
shall be conducted in such manner as not to interfere unreasonably with the
operation of the respective business of the other.
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4.2 Confidentiality. Between the date of this Agreement and the
Effective Date, SFB and FSBV each will maintain in confidence, and cause its
directors, officers, employees, agents and advisors to maintain in confidence,
and not use to the detriment of the other party, any written, oral or other
information obtained in confidence from the other party or a third party in
connection with this Agreement or the transactions contemplated hereby unless
such information is already known to such party or to others not bound by a duty
of confidentiality or unless such information becomes publicly available through
no fault of such party, unless use of such information is necessary or
appropriate in making any filing or obtaining any consent or approval required
for the consummation of the transactions contemplated hereby or unless the
furnishing or use of such information is required by or necessary or appropriate
in connection with legal proceedings. If the Reorganization is not consummated,
each party will return or destroy as much of such written information as may
reasonably be requested.
4.3 Registration Statement, Proxy Statement and Shareholder
Approval. The Board of Directors of FSBV will duly call and will hold a meeting
of its shareholders as soon as practicable for the purpose of approving the
Reorganization (the "FSBV Shareholders' Meeting" and, subject to the fiduciary
duties of the Board of Directors of FSBV (as advised in writing by its counsel),
FSBV shall use its best efforts to solicit and obtain votes of the holders of
its Common Stock in favor of the Reorganization and will comply with the
provisions in its Articles of Incorporation and Bylaws relating to the call and
holding of a meeting of shareholders for such purpose; each member of the Board
of Directors of FSBV shall vote all shares of FSBV Common Stock under his or her
control (and not held in a fiduciary capacity) in favor of the Reorganization;
and FSBV shall, at the request of SFB, but subject to the fiduciary duties of
FSBV's board of directors, recess or adjourn the meeting if fewer than
two-thirds of the issued and outstanding shares of FSBV Common Stock have voted
by proxy or in person in favor of the Reorganization and such recess or
adjournment is deemed by SFB to be necessary or desirable. SFB and FSBV will
prepare jointly the proxy statement/prospectus to be used in connection with the
FSBV Shareholders' Meeting (the "Proxy Statement"). SFB will prepare and file
with the SEC the Registration Statement, of which such Proxy Statement shall be
a part and will use its best efforts to have the Registration Statement declared
effective as promptly as possible. The Registration Statement will cover the
shares of SFB Common Stock to be issued in the Reorganization and shares of SFB
Common Stock that will be issuable upon the exercise of FSBV stock options that
become SFB stock options pursuant to Section 5.1
When the Registration Statement or any post-effective amendment or
supplement thereto shall become effective, and at all times subsequent to such
effectiveness, up to and including the date of the Meeting, such Registration
Statement and all amendments or supplements thereto, with respect to all
information set forth therein furnished or to be furnished by FSBV relating to
FSBV and by SFB relating to the SFB Companies, (i) will comply in all material
respects with the provisions of the Securities Act of 1933 and any other
applicable statutory or regulatory requirements, including applicable state
blue-sky and securities laws, and (ii) will not contain any untrue statement of
a material fact or omit to state a material fact required to be stated therein
or necessary to make the statements contained therein not misleading; provided,
however, in no event shall any party hereto be liable for any untrue statement
of a material fact or omission to state a material fact in the Registration
Statement made in reliance upon, and in conformity with, written information
concerning another party furnished by such other party specifically for use in
the
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Registration Statement. SFB will cause the SFB Common Stock to be issued in the
Reorganization to be listed on the Nasdaq National Market.
4.4 Operation of the Business of FSBV and SFB. (a) FSBV and SFB
each agrees that from the date hereof to the Effective Date it will operate its
business substantially as presently operated and only in the ordinary course,
and, consistent with such operation, it will use its best efforts to preserve
intact its relationships with persons having business dealings with it.
(b) Without limiting the generality of the foregoing, FSBV agrees
that it will not, without the prior written consent of SFB (which consent shall
not be unreasonably withheld):
(1) Make any change in its authorized capital stock, or
issue or sell any additional shares of, securities convertible into or
exchangeable for, or options, warrants or rights to purchase, its capital stock,
nor shall it purchase, redeem or otherwise acquire any of its outstanding shares
of capital stock, provided that FSBV may issue shares of common stock pursuant
to options granted or issued prior to the date hereof:
(2) Voluntarily make any changes in the composition of
its officers, directors or other key management personnel;
(3) Make any change in the compensation or title of any
officer, director or key management employee or make any change in the
compensation or title of any other employee, other than permitted by current
employment policies in the ordinary course of business, any of which changes
shall be reported promptly to the other party;
(4) Enter into any bonus, incentive compensation, stock
option, deferred compensation, profit sharing, thrift, retirement, pension,
group insurance or other benefit plan or any employment or consulting agreement;
(5) Incur any obligation or liability (whether absolute
or contingent, excluding suits instituted against it), make any pledge, or
encumber any of its assets, nor dispose of any of its assets in any other
manner, except in the ordinary course of its business and for adequate value, or
as otherwise specifically permitted in this Agreement;
(6) Except as permitted by Section 4.4(b)(1) hereof,
issue or contract to issue any shares of its Common Stock, options for shares of
its Common Stock, or securities exchangeable for or convertible into such
shares;
(7) Knowingly waive any right of substantial value:
(8) Enter into material transactions otherwise than in
the ordinary course of its business;
(9) Alter, amend or repeal its Bylaws or Articles of
Incorporation; or
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(10) Take any other action which would make any
representation or warranty in Section 3.1 or Section 3.2 hereof untrue.
4.5 Dividends. SFB and FSBV each agree that the other may declare
and pay only regular periodic cash dividends in the ordinary course of business
and consistent with past practice from the date of this Agreement through the
Effective Date.
4.6 No Solicitation. Unless and until this Agreement shall have
been terminated pursuant to its terms, neither FSBV nor any of its officers,
directors, representatives or agents shall, directly or indirectly, (i)
knowingly encourage, solicit or initiate discussions or negotiations with any
person other than SFB concerning any merger, share exchange, sale of substantial
assets, tender offer, sale of shares of capital stock or similar transaction
involving FSBV, (ii) enter into any agreement with any third party providing for
a business combination transaction, equity investment or sale of a significant
amount of assets not in the ordinary course of business, or (iii) furnish any
information to any other person relating to or in support of such transaction.
FSBV will promptly communicate to SFB the terms of any proposal which it may
receive in respect to any of the foregoing transactions.
4.7 Regulatory Filings. SFB, with FSBV's cooperation, shall
prepare all regulatory filings required to consummate the transactions
contemplated by the Agreement and the Plan of Merger and submit the filings for
approval with the Federal Reserve Board, the Office of Thrift Supervision and
the SCC, and any other governing regulatory authority, as soon as practicable
after the date hereof. SFB and FSBV shall use their best efforts to obtain
approvals of such filings.
4.8 Public Announcements. Each party will consult with the other
before issuing any press release or otherwise making any public statements with
respect to the Reorganization and shall not issue any such press release or make
any such public statement prior to such consultations except as may be required
by law.
4.9 Notice of Breach. SFB and FSBV will give written notice to the
other promptly upon becoming aware of the impending or threatened occurrence of
any event which would cause or constitute a breach of any of the
representations, warranties or covenants made to the other party in this
Agreement and will use its best efforts to prevent or promptly remedy the same.
4.10 Accounting Treatment. (a) SFB and FSBV shall each use their
best efforts to ensure that the Reorganization qualifies for
pooling-of-interests accounting treatment and shall not knowingly take action
that would cause the Reorganization to be accounted for as a purchase. However,
the availability of pooling of interests accounting treatment shall not be a
condition to either party's obligation to consummate the Reorganization.
(b) FSBV and SFB shall consult and cooperate with each
other with respect to determining the amount and the timing for recognizing for
financial accounting purposes the expenses of the Merger and the restructuring
charges related to or to be incurred in connection with the Merger, provided
that any such accounting shall be in accordance with generally accepted
accounting principles.
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(c) At the request of SFB, FSBV shall sell investment
securities in order to conform its securities portfolio to the amounts, types
and maturities that SFB deems advisable. At the request of SFB, FSBV shall
promptly establish and take such reserves and accruals as SFB shall request in
order to conform on a mutually satisfactory basis, FSBV's loan, accrual and
reserve policies to SFB's policies. It is the objective of SFB and FSBV that
such reserves, accruals and charges be taken on or before the Effective Date.
However, no such securities sales and no such reserves and
accruals shall not be deemed to have a Material Adverse Effect on FSBV, and FSBV
shall be obligated to take any such action pursuant to this Section 4.10(c)
unless and until (i) all conditions to the obligations of FSBV and SFB to
consummate the Merger set forth in Sections 6.1 through 6.3 have been waived or
satisfied by the appropriate party, and (ii) such reserves, accruals and charges
conform with generally accepted accounting principles, applicable laws,
regulations, and the requirements of governmental entities.
4.11 Reorganization Consummation. Subject to the terms and
conditions of this Agreement, each party shall use its best efforts in good
faith to take, or cause to be taken, all actions, and to do or cause to be done
all things necessary, proper or desirable, or advisable under applicable laws,
as promptly as practicable so as to permit consummation of the Reorganization at
the earliest possible date, consistent with Section 1.3 herein, and to otherwise
enable consummation of the transactions contemplated hereby and shall cooperate
fully with the other parties hereto to that end, and each of FSBV and SFB shall
use, and shall cause each of their respective subsidiaries to use, its best
efforts to obtain all consents (governmental or other) necessary or desirable
for the consummation of the transactions contemplated by this Agreement.
ARTICLE 5
Additional Agreements
5.1 Conversion of Stock Options. (a) On the Effective Date, all
rights with respect to FSBV Common Stock pursuant to stock options ("FSBV
Options") granted by FSBV which are outstanding on the Effective Date, whether
or not they are exercisable, shall be converted into and become rights with
respect to SFB Common Stock, and SFB shall assume each FSBV Option in accordance
with the terms of the stock option plan under which it was issued or the stock
option agreement, board resolution or other document by which it is evidenced.
From the Effective Date forward, (i) each FSBV Option assumed by SFB may be
exercised solely for shares of SFB Common Stock, (ii) the number of shares of
SFB Common Stock subject to each FSBV Option shall be equal to the number of
shares of FSBV Common Stock subject to such option immediately prior to the
Effective Date multiplied by the Exchange Ratio and (iii) the per share exercise
price under each such FSBV Option shall be adjusted by dividing the per share
exercise price under each such option by the Exchange Ratio and rounding down to
the nearest cent; provided, however, that the terms of each FSBV Option shall,
in accordance with its terms, be subject to further adjustment as appropriate to
reflect any stock split, stock dividend, recapitalization or other similar
transaction after the Effective Date. It is intended that the foregoing
assumption shall be undertaken in a manner that will not constitute a
"modification" as defined in Section 424 of the Code, as to any stock option
which is an "incentive stock option."
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5.2 Benefit Plans. Upon consummation of the Reorganization, as
soon as administratively practicable and subject to SFB's best efforts,
employees of FSBV shall be entitled to participate in SFB pension, benefit,
health and similar plans on the same terms and conditions as employees of SFB
and its subsidiaries, without waiting periods or exceptions for pre-existing
conditions and giving effect to years of service with FSBV as if such service
were with SFB. SFB also shall honor in accordance with their terms as in effect
on the date hereof (or as amended after the date hereof with the prior written
consent of SFB), all employment, severance, consulting and other compensation
contracts and agreements and arrangements Previously Disclosed at Section 5.3 of
the FSBV disclosure letter. FSBV shall take all steps necessary to terminate its
401(k) Plan as promptly as possible and prior to the Effective Date, and to file
as soon as possible, an Application For Determination with the Internal Revenue
Service regarding tax qualification upon termination.
5.3 Indemnification. SFB agrees that following the Effective Date,
it shall indemnify and hold harmless any person who has rights to
indemnification from FSBV, to the same extent and on the same conditions as such
person is entitled to indemnification pursuant to Virginia law and FSBV's
Articles of Incorporation or Bylaws, as in effect on the date of this Agreement,
to the extent legally permitted to do so, with respect to matters occurring on
or prior to the Effective Date. SFB further agrees that any such person who has
rights to indemnification pursuant to this Section 5.4 is expressly made a third
party beneficiary of this Section 5.4 and may directly, in such person's
personal capacity, enforce such rights through an action at law or in equity or
through any other manner or means of redress allowable under Virginia law to the
same extent as if such person were a party hereto. Without limiting the
foregoing, in any case in which corporate approval may be required to effectuate
any indemnification, SFB shall direct, at the election of the party to be
indemnified, that the determination of permissibility of indemnification shall
be made by independent counsel mutually agreed upon between SFB and the
indemnified party. SFB shall apply to its directors' and officers' liability
insurance carrier for coverage for persons who are currently covered by such
insurance of FSBV for a period of three years after the Effective Date.
ARTICLE 6
Conditions to the Reorganization
6.1 Conditions to Each Party's Obligations to Effect the
Reorganization. The respective obligations of each of SFB and FSBV to effect the
Reorganization and the other transactions contemplated by this Agreement shall
be subject to the fulfillment or waiver at or prior to the Effective Date of the
following conditions:
(a) Shareholder Approval. Shareholders of FSBV shall have
approved all matters relating to this Agreement and the Reorganization required
to be approved by such shareholders in accordance with Virginia law.
(b) Regulatory Approvals. This Agreement and the Plan of
Merger shall have been approved by the Federal Reserve, the SCC, and any other
regulatory authority whose approval is required for consummation of the
transactions contemplated hereby, and such approvals shall not have imposed any
condition or requirement which would so materially adversely impact the
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economic or business benefits of the transactions contemplated by this Agreement
as to render inadvisable the consummation of the Reorganization in the
reasonable opinion of the Board of Directors of SFB or FSBV.
(c) Registration Statement. The Registration Statement
shall have been declared effective and shall not be subject to a stop order or
any threatened stop order.
(d) Tax Opinion. SFB and FSBV shall have received an
opinion of Williams, Mullen, Clark & Dobbins, or other counsel reasonably
satisfactory to SFB and FSBV, to the effect that the Reorganization will
constitute a reorganization within the meaning of Section 368 of the Internal
Revenue Code and that no gain or loss will be recognized by the shareholders of
FSBV to the extent they receive SFB Common Stock solely in exchange for their
FSBV Common Stock in the Reorganization.
(e) Opinions of Counsel. FSBV shall have delivered to SFB
and SFB shall have delivered to FSBV opinions of counsel, dated as of the
Effective Date, as to such matters as they may each reasonably request with
respect to the transactions contemplated by this Agreement and in a form
reasonably acceptable to each of them.
(f) Legal Proceedings. Neither SFB nor FSBV shall be
subject to any order, decree or injunction of a court or agency of competent
jurisdiction which enjoins or prohibits the consummation of the Reorganization.
6.2 Conditions to Obligations of SFB. The obligations of SFB to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of FSBV shall be true and
correct as of the date of this Agreement and upon the Effective Date with the
same effect as though all such representations and warranties had been made on
the Effective Date, except (i) for any such representations and warranties made
as of a specified date, which shall be true and correct in all material respects
as of such date, (ii) as expressly contemplated by this Agreement, or (iii) for
representations and warranties the inaccuracies of which relate to matters that,
individually or in the aggregate, do not materially adversely affect the
Reorganization and the other transactions contemplated by this Agreement and SFB
shall have received a certificate or certificates signed by the Chief Executive
Officer and Chief Financial Officer of FSBV dated the Effective Date, to such
effect.
(b) Performance of Obligations. FSBV shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective Date, and SFB shall have received a
certificate signed by the Chief Executive Officer of FSBV to that effect.
(c) Affiliate Letters. Each shareholder of FSBV who may
be deemed by counsel for SFB to be an "affiliate" of FSBV within the meaning of
Rule 145 under the Securities Act of 1933 shall have executed and delivered a
commitment and undertaking to the effect that (1)
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such shareholder will dispose of the shares of SFB Common Stock received by him
in connection with the Reorganization only in accordance with the provisions of
paragraph (d) of Rule 145 and, if applicable, in a manner that would not prevent
the Reorganization from qualifying for pooling-of-interests accounting
treatment; (2) such shareholders will not dispose of any such shares until SFB
has received an opinion of counsel acceptable to it that such proposed
disposition will not violate the provisions of any applicable securities laws;
and (3) the certificates representing said shares may bear a conspicuous legend
referring to the forgoing restrictions.
(d) Investment Banking Letter. SFB shall have received a
written opinion in form and substance satisfactory to SFB from McKinnon &
Company, Inc. addressed to SFB and dated the date the Proxy Statement/Prospectus
is mailed to shareholders of SFB, to the effect that the terms of the
Reorganization, including the Exchange Ratio, are fair, from a financial point
of view, to SFB.
6.3 Conditions to Obligations of FSBV. The obligations of FSBV to
effect the Reorganization shall be subject to the fulfillment or waiver at or
prior to the Effective Date of the following additional conditions:
(a) Representations and Warranties. Each of the
representations and warranties contained herein of SFB shall be true and correct
as of the date of this Agreement and upon the Effective Date with the same
effect as though all such representations and warranties had been made on the
Effective date, except (i) for any such representations and warranties made as
of a specified date, which shall be true and correct as of such date, (ii) as
expressly contemplated by this Agreement, or (iii) for representations and
warranties the inaccuracies of which relate to matters that, individually or in
the aggregate, do not materially adversely affect the Reorganization and the
other transactions contemplated by this Agreement and FSBV shall have received a
certificate or certificates signed by the Chief Executive Officer and Chief
Financial Officer of SFB dated the Effective Date, to such effect.
(b) Performance of Obligations. SFB shall have performed
in all material respects all obligations required to be performed by it under
this Agreement prior to the Effective Date, and FSBV shall have received a
certificate signed by Chief Executive Officer of SFB to that effect.
(c) Investment Banking Letter. FSBV shall have received a
written opinion in form and substance satisfactory to FSBV from RP Financial LC
addressed to FSBV and dated the date the Proxy Statement/Prospectus is mailed to
shareholders of FSBV, to the effect that the terms of the Reorganization,
including the Exchange Ratio, are fair, from a financial point of view, to FSBV.
ARTICLE 7
Termination
7.1 Termination. Notwithstanding any other provision of this
Agreement, and notwithstanding the approval of this Agreement and the Plan of
Merger by the shareholders of SFB
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and FSBV, this Agreement may be terminated and the Reorganization abandoned at
any time prior to the Effective Date:
(a) By the mutual consent of the Board of Directors of
each of SFB and FSBV;
(b) By the respective Boards of Directors of SFB or FSBV
if the conditions set forth in Section 6.1 have not been met or waived by SFB
and FSBV;
(c) By the Board of Directors of SFB if the conditions
set forth in Section 6.2 have not been met or waived by SFB;
(d) By the Board of Directors of FSBV if the conditions
set forth in Section 6.3 have not been met or waived by FSBV;
(e) By the respective Boards of Directors SFB or FSBV if
the Reorganization is not consummated by February 28, 2001.
7.2 Effect of Termination. In the event of the termination and
abandonment of this agreement and the Reorganization pursuant to Section 7.1,
this Agreement shall become void and have no effect, except that (i) the last
sentence of Section 4.2 and all of Sections 4.8 and 7.4 shall survive any such
termination and abandonment and (ii) no party shall be relieved or released from
any liability arising out of an intentional breach of any provision of this
Agreement.
7.3 Non-Survival of Representations, Warranties and Covenants.
Except for Sections 1.2, 1.4, 2.1, 2.2, 2.3, 2.4, 5.3, 5.4 and 7.4 of this
Agreement, none of the respective representations and warranties, obligations,
covenants and agreements of the parties shall survive the Effective Date,
provided that no such representations, warranties, obligations, covenants and
agreements shall be deemed to be terminated or extinguished so as to deprive SFB
or FSBV (or any director, officer, or controlling person thereof) of any defense
in law or equity which otherwise would be available against the claims of any
person, including without limitation any shareholder or former shareholder of
either SFB or FSBV.
7.4 Expenses. The parties provide for the payment of expenses as
follows:
(a) Except as provided in this Section 7.4(a) or in
Section 7.4(b) below, each of the parties shall bear and pay all costs and
expenses incurred by it or on its behalf in connection with the transactions
contemplated herein, including fees and expenses of its own consultants,
investment bankers, accountants and counsel.
(b) Notwithstanding the provisions of Section 7.4(a)
hereof, if for any reason the Reorganization is not approved by the shareholders
of FSBV as required, that party shall bear and pay 50% of the costs and expenses
incurred by SFB with respect to the fees and expenses of accountants, counsel,
printers and persons involved in the transactions contemplated by this
Agreement, including the preparation of the Registration Statement and the Joint
Proxy Statement.
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(c) If this Agreement is terminated by SFB or FSBV
because of a willful and material breach by the other of any representation,
warranty, covenant, undertaking or restriction set forth herein, and provided
that the terminating party shall not have been in breach (in any material
respect) of any representation and warranty, covenant, undertaking or
restriction contained herein, then the breaching party shall bear and pay all
such costs and expenses of the other party, including fees and expenses of
consultants, investment bankers, accountants, counsel, printers, and persons
involved in the transactions contemplated by this Agreement, including the
preparation of the Registration Statement and the Joint Proxy Statement.
(d) Any liability to the other incurred by FSBV or SFB
pursuant to this Section 7.4 shall not exceed a total of $100,000.
(e) Final settlement with respect to the payment of such
fees and expenses by the parties shall be made within thirty (30) days after the
termination of this Agreement.
7.5 Termination Fee. If this Agreement terminates other than under
Section 7.1(g) and, after the date of this Agreement and prior to the date of
termination:
(a) FSBV shall have solicited or knowingly encouraged any
inquiry, offer or proposal from a third party to engage in a "Transaction" (as
hereafter defined) or initiated discussions or negotiations with a third party
with respect to a Transaction or FSBV receives an inquiry or unsolicited
proposal from a third party to engage in a Transaction; and
(b) within 12 months after this Agreement terminates, the
Board of Directors of FSBV determines by vote that a Transaction with such third
party is in the best interests of FSBV and its shareholders;
then, FSBV shall pay SFB the sum of One Hundred Thousand Dollars ($100,000.00);
provided, no payment under this Section 7.5 shall be due if (A) SFB wrongfully
terminates this Agreement or (B) if, at the time this Agreement terminates (y)
FSBV is entitled to terminate or to refuse to consummate the Reorganization on
the grounds that SFB has breached any representation, warranty or covenant of
SFB contained herein or (z) there has been a failure to satisfy any of the
conditions contained in Section 6.1 (other than approval of the shareholders of
FSBV), which failure has not been cured or waived by FSBV or SFB or both, as
appropriate. Any sum due under this Section 7.5 shall be paid to SFB on or
before the date on which a Transaction with another entity is agreed to in
principle and shall be paid by wire transfer in immediately available funds.
For purposes of this Section 7.5, a "Transaction" shall mean a merger,
share exchange, sale of all or substantially all assets or other combination or
plan of liquidation involving FSBV and any other entity, regardless of which
entity is the surviving entity.
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ARTICLE 8
General Provisions
8.1 Entire Agreement. This Agreement contains the entire agreement
among SFB and FSBV with respect to the Reorganization and the related
transactions and supersedes all prior arrangements or understandings with
respect thereto.
8.2 Waiver and Amendment. Any term or provision of this Agreement
may be waived in writing at any time by the party which is, or whose
shareholders are, entitled to the benefits thereof, and this Agreement may be
amended or supplemented by written instructions duly executed by the parties
hereto at any time, whether before or after the meetings of FSBV and SFB
shareholders referred to in Section 6.1(a) hereof, except statutory requirements
and requisite approvals of shareholders and regulatory authorities.
8.3 Descriptive Headings. Descriptive headings are for convenience
only and shall not control or affect the meaning and construction of any
provisions of this Agreement.
8.4 Governing Law. Except as required otherwise or otherwise
indicated herein, this Agreement shall be construed and enforced according to
the laws of the Commonwealth of Virginia.
8.5 Notices. All notices or other communications which are
required or permitted hereunder shall be in writing and sufficient if delivered
personally or sent by registered or certified mail, postage prepaid, addressed
as follows:
If to SFB:
Georgia S. Derrico
Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, Virginia 20186
(Tel. 540-349-3900)
Copy to:
Wayne A. Whitham, Jr.
Williams, Mullen, Clark & Dobbins
1021 East Cary Street
P.O. Box 1320
Richmond, Virginia 23210-1320
(Tel. 804-783-6473)
A-36
<PAGE>
If to FSBV:
Barbara J. Fried
First Savings Bank of Virginia
6551 Loisdale Court, Suite 900
Springfield, VA 22150
(Tel. 703-924-2703)
Copy to:
Cynthia R. Cross
Stradley Ronon Housley Kantarian & Bronstein, P.C.
1220 19th Street NW, Suite 700
Washington, D.C. 20036
(Tel. 202-822-9611)
8.6 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be an original, but such counterparts together
shall constitute one and the same agreement.
8.7 Severability. In the event any provisions of this Agreement
shall be held invalid or unenforceable by any court of competent jurisdiction,
such holding shall not invalidate or render unenforceable any other provisions
hereof. Any provision of this Agreement held invalid or unenforceable only in
part or degree shall remain in full force and effect to the extent not held
invalid or unenforceable. Further, the parties agree that a court of competent
jurisdiction may reform any provision of this Agreement held invalid or
unenforceable so as to reflect the intended agreement of the parties hereto.
8.8 Subsidiaries. All representations, warranties, and covenants
herein, where pertinent, include and shall apply to the wholly owned
subsidiaries belonging to the party making such representations, warranties, and
covenants.
A-37
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this
Agreement to be executed in counterparts by their duly authorized officers and
their corporate seals to be affixed hereto, all as of the dates first written
above.
SOUTHERN FINANCIAL BANCORP, INC.
By: /s/ Georgia S. Derrico
------------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
SOUTHERN FINANCIAL BANK
By: /s/ Georgia S. Derrico
------------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
FIRST SAVINGS BANK OF VIRGINIA
By: /s/ Barbara J. Fried
------------------------------------------
Barbara J. Fried
Chairman
A-38
<PAGE>
FIRST SAVINGS BANK OF VIRGINIA
BOARD OF DIRECTORS
Each of the undersigned members of the Board of Directors of First
Savings Bank of Virginia agrees to be bound by his personal obligations as
provided in Section 4.3 and 4.6 of this Agreement.
/s/ William A. Beverly
-------------------------------
William A. Beverly
/s/ Thomas W. Bradford
-------------------------------
Thomas W. Bradford
/s/ Jeffrey C. Constantz
-------------------------------
Jeffrey C. Constantz
/s/ Barbara J. Fried
-------------------------------
Barbara J. Fried
/s/ Steven L. Nadler
-------------------------------
Steven L. Nadler
/s/ Fred B. Rankin
-------------------------------
Fred B. Rankin
/s/ Adam M. Fried
-------------------------------
Adam M. Fried
/s/ Edward N. Frye
-------------------------------
Edward N. Frye
A-39
<PAGE>
EXHIBIT A
to the
Agreement and Plan
of Reorganization
PLAN OF MERGER
BETWEEN
FIRST SAVINGS BANK OF VIRGINIA
AND
SOUTHERN FINANCIAL BANCORP, INC.
Pursuant to this Plan of Merger ("Plan of Merger"), First Savings Bank
of Virginia ("FSBV"), a Virginia-chartered savings association, shall merge with
and into Southern Financial Bank, a Virginia state bank pursuant to Section
13.1-716 of the Virginia Stock Corporation Act.
ARTICLE 1
Terms of the Merger
1.1 The Merger. Subject to the terms and conditions of the
Agreement and Plan of Reorganization, dated as of March 31, 2000 between FSBV
and SFB, at the Effective Date, FSBV shall merge with and into Southern
Financial Bank. Southern Financial Bank shall be the surviving corporation. Each
outstanding share of common stock of FSBV shall be converted into shares of the
common stock of SFB in accordance with Section 2.1 of this Plan of Merger in a
merger under Section 13.1-716 of the Virginia Stock Corporation Act (the
"Merger"). At the Effective Date, the Share Exchange shall have the effect as
provided in Section 13.1-721 of the Virginia Stock Corporation Act.
1.2 Articles of Incorporation and Bylaws. The Articles of
Incorporation and Bylaws of Southern Financial Bank in effect immediately prior
to the consummation of the Share Exchange shall remain in effect following the
Effective Date until otherwise amended or repealed.
ARTICLE 2
Manner of Exchanging Shares
2.1 Conversion of Shares. Upon, and by reason of, the Merger
becoming effective pursuant to the issuance of a Certificate of Merger by the
Virginia State Corporation Commission, no cash, except as set forth in section
2.3 below, shall be allocated to the shareholders of FSBV, and stock shall be
issued and allocated as follows:
(a) Each share of common stock, par value $1.00 per
share, of FSBV ("FSBV Common Stock") issued and outstanding immediately prior to
the Effective Date shall be converted into 0.44 shares of SFB Common Stock (the
"Exchange Ratio"). Each holder of a certificate which immediately prior to the
Effective Date represented shares of FSBV Common Stock, upon the surrender of
his FSBV stock certificates to SFB, duly endorsed for transfer in accordance
with
A-40
<PAGE>
Section 2.2 below, will be entitled to receive in exchange therefor a
certificate or certificates representing the number of shares of SFB Common
Stock that such FSBV stock certificates shall entitle him to pursuant to the
Exchange Ratio. After the Effective Date, each such former holder of FSBV Common
Stock shall have the right to receive (i) any dividend or such distribution
payable at or as of any time after the Effective Date to holders of record of
SFB Common Stock at or as of any time after the Effective Date, and (ii) the
consideration described in Sections 2.1 and 2.3 upon the surrender of such
certificate in accordance with Section 2.2. In the event SFB changes the number
of shares of SFB Common Stock issued and outstanding prior to the Effective Date
as a result of any stock split, stock dividend, reclassification,
recapitalization or similar transaction with respect to the outstanding SFB
Common Stock and the record date therefor shall be prior to the Effective Date,
the Exchange Ratio shall be proportionally adjusted.
2.2 Conversion of Stock Options. (a) On the Effective Date, all
rights with respect to FSBV Common Stock pursuant to stock options ("FSBV
Options") granted by FSBV which are outstanding on the Effective Date, whether
or not then exercisable, shall be converted into and become rights with respect
to SFB Common Stock, and SFB shall assume each FSBV Option in accordance with
the terms of the stock option plan under which it was issued or the stock option
agreement, board resolution or other document by which it is evidenced. From the
Effective Date forward, (i) each FSBV Option assumed by SFB may be exercised
solely for shares of SFB Common Stock, (ii) the number of shares of SFB Common
Stock subject to each FSBV Option shall be equal to the number of shares of FSBV
Common Stock subject to such option immediately prior to the Effective Date
multiplied by the Exchange Ratio and (iii) the per share exercise price under
each such FSBV Option shall be adjusted by dividing the per share exercise price
under each such option by the Exchange Ratio and rounding down to the nearest
cent; provided, however, that the terms of each FSBV Option shall, in accordance
with its terms, be subject to further adjustment as appropriate to reflect any
stock split, stock dividend, recapitalization or other similar transaction after
the Effective Date. It is intended that the forgoing assumption shall be
undertaken in a manner that will not constitute a "modification" as defined in
Section 424 of the Code, as to any stock option which is an "incentive stock
option."
(b) Pursuant to approval of this Plan of Merger, the SFB
stock option plan shall be amended to increase the number of authorized shares
to cover the conversion of the FSBV Options into options to purchase SFB common
stock pursuant to Section 2.2(a) above and to otherwise provide for conversion
of the FSBV Options as described herein.
2.3 Manner of Exchange. As promptly as practicable after the
Effective Date, SFB shall cause Chase Mellon Shareholder Services, acting as the
exchange agent ("Exchange Agent") to send to each former shareholder of record
of FSBV immediately prior to the Effective Date transmittal materials for use in
exchanging such shareholder's certificates of FSBV Common Stock (other than
shares held by shareholders who perfect their dissenter's rights as provided
under Section 2.5 hereof) for the consideration set forth in Section 2.1 above
and Section 2.4 below. Any fractional share checks which a FSBV shareholder
shall be entitled to receive in exchange for such shareholder's shares of FSBV
Common Stock, and any dividends paid on any shares of SFB Common Stock that such
shareholder shall be entitled to receive prior to the delivery to the Exchange
Agent of such shareholder's certificates representing all of such shareholder's
shares of FSBV Common Stock will be delivered to such shareholder only upon
delivery to the Exchange
A-41
<PAGE>
Agent of the certificates representing all of such shares (or indemnity
satisfactory to SFB and the Exchange Agent, in their judgment, if any of such
certificates are lost, stolen or destroyed). No interest will be paid on any
such fractional share checks or dividends to which the holder of such shares
shall be entitled to receive upon such delivery.
2.4 Fractional Shares. In lieu of issuing fractional shares, SFB
will pay the value of such fractional shares in cash on the basis of the average
of the closing prices of SFB Common Stock as reported on the National
Association of Securities Dealers Automated Quotation National Market System for
trades reported during the ten (10) trading days immediately preceding the
Effective Date.
2.5 Dividends. No dividend or other distribution payable to the
holders of record of SFB Common Stock at or as of any time after the Effective
Date shall be paid to the holder of any certificate representing shares of FSBV
Common Stock issued and outstanding immediately prior to the Effective Date
until such holder physically surrenders such certificate for exchange as
provided in Section 2.3, promptly after which time all such dividends or
distributions shall be paid by SFB (without interest).
ARTICLE 3
Termination
This Plan of Merger may be terminated at any time prior to the
Effective Date by the parties hereto as provided in Article 7 of the Agreement
and Plan of Reorganization, dated March 31, 2000, between the parties.
A-42
<PAGE>
Appendix B
INDEX TO FINANCIAL STATEMENTS
SOUTHERN FINANCIAL BANCORP, INC.
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report of KPMG LLP........................................................................B-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1999 and 1998...............................................B-3
Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997.....................B-4
Consolidated Statement of Comprehensive Income for the years ended
December 31, 1999, 1998 and 1997........................................................................B-5
Consolidated Statement of Changes in Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997........................................................................B-6
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997.................B-7
Notes to Consolidated Financial Statements...............................................................B-8 - B-27
Independent Auditors' Report of Thompson, Greenspon & Co., P.C.................................................B-28
Interim Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999....................................B-29
Consolidated Statements of Income for the three months ended
March 31, 2000 and 1999................................................................................B-30
Consolidated Statement of Comprehensive Income for the three months
ended March 31, 2000 and 1999..........................................................................B-31
Consolidated Statements of Cash Flows for the the three months ended
March 31, 2000 and 1999................................................................................B-32
Notes to Consolidated Financial Statements (unaudited)..................................................B-33 - B-36
</TABLE>
B-1
<PAGE>
Independent Auditors' Report
To the Board of Directors and Stockholders of
Southern Financial Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of
Southern Financial Bancorp, Inc. and subsidiaries (Bancorp) as of December 31,
1999 and 1998, and the related consolidated statements of income, comprehensive
income, changes in stockholders' equity and cash flows for each of the years in
the three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of Bancorp's management. Our responsibility is
to express an opinion on these consolidated financial statements based on our
audits. We did not audit the consolidated financial statements of The Horizon
Bank of Virginia (Horizon) which was acquired during 1999 in a transaction
accounted for as a pooling of interests, as discussed in note 1. Such statements
are included in the consolidated financial statements of the Bancorp and reflect
total assets constituting 36% at December 31, 1998, and total interest income
constituting 33% in both 1998 and 1997 of the related consolidated totals. Those
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Horizon, is
based solely on the report of the other auditors.
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, based on our audits and the report of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Southern Financial
Bancorp, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
Richmond, Virginia
February 10, 2000
B-2
<PAGE>
Consolidated Balance Sheets
<TABLE>
<CAPTION>
Assets December 31, 1999 December 31, 1998
----------------- -----------------
<S> <C> <C>
Cash and due from banks $ 12,667,620 $ 10,820,765
Overnight earning deposits 4,464,338 31,774,435
Investment securities, available-for-sale 97,721,012 84,075,537
Investment securities, held-to-maturity (estimated market value
of $36,445,749 and $57,347,692, respectively) 37,110,889 57,682,992
Loans held for sale 442,000 602,500
Loans receivable, net 234,086,432 206,355,076
Premises and equipment, net 6,445,589 5,523,304
Other assets 13,283,684 7,419,507
----------------- -----------------
Total assets $ 406,221,564 $ 404,254,116
----------------- -----------------
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 367,187,558 $ 366,905,334
Advances from Federal Home Loan Bank 5,000,000 3,500,000
Other liabilities 5,169,909 3,222,915
----------------- -----------------
Total liabilities
377,357,467 373,628,249
----------------- -----------------
Commitments
Stockholders' equity:
6% cumulative convertible preferred stock, $.01 par value,
500,000 shares authorized, 13,621 shares issued
and outstanding, respectively 136 136
Common stock, $.01 par value, 5,000,000 shares authorized,
2,656,196 and 2,636,249 shares issued and outstanding,
respectively 26,562 26,363
Capital in excess of par value 23,662,935 23,490,506
Retained earnings 6,898,249 6,822,119
Accumulated other comprehensive income (loss) (1,723,785) 286,743
----------------- -----------------
Total stockholders' equity
28,864,097 30,625,867
----------------- -----------------
Total liabilities and stockholders' equity $ 406,221,564 $ 404,254,116
================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-3
<PAGE>
Consolidated Statements of Income
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------
1999 1998 1997
------------------ ------------------ ------------------
<S> <C> <C> <C>
INTEREST INCOME:
Loans $19,982,224 $19,554,490 $18,589,810
Investment securities 9,773,796 8,303,057 6,946,388
------------------ ------------------ ------------------
TOTAL INTEREST INCOME 29,756,020 27,857,547 25,536,198
------------------ ------------------ ------------------
INTEREST EXPENSE:
Deposits 13,576,177 13,950,093 12,292,289
Borrowings 731,801 270,099 334,346
------------------ ------------------ ------------------
TOTAL INTEREST EXPENSE 14,307,978 14,220,192 12,626,635
------------------ ------------------ ------------------
NET INTEREST INCOME 15,448,042 13,637,355 12,909,563
Provision for loan losses 2,129,660 1,300,801 1,265,314
------------------ ------------------ ------------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 13,318,382 12,336,554 11,644,249
OTHER INCOME:
Fee income 2,154,923 1,898,188 1,889,040
Gain on sale of loans 1,115,351 1,116,650 268,445
Gain (loss) on investment securities, net (692,419) (67,817) -
Other 256,162 198,006 100,453
------------------ ------------------ ------------------
TOTAL OTHER INCOME 2,834,017 3,145,027 2,257,938
------------------ ------------------ ------------------
OTHER EXPENSE:
Employee compensation and benefits 6,448,960 5,379,683 4,785,083
Premises and equipment 3,362,410 2,721,603 2,757,955
Restructuring charges 685,336 - -
Merger expenses 1,751,657 - -
Other 2,340,607 2,585,817 2,219,285
------------------ ------------------ ------------------
TOTAL OTHER EXPENSE 14,588,970 10,687,103 9,762,323
------------------ ------------------ ------------------
INCOME BEFORE INCOME TAXES 1,563,429 4,794,478 4,139,864
Provision for income taxes 602,700 1,442,075 1,331,800
------------------ ------------------ ------------------
NET INCOME $960,729 $3,352,403 $2,808,064
================== ================== ==================
Earnings Per Common Share:
Basic $0.36 $1.28 $1.10
Diluted $0.35 $1.22 $1.06
Weighted average shares outstanding:
Basic 2,648,643 2,618,930 2,558,622
Diluted 2,722,251 2,747,726 2,647,717
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-4
<PAGE>
Consolidated Statement of Comprehensive Income
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1999 1998 1997
------------------ -------------------- ------------------
<S> <C> <C> <C>
Net income $960,729 $3,352,403 $2,808,064
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain 1,260,465 - -
Reclassification adjustment for net interest
income included in net income (4,165) - -
Available-for-sale securities:
Unrealized holding gain/(loss) (4,303,729) 215,803 188,091
Unrealized gain on transfer of held-to-
maturity securities - 229,612 -
Reclassification adjustment for net (gains)/losses
included in net income 1,175 (67,817) -
------------------ -------------------- ------------------
Other comprehensive income (loss) before tax (3,046,254) 377,598 188,091
Income tax expense (benefit) related to items of other
comprehensive income (1,035,726) 128,383 63,951
------------------ -------------------- ------------------
Other comprehensive income (loss), net of tax (2,010,528) 249,215 124,140
Comprehensive income (loss) $(1,049,799) $3,601,618 $2,932,204
================== ==================== ==================
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-5
<PAGE>
Consolidated Statement of Changes in Stockholders' Equity
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999, 1998, 1997
-----------------------------------------------------------------------------------------------------------------------------------
Convertible Capital in Other Total
Preferred Common Excess of Retained Comprehensive Stockholders'
Stock Stock Par Value Earnings Income Equity
----------- --------- ------------- ------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 156 $ 25,455 $ 22,253,736 $ 2,556,886 $ (86,612) $ 24,749,621
Dividends on preferred and
common stock ($0.2175 per
preferred share)
($0.17 per common share) - - - (455,344) - (455,344)
Options exercised - 276 281,308 - - 281,584
Change in other
comprehensive income - - - - 124,140 124,140
Net income - - - 2,808,064 - 2,808,064
--------------------------------------------------------------------------------
Balance, December 31, 1997 156 25,731 22,535,044 4,909,606 37,528 27,508,065
Dividends on preferred and
common stock ($0.2175 per
preferred share)
($0.22 per common share) - - - (596,127) - (596,127)
Conversion of preferred
stock to common stock (20) 32 (12) - - -
Options exercises - 109 112,202 - - 112,311
Stock dividend of 5% - 491 843,272 (843,763) - -
Change in other
comprehensive income - - - - 249,215 249,215
Net income - - - 3,352,403 - 3,352,403
-------------------------------------------------------------------------------
Balance, December 31, 1998 136 26,363 23,490,506 6,822,119 286,743 30,625,867
Dividends on preferred and
common stock ($0.2175 per
preferred share)
($0.33 per common share) - - - (884,599) - (884,599)
Options exercised - 199 172,429 - - 172,628
Change in other
comprehensive income - - - - (2,010,528) (2,010,528)
Net income - - - 960,729 - 960,729
Balance December 31, 1999 $ 136 $ 26,562 $ 23,662,935 $ 6,898,249 $ (1,723,785) $ 28,864,097
================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-6
<PAGE>
Consolidate Statements of Cash Flows
<TABLE>
<CAPTION>
For the Years Ended December 31, 1999, 1998, 1997
-------------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
------------------ ------------------- ------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $960,729 $3,352,403 $2,808,064
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 919,377 1,210,678 830,861
Provision for loan losses 2,129,660 1,300,801 1,265,314
Gain on sale of loans (1,115,351) (1,116,650) (268,445)
(Gain) loss on sale of securities 692,419 (67,817) -
Amortization of deferred loan fees (787,294) (623,098) (607,286)
Net funding of loans held for sale 583,820 1,928,595 (701,500)
(Increase) decrease in other assets (2,378,692) (1,984,651) 1,289,823
Increase in other liabilities 1,960,441 1,125,299 195,554
------------------ ------------------- ------------------
Net cash provided by operating activities 2,965,109 5,125,560 4,812,385
------------------ ------------------- ------------------
Cash flows from investing activities:
Increase in loans receivable (28,513,323) (2,483,168) (27,448,177)
Purchase of investment securities, held-to-maturity (11,462,105) (19,077,011) (36,829,014)
Purchase of investment securities, available-for-sale (61,056,211) (83,887,904) (8,563,636)
Sale of investment securities available-for-sale 37,455,059 16,965,806 -
Paydowns of investment securities 35,966,620 49,200,004 29,758,676
(Increase) decrease in overnight earning deposits 27,310,097 (10,920,965) (3,572,896)
Increase in premises and equipment, net (1,628,444) (533,278) (1,271,779)
Increase in Federal Home Loan Bank stock (260,200) (152,000) (62,900)
------------------ ------------------- ------------------
Net cash used in investing activities (2,188,507) (50,888,516) (47,989,726)
------------------ ------------------- ------------------
Cash flows from financing activities:
Net increase in deposits 282,224 46,540,850 45,392,986
Increase (decrease) in advances from FHLB 1,500,000 (500,000) (4,500,000)
Proceeds from stock options exercised 172,628 112,311 281,584
Dividends on preferred and common stock (884,599) (596,127) (455,344)
------------------ ------------------- ------------------
Net cash provided by financing activities 1,070,253 45,557,034 40,719,226
------------------ ------------------- ------------------
Net increase (decrease) in cash and due from banks 1,846,855 (205,922) (2,458,115)
Cash and due from banks, beginning of period 10,820,765 11,026,687 13,484,802
------------------ ------------------- ------------------
Cash and due from banks, end of period $12,667,620 $10,820,765 $11,026,687
================== =================== ==================
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-7
<PAGE>
Notes to Consolidated Financial Statements
December 31, 1999, 1998, and 1997
1. Organization and Significant Accounting Policies:
Southern Financial Bancorp, Inc. (the "Bancorp" or "Southern
Financial") was incorporated in the Commonwealth of Virginia on December 1,
1995. On December 1, 1995, Bancorp acquired all of the outstanding shares of
Southern Financial Bank (the "Bank"). The Bank, formerly Southern Financial
Federal Savings Bank, converted from a savings bank to a state chartered
commercial bank effective December 1, 1995.
In October of 1999, the Bancorp incorporated Southern WebTech.com, 70%
of which is owned by the Bancorp. The accounts of Southern WebTech.com are
included in the Bancorp's Consolidated Financial Statements.
On October 1, 1999, the Bancorp completed its merger with The Horizon
Bank of Virginia ("Horizon"). The merger qualified as a tax-free exchange and
was accounted for as a pooling of interests. Southern Financial issued 0.63
shares of its common stock for each share of Horizon stock outstanding. A total
of 1,045,523 shares (after adjustments for fractional shares) of Southern
Financial's common stock was issued as a result of the merger. Horizon had no
stock options outstanding prior to the merger. Southern Financial and Horizon
incurred $3,973,530 of merger-related costs which were charged to operations
during the year ended December 31, 1999. All financial statements and amounts
included herein have been restated due to the merger.
The following table presents the combined results of operations based
on the audited financial statements of Southern Financial and Horizon for the
two years ended December 31:
(dollars in thousands, except per share data) 1998 1997
-----------------------------------------------------------------------
Net Interest Income:
Southern Financial $ 8,526 $ 7,962
Horizon 5,111 4,948
------------ -----------
Combined $ 13,637 $ 12,910
============ ===========
Net Income:
Southern Financial $ 2,658 $ 2,206
Horizon 694 602
------------ -----------
Combined $ 3,352 $ 2,808
============ ===========
Diluted Net Income per Share:
Southern Financial $ 1.55 $ 1.33
Horizon 0.42 0.38
------------ -----------
Combined $ 1.22 $ 1.06
============ ===========
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, Woodbridge,
Manassas, Fredericksburg, Fairfax Circle, Vienna, Annandale, and Merrifield,
Virginia, which are managed as a single business segment.
The accounting and reporting policies of the Bancorp are in accordance
with generally accepted accounting principles and conform to general practices
within the banking industry. The more significant of
B-8
<PAGE>
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, 1999 and 1998, and for the years
ended December 31, 1999, 1998 and 1997. Additionally, as of and for the year
ended December 31, 1999, the accounts of Southern WebTech.com, Inc. have been
included in the accompanying consolidated financial statements. 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
B-9
<PAGE>
present portfolio based upon management's evaluation of the loan portfolio.
Estimates of losses inherent in the portfolio involve the exercise of judgment
and the use of assumptions. The evaluations take into consideration such factors
as changes in the nature, volume and quality of the loan portfolio, prior loss
experience, level of nonperforming loans, current and anticipated general
economic conditions and the value and adequacy of collateral. Changes in the
estimate of future losses may occur due to changing economic conditions and the
economic conditions of borrowers.
A loan is considered impaired when, based on all current information
and events, it is probable that the Bancorp will be unable to collect all
amounts due according to the contractual terms of the agreement, including all
scheduled principal and interest payments. Such impaired loans are measured
based on the present value of expected future cash flows, discounted at the
loan's effective interest rate or, as a practical expedient, impairment may be
measured based on the loan's observable market price, or if, the loan is
collateral - dependent, the fair value of the collateral. When the measure of
the impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Loans for which
foreclosure is probable continue to be accounted for as loans.
Each impaired loan is evaluated individually to determine the income
recognition policy. Generally, payments received are applied in accordance with
the contractual terms of the note or as a reduction of principal.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation
and amortization. Expenditures for maintenance and repairs that do not
materially prolong the useful lives of the assets are charged to expense as
incurred.
Depreciation is computed using the straight-line method over estimated
useful lives of three to ten years for furniture and equipment and 30 years for
buildings. Amortization of leasehold improvements is computed using the
straight-line method over the shorter of ten years or the lease term.
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.
B-10
<PAGE>
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.
Recent Accounting Developments
Effective October 1, 1998, the Bancorp adopted Statement of Financial
Accounting Standards, No. 133, Accounting for Derivative Instruments and Hedging
Activities ("FAS 133"). Concurrent with this adoption the Bancorp reclassified
certain investments, 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 as of October 1,
1998 of $18.2 million and a market value as of October 1, 1998 of $18.4 million,
and the Bancorp recognized an addition to Stockholders' Equity of the difference
between book value and market value amounting to $229.6 thousand. 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 ended December 31, 1999, approximately $5,000 of gains in
accumulated other comprehensive income related to the interest rate swaps were
reclassified into interest expense as a yield adjustment of the hedged CD's.
B-11
<PAGE>
2. Investment Securities:
The portfolio consists of the following securities:
<TABLE>
<CAPTION>
December 31, 1999
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
------------------- ----------------- ------------------ --------------------
<S> <C> <C> <C> <C>
Available-for-sale:
FHLMC MBS $16,361,253 $39,461 $31,497 $16,369,217
GNMA MBS 2,633,942 - 44,995 2,588,947
FNMA MBS 25,509,631 255,832 87,642 25,677,821
Collateralized mortgage obligations 27,275,536 - 1,972,447 25,303,089
Commercial MBS 24,102,513 - 1,607,513 22,495,000
Obligations of counties and
municipalities 3,924,186 - 352,713 3,571,473
Corporate obligations 990,745 - 45,374 945,371
U.S. Treasury securities 791,301 780 21,987 770,094
----------------------------------------------------------------------------------
$101,589,107 $296,073 $4,164,168 $97,721,012
==================================================================================
December 31, 1998
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
------------------- ----------------- ------------------ --------------------
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. Treasury and agency obligations 10,544,943 69,257 6,095 10,608,105
----------------------------------------------------------------------------------
$83,639,903 $613,956 $178,322 $84,075,537
==================================================================================
</TABLE>
B-12
<PAGE>
<TABLE>
<CAPTION>
December 31, 1999
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
------------------- ----------------- ------------------ --------------------
<S> <C> <C> <C> <C>
Held-to-maturity:
FHLMC MBS $ 3,837,207 $ 10,235 $ 41,612 $ 3,805,831
GNMA MBS 17,177,221 1,080 244,458 16,933,843
FNMA MBS 6,764,242 1,914 142,246 6,623,910
Collateralized mortgage obligations 4,073,233 - 67,718 4,005,515
Commercial MBS 2,864,392 - 67,695 2,796,697
Obligations of counties and
municipalities 2,394,594 682 115,322 2,279,954
----------------------------------------------------------------------------------
$37,110,889 $13,911 $679,051 $36,445,749
==================================================================================
December 31, 1998
----------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Gains Losses Value
------------------- ----------------- ------------------ --------------------
Held-to-maturity:
FHLMC MBS $ 4,091,316 $ 6,484 $ 27,668 $ 4,070,132
GNMA MBS 24,305,052 1,150 301,533 24,004,669
FNMA MBS 6,779,894 5,772 53,996 6,731,670
Collateralized mortgage obligations 1,015,264 - 1,699 1,013,565
Obligations of counties and
municipalities 1,959,595 17,813 3,100 1,974,308
U.S. Treasury and agency obligations 19,531,871 59,187 37,710 19,553,348
----------------------------------------------------------------------------------
$57,682,992 $90,406 $425,706 $57,347,692
==================================================================================
</TABLE>
At December 31, 1999, held-to-maturity securities totaling $24,858,354
have adjustable rates of interest while the remaining held-to-maturity
securities totaling $12,252,536 have fixed interest rates.
At December 31, 1999, available-for-sale securities totaling
$67,570,492 have fixed interest rates, and the remaining available-for-sale
securities totaling $30,150,519 have adjustable rates of interest.
Gross gains of $88,117 and gross losses of $780,536 were realized on
the sale of investment securities during the year ended December 31, 1999. The
losses realized during 1999 were related to the restructuring of the investment
securities portfolio following the merger with The Horizon Bank. 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 year ended December 31, 1997.
As of December 31, 1999 and December 31, 1998, securities having a book
value of $63,951,147 and $88,024,504, 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.
B-13
<PAGE>
The following table sets forth information regarding maturity and
average yields of the investment portfolio:
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------------------------------------------------------
Available-for-sale Held-to-maturity
Weighted Weighted
Fair Amortized Average Fair Amortized Average
Value Cost Yield Value Cost Yield
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
Maturing after 10 years $44,635,985 $44,504,826 6.55% $27,363,584 $27,778,670 6.11%
Collateralized mortgage obligations:
Maturing after 5 years through 10 years 2,015,127 2,089,491 6.65 - - -
Maturing after 10 years 23,287,962 25,186,045 7.28 4,005,515 4,073,233 7.67
Commercial MBS:
Maturing after 5 years through 10 years 11,325,000 12,018,195 6.95 1,987,500 2,037,909 7.41
Maturing after 10 years 11,170,000 12,084,318 6.82 809,197 826,484 8.00
Obligations of counties and municipalities:
Maturing in less than 1 year 194,756 195,000 8.00 - - -
Maturing after 1 year through 5 years - - - 198,821 199,827 4.60
Maturing after 5 years through 10 years - - - 328,245 346,246 4.45
Maturing after 10 years 3,376,716 3,729,186 4.91 1,752,887 1,848,520 4.73
Corporate obligations:
Maturing after 5 years through 10 years 945,371 990,745 6.71 - - -
U.S. Treasury obligations:
Maturing in less than 1 year 300,563 299,783 6.39 - - -
Maturing after 1 year through 5 years 469,532 491,518 5.21 - - -
--------------------------------- -----------------------------
$97,721,012 $101,589,107 $36,445,749 $37,110,889
================================= =============================
</TABLE>
Contractual maturity of mortgage-backed securities is not a reliable
indicator of their expected life because borrowers have the right to repay their
obligations at any time.
B-14
<PAGE>
3. Loans Receivable:
Loans receivable consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1999 1998
------------------ ------------------
<S> <C> <C>
Mortgage:
Residential $48,604,205 $54,822,289
Nonresidential 109,871,210 85,124,406
Construction:
Residential 7,852,907 6,948,844
Nonresidential 8,270,290 11,213,848
Non-Mortgage:
Business 54,175,076 40,814,003
Consumer 9,994,326 11,559,188
------------------ ------------------
Total loans receivable 238,768,014 210,482,578
Less:
Deferred loan fees, net 1,229,451 1,065,871
Allowance for loan losses 3,452,131 3,061,631
------------------ ------------------
Loans receivable, net $234,086,432 $206,355,076
================== ==================
</TABLE>
The following sets forth information regarding the allowance for loan
losses:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------
1999 1998
---------------------- ---------------------
<S> <C> <C>
Allowance at beginning of period $3,061,631 $2,743,369
Provisions for losses charged to income 2,129,660 1,300,801
Charge-offs, net (1,739,160) (982,539)
---------------------- ---------------------
Allowance at end of period $3,452,131 $3,061,631
====================== =====================
</TABLE>
The Bancorp's loan portfolio is concentrated in the Northern Virginia
area. The amount of loans being serviced for others was $17,106,340 and
$13,513,792 at December 31, 1999 and 1998, respectively. At December 31, 1999,
there were 6 loans with balances totaling approximately $87,230, net of Small
Business Administration guarantees, that had payments ninety days or more past
due on which interest was still accruing. At December 31, 1998, there were 20
loans with balances totaling approximately $678,700, net of Small Business
Administration guarantees, that had payments ninety days or more past due and on
which interest was still accruing. The Bancorp had foreclosed properties on its
books at December 31, 1999 and 1998 in the following amounts respectively,
$2,296,269 and $498,087. The Bancorp had nonaccruing loans on its books at
December 31, 1999 and 1998 in the following amounts respectively, $521,801 and
$2,905,398.
B-15
<PAGE>
Impaired loans were as follows:
December 31,
-----------------------------
1999 1998
------------- -------------
Carrying value $521,801 $2,905,398
Allocation of general reserve 78,648 684,148
The average carrying balances and interest income earned on impaired
loans were as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------------- ---------------- ---------------
<S> <C> <C> <C>
Average carrying value $1,239,805 $2,500,091 $2,291,997
Income anticipated under original loan agreements 21,845 296,367 211,849
Income recorded - - 5,000
</TABLE>
4. Premises and Equipment:
Premises and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Land $1,872,533 $1,872,533
Building and improvements 1,977,794 1,969,169
Furniture and equipment 4,123,461 3,772,676
Leasehold improvements 2,395,524 1,626,023
--------------- ---------------
10,369,312 9,240,401
Less: Accumulated depreciation and amortization (3,923,723) (3,717,097)
--------------- ---------------
Premises and equipment, net $6,445,589 $5,523,304
=============== ===============
</TABLE>
Depreciation and amortization expense aggregated $919,377, $1,210,678
and $830,861 for the years ended December 31, 1999 and December 31, 1998 and,
respectively.
B-16
<PAGE>
5. Deposits:
Deposits consist of the following:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------
1999 1998
------------------------------- -------------------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
------------ --------------- ------------- ---------------
<S> <C> <C> <C> <C>
Demand 0.00% $50,325,239 0.00% $50,446,120
Interest checking 1.11% 25,747,713 1.12% 27,085,841
Money market and savings accounts 3.32% 75,725,516 3.19% 74,325,104
Certificates of accounts 5.51% 215,389,090 5.46% 215,048,269
---- --------------- ---- ---------------
3.99% $367,187,558 3.93% $366,905,334
=============== ===============
</TABLE>
As of December 31, 1999, certificates of deposit mature as follows:
2000 $180,370,346
2001 17,062,049
2002 6,470,695
2003 10,307,267
2004 983,232
Therafter 195,501
---------------------
$215,389,090
=====================
Deposits with balances greater than $100,000 totaled approximately
$131,919,748 and $99,168,283 at December 31, 1999 and 1998, respectively, of
which $59,100,300 and $49,167,931 represented certificates of deposit at
December 31, 1999 and 1998, respectively.
Interest expense by deposit category follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------
1999 1998 1997
-------------------- -------------------- -------------------
<S> <C> <C> <C>
Interest checking accounts $324,004 $362,763 $316,751
Money market and savings accounts 1,929,025 1,929,199 1,860,190
Certificates of deposit 11,323,148 11,658,131 10,115,348
-------------------- -------------------- -------------------
$13,576,177 $13,950,093 $12,292,289
==================== ==================== ===================
</TABLE>
Total cash paid for interest aggregated approximately $3,640,548,
$3,373,871, and $3,344,903 for the years ended December 31, 1999, 1998, and
1997, respectively.
6. Advances from Federal Home Loan Bank:
The Bancorp has a credit availability agreement with FHLB totaling 20%
of Southern Financial's assets. At December 31, 1999, this amount was
approximately $81,000,000. The agreement does not have a maturity date and
advances are made at FHLB's discretion. At December 31, 1999 and 1998, advances
from FHLB totaled $5,000,000 and $3,500,000, respectively. The advance
outstanding at December 31, 1999 was made at a fixed rate of 6.32%, matures
September 8, 2009, and is callable September 8, 2004. The advances at December
31, 1998 were made at variable interest rates, and the weighted average interest
rate was 5.15%.
B-17
<PAGE>
Investment securities totaling $64.0 million and $88.0 million were pledged to
secure these advances at December 31, 1999 and 1998, respectively.
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 each of the years 1994, 1997 and 1999, this 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.
On April 9, 1991, the Horizon shareholders approved a stock option plan
authorizing options for 160,000 shares, of which 154,000 shares were granted to
eligible directors. In 1997 and 1996, the remaining 6,000 shares were granted to
officers and employees. The purchase price of the stock is $5.00 and all options
expired April 9, 1999. Compensation expense has benn recognized for options
granted at less than the market price at the measurement date.
The Bancorp accounts for its stock option plan under APB Opinion No.
25, under which no compensation cost has been recognized. Had compensation cost
for the plan been determined consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation," the Bancorp's net income and earnings per share in
the Consolidated Statements of Income, would have been reduced to the following
pro forma amounts:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------
1999 1998 1997
-------------------- -------------------- --------------------
<S> <C> <C> <C>
Net income:
As reported $960,729 $3,352,403 $2,808,064
Pro forma 668,412 3,072,743 2,646,481
-------------------- -------------------- --------------------
Basic earnings per share:
As reported 0.36 1.28 1.10
Pro forma 0.25 1.17 1.03
Diluted earnings per share:
As reported 0.35 1.22 1.06
Pro forma 0.25 1.12 1.00
-------------------- -------------------- --------------------
Weighted-average assumptions:
Expected lives (years) 10 10 10
Risk-free interest rate (%) 6.48% 4.50% 5.76%
Expected volatility (%) 21.43% 25.07% 23.39%
Expected dividends (annual per share) 0.13% 0.13% 0.13%
==================== ==================== ====================
</TABLE>
The Bancorp did not record any compensation costs in 1999, 1998, or
1997 related to its stock option plan. In addition, no significant modifications
to the plan were made during the periods. The fair values of the stock options
outstanding used to determine the pro forma impact of the options to
compensation expense, and thus, net income and earnings per share, were
calculated using an acceptable option pricing model using the key assumptions
detailed above.
B-18
<PAGE>
A summary of the status of the Bancorp's stock option plan as of
December 31, 1999, 1998 and 1997, respectively, and changes during the years
ended December 31, 1999, 1998 and 1997 is presented below. Average prices and
shares subject to options have been adjusted to reflect stock dividends.
<TABLE>
<CAPTION>
1999 1998 1997
---------------------------- ---------------------------- -----------------------------
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 235,889 $13.53 200,304 $11.07 202,127 $10.28
Granted 88,500 20.31 51,000 22.47 32,850 15.35
Exercised 27,618 6.40 12,415 9.05 27,591 10.21
Expired 7,711 17.94 3,000 19.50 7,082 11.74
------------ ------------ ------------ ------------ ------------- ------------
Outstanding at end of period 289,060 16.16 235,889 13.53 200,304 11.07
------------ ------------ ------------ ------------ ------------- ------------
Options exercisable at end of period 200,560 186,889 168,804
============ ============ =============
Weighted average fair value of
options granted during the period $7.23 $10.29 $7.74
============ ============ ============
</TABLE>
The following table summarizes information about stock options
outstanding December 31, 1999:
<TABLE>
<CAPTION>
Remaining
Contractual
Exercise Options Options Life
Price Outstanding Exercisable (months)
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$ 7.490 7,260 7,260 6
$ 8.830 29,039 29,039 54
$ 9.610 16,133 16,133 40
$ 11.980 29,039 29,039 67
$ 12.730 9,902 9,902 79
$ 13.640 37,687 37,687 73
$ 13.750 3,000 3,000 85
$ 16.000 25,500 25,500 91
$ 21.250 31,000 31,000 97
$ 25.250 2,000 2,000 101
$ 26.000 10,000 10,000 101
$ 21.000 51,500 - 110
$ 20.625 12,000 - 111
$ 20.250 3,000 - 114
$ 20.000 7,000 - 116
$ 17.875 15,000 - 118
---------------------------------------------------------------------------------
289,060 200,560
=================================================================================
</TABLE>
There were 21 option holders at December 31, 1999. Options exercised
during 1999 had exercise prices ranging from $9.30 to $16.00. 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. The closing price
of the Bancorp's stock at December 31, 1999 was $16.50 per share.
B-19
<PAGE>
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, 1999, the Federal Reserve Bank categorized the
Bancorp as well 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>
<CAPTION>
For To Be Well Capitalized
Capital 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, 1999
Total Capital $33,704 12.2 % $22,142 8.0 % $27,677 10.0 %
(to risk-weighted assets)
Tier I Capital 30,252 10.9 11,071 4.0 16,606 6.0
(to risk-weighted assets)
Tier I Capital 30,252 7.5 16,140 4.0 20,175 5.0
(to average assets)
As of December 31, 1998
Total Capital 33,188 14.1 18,841 8.0 23,551 10.0
(to risk-weighted assets)
Tier I Capital 30,079 12.8 9,420 4.0 14,131 6.0
(to risk-weighted assets)
Tier I Capital 30,079 7.8 15,340 4.0 19,175 5.0
(to average assets)
</TABLE>
B-20
<PAGE>
9. Parent Company Activity:
The Bancorp owns all of the outstanding shares of the Bank. Summary
financial statements of the Bancorp follow:
<TABLE>
<CAPTION>
BALANCE SHEETS December 31,
--------------------------------------------------------
1999 1998
------------------- -------------------
<S> <C> <C>
Assets:
Cash $3,047 $1,843
Investment in subsidiaries 28,663,963 30,626,987
Other assets 200,050 -
------------------- -------------------
Total assets $28,867,060 $30,628,830
------------------- -------------------
Liabilities:
Other liabilities $2,963 $2,963
------------------- -------------------
Total stockholders' equity 28,864,097 30,625,867
------------------- -------------------
Total liabilities and stockholders' equity $28,867,060 $30,628,830
=================== ===================
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF INCOME Year Ended December 31,
----------------------------------------------------------------
1999 1998 1997
------------------ ------------------ ------------------
<S> <C> <C> <C>
Equity in earnings of Southern Financial Bank $955,539 $3,352,403 $2,808,064
Equity in earnings of Southern Web Tech 5,190 - -
------------------ ------------------ ------------------
$960,729 $3,352,403 $2,808,064
================== ================== ==================
STATEMENT OF CASH FLOWS Year Ended December 31,
----------------------------------------------------------------
1999 1998 1997
------------------ ------------------ ------------------
Operating activities:
Net income $ 960,729 $ 3,352,403 $ 2,808,064
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Equity in undistributed income of subsidiaries 202,446 (2,932,412) (2,605,511)
Other operating activities (200,050) - 3,385
------------------ ------------------ ------------------
Net cash provided by operating activities 963,125 419,991 205,938
------------------ ------------------ ------------------
Net cash used by investing activities:
Investment in Southern WebTech and P/S Web
Services (249,950) - -
------------------ ------------------ ------------------
Financing activities:
Issuance of common stock 172,628 112,311 281,584
Dividends on preferred and common stock (884,599) (596,127) (455,344)
------------------ ------------------ ------------------
Net cash used by financing activities (711,971) (483,816) (173,760)
------------------ ------------------ ------------------
Increase (decrease) in cash 1,204 (63,825) 32,178
Cash, beginning of year 1,843 65,668 33,490
------------------ ------------------ ------------------
Cash, end of year $ 3,047 $ 1,843 $ 65,668
================== ================== ==================
</TABLE>
B-21
<PAGE>
10. Estimated Fair Value of Financial Instruments:
The assumptions used and the estimates disclosed below in connection
with the fair value of the Bancorp's financial statements represent management's
best judgment of appropriate valuation methods. These estimates are based on
pertinent information available to management as of December 31, 1999. 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, 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------
(dollars in thousands) 1999 1998
---------------------------------- -----------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
<S> <C> <C> <C> <C>
Financial assets:
Cash and amounts due from banks $17,132 $17,132 $42,595 $42,595
Available-for-sale securities 97,721 97,721 84,076 84,076
Held-to-maturity securities 37,111 36,446 57,683 57,348
Loans receivable, net of allowance 234,086 231,761 206,355 208,604
Loans held for sale 442 442 603 603
Financial liabilities:
Deposits
Checking accounts 76,073 70,026 97,579 94,244
Money market and savings accounts 75,726 69,707 54,278 53,818
Certificates of deposit 215,389 214,577 215,048 216,038
Off balance sheet instruments
Interest rate swaps 440 1,395 - -
</TABLE>
The following methods and assumptions were used to estimate the fair
value amounts at December 31, 1999 and 1998:
Cash and Due from Banks
Carrying amount approximates fair value.
Available-for-Sale Securities
Fair value is based on quoted market prices.
B-22
<PAGE>
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:
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 employees may defer a
portion of their pretax earnings, up to the Internal Revenue Service annual
contribution limit. The Bancorp matches one half of each employee's
contributions on a discretionary basis based on Bancorp profit, such match not
to exceed 3 percent of the employee's earnings. The Bancorp's matching
contributions to the Savings Plan were $70,275, $60,213 and $40,308 for the
years ended December 31, 1999, 1998, and 1997, respectively.
12. Provision for Income Taxes:
The provision for income taxes consists of the following
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1999 1998 1997
----------------- ------------------- -------------------
<S> <C> <C> <C>
Current benefit provision:
Federal $ (463,160) $1,400,752 $1,517,683
Deferred (benefit) provision:
Federal 1,065,860 41,323 (185,883)
----------------- ------------------- -------------------
$602,700 $1,442,075 $1,331,800
================= =================== ===================
</TABLE>
B-23
<PAGE>
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, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
------------------ ----------------
<S> <C> <C>
Assets:
Provision for losses on loans and real estate owned $ 479,423 $ 547,275
Valuation of loans and securities - 134,183
Depreciation 155,380 136,731
Nonaccrual interest 93,981 33,572
Real estate owned 77,655 -
Lease 51,000 -
Other 22,062 2,110
------------------ ----------------
Gross deferred tax assets 879,501 853,871
------------------ ----------------
Liabilities:
FHLB dividend 15,858 35,771
Deferred loan fees 368,055 144,662
Valuation of loans and securities 888,010 -
------------------ ----------------
Gross deferred tax liabilities 1,271,923 180,433
------------------ ----------------
Net deferred tax assets (liability) attributable to operations $ (392,422) $ 673,438
================== ================
</TABLE>
The provision for income taxes differs from the amount of income tax
determined by applying the applicable U.S. statutory Federal income tax rate to
pretax income as a result of the following differences:
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------
1999 1998 1997
--------------- -------------- ---------------
<S> <C> <C> <C>
Statutory Federal Income tax rate 34% 34% 34%
Dividend received deduction - -2 -2
Merger expenses 12 - -
Prior year adjustment -4 -2 -
Other -3 - -
--------------- -------------- ---------------
Effective tax rate 39% 30% 32%
--------------- -------------- ---------------
</TABLE>
Cash paid for income taxes was $1,218,000, $1,432,000, and $1,004,040
for the years ended December 31, 1999, 1998, and 1997, respectively.
B-24
<PAGE>
13. Commitments:
The Bank leases its corporate headquarters and branch facilities under
operating lease agreements. Most of the leases provide for the payment of
property taxes and other costs by the Bank and include one or more renewal
options ranging up to ten years. Annual rental commitments under all lease
agreements consist of the following at December 31, 1999:
<TABLE>
<CAPTION>
Real
Property Sublease
Leases Income Total
------------------ ------------------ -------------------
<S> <C> <C> <C>
2000 $ 1,130,015 $ 171,708 $ 958,307
2001 1,097,177 181,186 915,991
2002 992,139 163,806 828,333
2003 947,279 164,132 783,147
2004 716,201 83,908 632,293
2005 and Thereafter 1,802,714 - 1,802,714
------------------ ------------------ -------------------
$ 6,685,525 $ 764,740 $ 5,920,785
------------------ ------------------ -------------------
</TABLE>
Rent expense aggregated $1,071,905, $905,792, and $960,204 for the
years ended December 31, 1999, 1998, and 1997, respectively.
Outstanding loan commitments amounted to $11,945,081 (of which
$1,100,000 had fixed interest rates) and $11,842,340 (of which $3,887,840 had
fixed interest rates) at December 31, 1999 and 1998, respectively. The Bank had
commitments from investors of $542,000 and $1,171,500 to purchase loans from the
Bank at December 31, 1999 and 1998, respectively.
At December 31, 1999, the Bank had commercial letters of credit
outstanding in the amount of approximately $1,930,000.
At December 31, 1999, the Bank had unfunded lines of credit of
$31,606,535 and undisbursed construction loan funds of $8,171,067.
B-25
<PAGE>
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 potential diluted common stock. Potential dilutive common stock has no
effect on income available to common stockholders. Income attributable to
preferred stock is immaterial. Earnings per share amounts for prior periods have
been restated to give effect to the application of SFAS 128 which was adopted in
1997.
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------- ------------------------------ ------------------------------
Per Per Per
Share Share Share
Shares Amount Shares Amount Shares Amount
---------------- -------------- --------------- ------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS 2,648,643 $0.36 2,618,930 $1.28 2,558,622 $1.10
============== ============= =============
Effect of dilution
Securities:
Stock Options 51,633 105,139 63,872
Convertible Preferred Stock 21,975 23,657 25,223
---------------- --------------- ---------------
Diluted EPS 2,722,251 $0.35 2,747,726 $1.22 2,647,717 $1.06
================ ============== =============== ============= =============== =============
</TABLE>
15. Quarterly Financial Information (Unaudited - in thousands, except per
share data):
<TABLE>
<CAPTION>
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
Dec. 31, Sept. 30, June 30, March 31,
1999 1999 1999 1999
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Net interest income $ 4,096 $ 3,944 $ 3,876 $ 3,532
Provision for loan losses 300 1,049 440 341
Total other income (79) 918 975 1,020
Total other expense 3,749 4,870 3,040 2,930
Net income (205) (710) 989 887
Earnings per share:
Basic (0.08) (0.27) 0.37 0.34
Diluted (0.08) (0.27) 0.36 0.32
Weighted average shares outstanding:
Basic 2,658,587 2,652,163 2,644,415 2,636,544
Diluted 2,658,587 2,652,163 2,722,633 2,734,200
</TABLE>
B-26
<PAGE>
<TABLE>
<CAPTION>
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
Dec. 31, Sept. 30, June 30, March 31,
1998 1998 1998 1998
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Net interest income $ 3,749 $ 3,386 $ 3,187 $ 3,315
Provision for loan losses 300 384 328 289
Total other income 756 883 753 753
Total other expense 2,860 2,777 2,484 2,566
Net income 917 760 857 818
Earnings per share:
Basic 0.35 0.29 0.33 0.32
Diluted 0.34 0.28 0.31 0.30
Weighted average shares outstanding
Basic 2,624,335 2,619,639 2,603,813 2,583,108
Diluted 2,736,928 2,743,051 2,739,487 2,715,945
</TABLE>
B-27
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders
The Horizon Bank of Virginia
Merrifield, Virginia
We have audited the accompanying balance sheets of The Horizon Bank of
Virginia as of December 31, 1998 and 1997, and the related statements of
operations, other comprehensive income, changes in stockholders' equity and cash
flows for the years then ended. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of The Horizon Bank of
Virginia as of December 31, 1998 and 1997, and the results of its operations and
its cash flows for the years then ended in conformity with generally accepted
accounting principles.
/s/ Thompson, Greenspon & Co., P.C.
Fairfax, Virginia
January 29, 1999
B-28
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31,
2000 December 31,
(Unaudited) 1999
------------- --------------
<S> <C> <C>
Assets
Cash and due from banks $ 12,721,778 $ 12,667,620
Overnight earning deposits 19,903,764 4,464,338
Investment securities, available for sale 99,824,031 97,721,012
Investment securities, held to maturity 39,847,163 37,110,889
Loans held for sale 193,125 442,000
Loans receivable, net 236,739,850 234,086,432
Premises and equipment, net. 6,261,385 6,445,589
Other assets 12,248,022 13,283,684
------------- -------------
Total assets $ 427,739,118 $ 406,221,564
============= =============
Liabilities and Stockholders' Equity
Liabilities:
Deposits $ 387,751,974 $ 367,187,558
Advances from Federal Home Loan Bank 5,000,000 5,000,000
Other liabilities 5,059,771 5,169,909
------------- -------------
Total liabilities 397,811,745 377,357,467
------------- -------------
Commitments
Stockholders' equity:
Preferred stock 136 136
Common stock 26,662 26,562
Capital in excess of par value 23,812,835 23,662,935
Retained earnings 7,750,893 6,898,249
Accumulated other comprehensive loss (1,663,153) (1,723,785)
------------- -------------
Total stockholders' equity 29,927,373 28,864,097
------------- -------------
Total liabilities and stockholders' equity $ 427,739,118 $ 406,221,564
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-29
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
2000 1999
----------- -----------
<S> <C> <C>
Interest income:
Loans $ 5,556,164 $ 4,794,117
Investment securities 2,482,395 2,438,125
----------- -----------
Total interest income 8,038,559 7,232,242
----------- -----------
Interest expense:
Deposits 3,567,518 3,509,263
Borrowings 273,414 102,833
----------- -----------
Total interest expense 3,840,932 3,612,096
----------- -----------
Net interest income 4,197,627 3,620,146
Provision for loan losses 350,000 341,036
----------- -----------
Net interest income after provision for loan losses 3,847,627 3,279,110
----------- -----------
Other income:
Fee income 658,614 574,465
Gain on sale of loans 333,378 343,773
Other 31,228 14,648
----------- -----------
Total other income 1,023,220 932,886
----------- -----------
Other expense:
Employee compensation and benefits 1,658,386 1,550,202
Premises and equipment 615,549 548,295
Data processing expense 275,243 217,188
Advertising 60,886 77,721
Deposit insurance expense 17,664 36,726
Other 493,569 500,446
----------- -----------
Total other expense 3,121,297 2,930,578
----------- -----------
Income before income taxes 1,749,550 1,281,418
Provision for income taxes 574,000 394,425
----------- -----------
Net income $ 1,175,550 $ 886,993
=========== ===========
Earnings per common share:
Basic $ 0.44 $ 0.34
Diluted $ 0.44 $ 0.32
Weighted average shares outstanding:
Basic 2,666,196 2,636,544
Diluted 2,688,171 2,734,200
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-30
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31,
2000 1999
----------- -----------
<S> <C> <C>
Net income $ 1,175,550 $ 886,993
Other comprehensive income:
Cash flow hedge:
Unrealized holding gain 79,785 367,013
Reclassification adjustment for net interest
expense included in net income (39,785) 11,272
Available-for-sale securities:
Unrealized holding gain/(loss) 51,866 (137,913)
------------ ------------
Other comprehensive income before tax 91,866 240,372
Income tax expense related to items of other
comprehensive income (31,234) (78,900)
------------ ------------
Other comprehensive income, net of tax 60,632 161,472
Comprehensive income $ 1,236,182 $ 1,048,465
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-31
<PAGE>
SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------
2000 1999
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 1,175,550 $ 886,993
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 217,841 288,955
Provision for loan losses 350,000 341,036
Gain on sale of loans (333,378) (343,773)
Amortization of deferred loan fees (138,236) (148,859)
Net change in loans held for sale 285,319 (115,873)
Decrease in other assets 1,043,627 1,354,342
Decrease in other liabilities (108,448) (186,123)
------------ ------------
Net cash provided by operating activities 2,492,275 2,076,698
------------ ------------
Cash flows from investing activities:
Increase in loans receivable (2,441,655) (2,093,122)
Purchase of investment securities, held-to-maturity (4,143,635) (3,926,622)
Purchase of investment securities, available-for-sale (3,895,287) (24,762,045)
Paydowns of investment securities 3,232,502 38,635,602
Increase in overnight earning deposits, net (15,439,426) (121,941)
Increase in premises and equipment, net (27,125) (768,497)
(Increase) decrease in Federal Home Loan Bank stock 35,000 (171,200)
------------ ------------
Net cash provided by (used) in investing activities (22,679,626) 6,792,175
------------ ------------
Cash flows from financing activities:
Net increase (decrease) in deposits 20,564,416 (5,397,074)
Decrease in advances from FHLB - (500,000)
Proceeds from issuance of common stock - 17,500
Dividends on preferred and common stock (322,907) (179,317)
------------ ------------
Net cash provided by (used) in financing activities 20,241,509 (6,058,891)
------------ ------------
Net increase in cash and due from banks 54,158 2,809,982
Cash and due from banks, beginning of period 12,667,620 10,820,765
------------ ------------
Cash and due from banks, end of period $ 12,721,778 $ 13,630,747
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
B-32
<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, 2000 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, 1999.
NOTE 2 - HEDGE ACCOUNTING
During the first quarter of 1999, Southern Financial entered into four
interest rate swap agreements that are accounted for as cash flow hedges. In
accordance with SFAS 133, Southern Financial 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 Southern Financial's floating rate liabilities, specifically Southern
Financial's CD's in amounts greater than $90,000, which have maturities of one
month to six months. Southern Financial performed a regression analysis using
monthly averages of both 3 month LIBOR and Southern Financial's hedged CD's and
determined that there was a highly effective correlation. Southern Financial
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, Southern Financial has
identified other individual CD's to replace them. During the remaining nine
months of the year ending December 31, 2000, it is estimated that an immaterial
amount 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 March 31, 2000, no portion of the hedge was
"ineffective" as the spread between LIBOR (the denomination of the floating rate
side of the interest rate swaps) and Southern Financial's CD issuance costs
changed only minimally. Since there was no change in the net present value of
the favorable variance in the spread for the weighted average remaining life of
the interest rate swaps, no income was recognized.
During the quarter ended March 31, 2000, Southern Financial entered
into an interest rate swap agreement in the amount of $10 million in connection
with the issuance of a like amount of its certificates of deposit. The interest
rate swap agreement is accounted for as a fair value hedge. Changes in the
present value of the hedge are accounted for in the income statement, as are
changes in the present value of the certificates of deposit. The swap has a
termination date of September 29, 2005, however it may be terminated on March
29, 2001 or the 29th day of each successive calendar month thereafter by the
other party to the swap transaction. Southern Financial agreed to pay a floating
rate of 1 month LIBOR plus 12 basis points and receive a fixed rate of 7.25%.
B-33
<PAGE>
NOTE 3 - INVESTMENT SECURITIES
The following table sets forth the investment securities portfolio as
of the dates indicated:
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Available-for-sale securities:
FHLMC MBS $ 15,994,261 $ 16,053,668 $ 16,361,253 $ 16,369,217
GNMA MBS 6,369,894 6,207,444 2,633,942 2,588,947
FNMA MBS 24,356,493 24,181,572 25,509,631 25,677,821
Collaterized mortgage obligations 27,174,203 25,648,743 27,275,536 25,303,089
Commercial MBS 24,101,024 22,440,000 24,102,513 22,495,000
Obligations of counties and municipalities 3,861,296 3,588,666 3,924,186 3,571,473
Corporate obligations 991,245 931,079 990,745 945,371
U.S. Treasury securities 791,843 772,859 791,301 770,094
------------- ------------ ------------- ------------
$ 103,640,259 $ 99,824,031 $ 101,589,107 $ 97,721,012
============= ============ ============= ============
Held-to-maturity securities:
FHLMC MBS $ 6,668,831 $ 6,625,982 $ 3,837,207 $ 3,805,831
GNMA MBS 16,315,452 15,979,963 17,177,221 16,933,843
FNMA MBS 7,536,024 7,385,308 6,764,242 6,623,910
Collateralized mortgage obligations 4,895,490 4,838,581 4,073,233 4,005,515
Commercial MBS 2,036,971 1,975,000 2,864,392 2,796,697
Obligations of counties and municipalities 2,394,395 2,311,370 2,394,594 2,279,954
------------- ------------ ------------- ------------
$ 39,847,163 $ 39,116,204 $ 37,110,889 $ 36,445,750
============= ============ ============= ============
</TABLE>
B-34
<PAGE>
NOTE 4 - LOANS RECEIVABLE
Loans receivable consist of the following:
March 31, December 31,
2000 1999
-------------- -------------
Mortgage:
Residential $ 43,910,911 $ 48,604,205
Nonresidential 120,488,013 109,871,210
Construction:
Residential 7,784,703 7,852,907
Nonresidential 7,055,624 8,270,290
Non-Mortgage:
Business 51,804,245 54,175,076
Consumer 10,684,105 9,994,326
------------- -------------
Total loans receivable 241,727,601 238,768,014
Less:
Deferred loan fees, net 1,387,233 1,229,451
Allowance for loan losses 3,600,518 3,452,131
------------- -------------
Loans receivable, net $ 236,739,850 $ 234,086,432
============= =============
The following sets forth information regarding the allowance for loan
losses:
<TABLE>
<CAPTION>
Three Months Three Months
Ended Ended
03/31/2000 03/31/1999
-------------- --------------
<S> <C> <C>
Allowance at beginning of period $ 3,452,131 $ 3,061,631
Provision for losses charged to income 350,000 341,036
Charge-offs (207,186) (402,153)
Recoveries 5,573 203,312
----------- -----------
Allowance at end of period $ 3,600,518 $ 3,203,826
=========== ===========
</TABLE>
B-35
<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 2000 March 1999
---------------------------- ----------------------------
Per Per
Share Share
Shares Amount Shares Amount
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Basic EPS 2,666,196 $ 0.44 2,636,544 $ 0.34
=========== ===========
Effect of dilutive
Securities:
Stock Options - 75,681
Convertible Preferred Stock 21,975 21,975
------------ ------------
Diluted EPS 2,688,171 $ 0.44 2,734,200 $ 0.32
============ =========== ============ ===========
</TABLE>
NOTE 6 - OTHER SIGNIFICANT MATTERS
Southern Financial signed a definitive Merger Agreement providing for a
merger with First Savings Bank of Virginia. Southern Financial will issue .44
shares of its common stock in exchange for each share of common stock of First
Savings Bank of Virginia. Subject to certain conditions including receipt of
regulatory approval and approval of the shareholders of First Savings Bank of
Virginia, closing of the merger is anticipated to occur in the third quarter of
2000. The merger will be accounted for under the purchase method.
B-36
<PAGE>
Appendix C
FIRST SAVINGS BANK OF VIRGINIA AND SUBSIDIARY
Consolidated Financial Statements and Report of
Independent Certified Public Accountants
December 31, 1999 and 1998
--------------------------------------------------------------------------------
C-1
<PAGE>
First Savings Bank of Virginia and Subsidiary
Contents
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Certified Public Accountants C-3
Consolidated Financial Statements
Consolidated Statements of Financial Condition C-4
Consolidated Statements of Income C-5
Consolidated Statements of Stockholders' Equity and Comprehensive Income C-6
Consolidated Statements of Cash Flows C-7
Notes to Consolidated Financial Statements C-8 - C-23
Interim Consolidated Financial Statements (unaudited)
Consolidated Statements of Financial Condition C-24
Consolidated Statements of Income C-25
Consolidated Statements of Stockholders' Equity and Comprehensive Income C-26
Consolidated Statements of Cash Flows C-27
Notes to Consolidated Financial Statements C-28 - C-30
</TABLE>
C-2
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors
First Savings Bank of Virginia and Subsidiary
We have audited the accompanying consolidated statements of financial condition
of First Savings Bank of Virginia and Subsidiary (the Institution) as of
December 31, 1999 and 1998, and the related consolidated statements of income,
stockholders' equity and comprehensive income, and cash flows for the years then
ended. These financial statements are the responsibility of the Institution's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Savings Bank
of Virginia and Subsidiary as of December 31, 1999 and 1998, and the results of
their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
/s/ Grant Thornton LLP
Vienna, Virginia
February 18, 2000
C-3
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
December 31, 1999 1998
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Assets
Cash and due from banks $ 1,498,144 $ 2,401,577
Federal Home Loan Bank overnight investments 6,104,409 8,209,901
Investment securities available for sale 1,244,160 4,398,035
Investment securities held to maturity 10,981,544 8,103,127
Federal Home Loan Bank stock 241,500 396,900
Loans receivable, net 47,681,905 40,274,250
Foreclosed real estate, net 157,419 10,000
Accrued interest receivable 445,310 361,561
Premises and equipment, net 511,767 558,928
Other assets 178,803 349,566
-----------------------------------------------------
$ 69,044,961 $ 65,063,845
-----------------------------------------------------
Liabilities and Stockholders' Equity
Liabilities
Deposits $ 55,127,762 $ 58,018,972
Advances from Federal Home Loan Bank 3,000,000 --
Securities sold under agreement to repurchase 5,860,751 2,515,982
Accrued interest payable 73,943 43,842
Advances from borrowers for taxes and insurance 37,292 24,133
Deferred income taxes 123,261 --
Other liabilities 94,259 111,109
-----------------------------------------------------
Total Liabilities 64,317,268 60,714,038
Stockholders' Equity
Common stock ($1 par value, 12,000,000
shares authorized, 931,605 and 930,105
shares issued and outstanding, respectively) 931,605 930,105
Additional paid-in capital 3,276,339 3,273,339
Retained earnings 510,873 146,363
Accumulated other comprehensive income 8,876 --
-----------------------------------------------------
Total Stockholders' Equity 4,727,693 4,349,807
-----------------------------------------------------
$ 69,044,961 $ 65,063,845
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-4
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Income
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1999 1998
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest Income
Loans $ 4,141,404 $ 3,668,992
Investments 1,071,540 770,559
---------------------------------------------------------
Total Interest Income 5,212,944 4,439,551
Interest Expense
Deposits 2,429,225 2,441,830
Borrowed funds 452,054 110,653
---------------------------------------------------------
Total Interest Expense 2,881,279 2,552,483
---------------------------------------------------------
Net Interest Income 2,331,665 1,887,068
Provision for Loan Losses 130,000 85,000
---------------------------------------------------------
Interest Income After Provision for Loan Losses 2,201,665 1,802,068
Non-interest Income
Service charges 555,814 481,946
Gain on sale of real estate owned 75,641 16,193
Gain on sale of loans 21,668 62,966
Other 24,484 21,879
---------------------------------------------------------
Total Non-interest Income 677,607 582,984
Non-interest Expense
Compensation and related benefits 1,098,554 915,460
Occupancy expense 121,224 88,788
Property and equipment expense including depreciation
and amortization 257,392 188,538
Professional fees 166,790 134,050
Federal deposit insurance premium and regulatory fees 75,549 68,771
Data processing expense 177,599 152,015
Other 394,454 336,412
---------------------------------------------------------
Total Non-interest Expense 2,291,562 1,884,034
---------------------------------------------------------
Income Before Income Taxes 587,710 501,018
Income Tax Expense 223,200 63,000
---------------------------------------------------------
Net Income $ 364,510 $ 438,018
---------------------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share of Common Stock $ .39 $ .52
---------------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock $ .39 $ .51
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-5
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended December 31, 1999 and 1998.
<TABLE>
<CAPTION>
Retained Accumulated
Additional Earnings Other
Common Paid-in (Accumulated Comprehensive
Stock Capital Deficit) Income Total
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1998 $ 745,030 $2,760,314 $ (291,655) $-- $3,213,689
Net Income for the Year -- -- 438,018 -- 438,018
Other Comprehensive Income -- -- -- -- --
Total Comprehensive Income 438,018
Options Exercised 22,325 24,650 -- -- 46,975
Stock Issuance 162,750 488,375 -- -- 651,125
Balance, December 31, 1998 930,105 3,273,339 146,363 -- 4,349,807
Net Income for the Year -- -- 364,510 -- 364,510
Other Comprehensive Income
Unrealized holding gain during
the period, net of tax of $5,440 -- -- -- 8,876 8,876
Total Comprehensive Income 373,386
Options Exercised 1,500 3,000 -- -- 4,500
Balance, December 31, 1999 $ 931,605 $3,276,339 $ 510,873 $ 8,876 $4,727,693
</TABLE>
The accompanying notes are an integral part of these statements.
C-6
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1999 1998
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash Flows from Operating Activities
Net income $ 364,510 $ 438,018
------------------------------------------------
Adjustments to reconcile net income to net cash from
operating activities
Depreciation and amortization 115,564 111,720
Amortization of loan fees (70,829) (108,305)
Amortization of premiums and discounts from
investment purchases 22,240 58,072
Provision for possible loan losses 130,000 85,000
Deferred income taxes 189,821 --
Gain on sale of loans (21,668) (62,966)
Gain on sale of real estate owned (75,641) (16,193)
Net gain on sale of investments (1,448) --
Proceeds from sale of loans held for sale -- 1,262,966
Increase in accrued interest receivable (83,749) (96,332)
Decrease (increase) in other assets 93,323 (109,586)
Increase in accrued interest payable 30,101 23,391
Increase (decrease) in advances from borrowers
for taxes and insurance 13,159 (8,360)
Decrease in other liabilities (16,850) (21,674)
------------------------------------------------
Total adjustments 324,023 1,117,733
------------------------------------------------
Net Cash Provided by Operating Activities 688,533 1,555,751
------------------------------------------------
Cash Flows from Investing Activities
Proceeds from sale of loans 945,840 4,109,341
Proceeds from sale of real estate owned 679,181 297,838
Purchases of equipment (68,403) (72,013)
Net increase in loans (9,141,957) (5,558,335)
Purchase of available-for-sale securities (578,735) (6,458,403)
Proceeds from sale of available-for-sale securities 2,165,384 --
Purchases of held-to-maturity securities (6,605,018) (9,092,775)
Proceeds from sale of held-to-maturity securities 377,882 --
Principal repayment on investments 4,914,909 5,447,555
Redemption of Federal Home Loan Bank stock 155,400 --
------------------------------------------------
Net Cash Used in Investing Activities (7,155,517) (11,326,792)
------------------------------------------------
Cash Flows from Financing Activities
Net (decrease) increase in demand deposits, NOW accounts
and savings accounts (1,831,137) 8,659,250
Net (decrease) increase in certificates (1,060,073) 3,139,971
Proceeds from FHLB advances 3,000,000 --
Payment of FHLB advances -- (200,000)
Securities sold under agreement to repurchase 3,344,769 2,515,982
Proceeds from common stock issuance 4,500 698,100
------------------------------------------------
Net Cash Provided by Financing Activities 3,458,059 14,813,303
------------------------------------------------
Net Increase in Cash and Cash Equivalents (3,008,925) 5,042,262
------------------------------------------------
Cash and Cash Equivalents, beginning of year 10,611,478 5,569,216
------------------------------------------------
Cash and Cash Equivalents, end of year $ 7,602,553 $ 10,611,478
------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-7
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Bank with its subsidiary (the Institution) is headquartered in
Springfield, Virginia, and currently operates from two branches in
Springfield and Fredericksburg. The Institution, a SAIF-insured institution,
is engaged primarily in originating one- to four-family residential and
construction real estate loans in Northern Virginia. The Institution follows
generally accepted accounting principles applicable to depository
institutions.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
First Savings Bank of Virginia and its wholly owned subsidiary, FSB
Financial Corporation. The subsidiary was inactive in both 1999 and 1998.
All material intercompany accounts and transactions have been eliminated in
consolidation.
Cash Equivalents
For purposes of presentation in the consolidated statement of cash flows,
cash and cash equivalents are defined as those amounts included in the
statement of financial condition captions, "Cash and due from banks" and
"Federal Home Loan Bank overnight investments." For purposes of the
statements of cash flows, the Institution considers all highly liquid debt
instruments when purchased with original maturities of three months or less
to be cash equivalents.
Investment Securities
Investment securities which the Institution has the positive intent and
ability to hold to maturity are reported at amortized cost. Investment
securities which management has designated as available for sale are
recorded at their fair market value. The net unrealized gain or loss, net of
taxes, is shown as a component of stockholders' equity.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. Gains and losses on the
sale of securities are recorded on the trade date and determined using the
specific identification method.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal balances adjusted for any charge-offs, the allowance
for loan losses and any deferred fees or costs on originated loans and
unamortized premiums or discounts on purchased loans.
Interest income is accrued on the unpaid principal balance. Loan origination
fees and certain direct origination costs are capitalized and recognized as
an adjustment of the yield of the related loan.
C-8
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
A loan is considered impaired when, based on current information and events,
it is probable that the Institution will be unable to collect the scheduled
payments of principal or interest when due according to the contractual
terms of the loan agreement. Factors considered by management in determining
impairment include payment status, collateral value and the probability of
collecting scheduled principal and interest payments when due. Loans that
experience insignificant payment delays and payment shortfalls generally are
not classified as impaired. Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the
borrower, including the length of the delay, the reasons for the delay, the
borrower's prior payment record and the amount of shortfall in relation to
the principal and interest owed.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due. When interest accrual is discontinued, all unpaid unaccrued
interest is reversed. Interest income is subsequently recognized only to the
extent cash payments are received.
The allowance for loan losses is increased by charges to income and
decreased by charge-offs (net of recoveries). Management's periodic
evaluation of the adequacy of the allowance is based on the Institution's
past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay, the
estimated value of any underlying collateral and current economic
conditions.
Foreclosed Real Estate
The Institution's real estate acquired by foreclosure is initially recorded
at the net realizable value at the date of foreclosure. Costs relating to
the improvement of property are capitalized. Holding costs are charged to
expense as incurred. Valuations are periodically performed by management,
and an allowance is established by a charge to operations if the carrying
value of the asset exceeds its fair value.
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. A valuation allowance must also be
established to the extent to which sufficient evidence does not exist to
support realization of a deferred tax benefit arising from temporary
differences.
Premises and Equipment
Leasehold improvements and furniture, fixtures and equipment are carried at
cost, less accumulated depreciation and amortization. Furniture, fixtures
and equipment are depreciated using the straight-line method over the
estimated useful lives of the assets. The cost of leasehold improvements is
being amortized using the straight-line method over the terms of the related
leases.
C-9
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Earnings Per Share
Basic earnings per share have been computed on the basis of the
weighted-average number of shares of common stock outstanding. The
weighted-average number of shares outstanding was 931,465 and 844,238 in
1999 and 1998, respectively.
Diluted earnings per share have been computed using the weighted-average
shares outstanding during the year plus the potential effect of shares
issued for stock options outstanding (939,360 and 866,376 for 1999 and 1998,
respectively). The potential dilutive securities have no effect on net
income used to compute diluted earnings per share.
Comprehensive Income
The Institution adopted Statement of Financial Accounting Standards (SFAS)
No. 130, Reporting Comprehensive Income, as of January 1, 1998. The
Institution had no items of other comprehensive income in 1998.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when (1) the assets have been isolated from the
Institution, (2) the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the
transferred assets and (3) the Institution does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity.
Reclassifications
Certain reclassifications have been made to the 1998 financial statements to
conform to the 1999 presentation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, effective for
fiscal years beginning after June 15, 2000. This Statement establishes
accounting and reporting standards for derivative instruments and hedging
activities, including certain derivative instruments embedded in other
contracts, and requires that an entity recognize all derivatives as assets
or liabilities in the balance sheet and measure them at fair value. If
certain conditions are met, an entity may elect to designate a derivative as
follows: (1) a hedge of the exposure to changes in
C-10
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
the fair value of a recognized asset or liability or an unrecognized firm
commitment, (2) a hedge of the exposure to variable cash flows of a
forecasted transaction or (3) a hedge of the foreign currency exposure of an
unrecognized firm commitment, an available-for-sale security, a foreign
currency denominated forecasted transaction, or a net investment in a
foreign operation. The Statement generally provides for matching the timing
of the recognition of the gain or loss on derivatives designated as hedging
instruments with the recognition of changes in the fair value of the item
being hedged. Depending on the type of hedge, such recognition will be in
either net income or other comprehensive income. For a derivative not
designated as a hedging instrument, changes in fair value will be recognized
in net income in the period of change. Management is currently evaluating
the impact of adopting this Statement on the consolidated financial
statements, but does not anticipate that it will have a material impact.
--------------------------------------------------------------------------------
NOTE B--INVESTMENT SECURITIES
Investment securities classified as available for sale are recorded at their
estimated market value. The carrying values and estimated fair values of
investment securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1999 Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 1,229,844 $ 14,316 $ -- $ 1,244,160
---------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1998 Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 4,398,035 $ -- $ -- $ 4,398,035
---------------------------------------------------------------------
</TABLE>
Investment securities classified as held to maturity are recorded at
amortized cost. The carrying amounts and estimated fair values of such
investment securities are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1999 Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bonds, notes and debentures at
amortized cost:
U.S. government and agency
obligations $ 5,515,473 $ 1,463 $ (119,750) $ 5,397,186
Mortgage-backed securities 5,466,071 11,059 (54,031) 5,423,099
---------------------------------------------------------------------
$ 10,981,544 $ 12,522 $ (173,781) $ 10,820,285
---------------------------------------------------------------------
</TABLE>
C-11
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE B--INVESTMENT SECURITIES--Continued
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1999 Cost Gains Losses Value
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bonds, notes and debentures at
amortized cost:
U.S. government and agency
obligations $ 454,874 $ 687 $ -- $ 455,561
Mortgage-backed securities 7,648,253 6,435 (34,520) 7,620,168
---------------------------------------------------------------------
$ 8,103,127 $ 7,122 $ (34,520) $ 8,075,729
---------------------------------------------------------------------
</TABLE>
The scheduled maturities of securities at December 31, 1999, were as
follows:
<TABLE>
<CAPTION>
Securities Available Securities Held
for Sale to Maturity
-------------------------------- --------------------------------
Amortized Fair Amortized Fair
December 31, 1999 Cost Value Cost Value
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due within one year $ -- $ -- $ -- $ --
Due from one year to five years -- -- 142,880 139,439
Due from five to ten years -- -- 647,301 609,631
Due after ten years 1,229,844 1,244,160 10,191,363 10,071,215
---------------------------------------------------------------------
$ 1,229,844 $ 1,244,160 $ 10,981,544 $ 10,820,285
---------------------------------------------------------------------
</TABLE>
Investments with carrying values of $7,206,180 and $3,767,992 were pledged
at December 31, 1999 and 1998, respectively.
Gross realized gains and losses on sales of available for sale securities
totaled $1,727 and $-0- in 1999. There were no sales of securities in 1998.
The tax provision for the 1999 gain amounted to $656.
During 1999, the Institution sold a held-to-maturity security for a loss of
$278. At the time of sale, the security's remaining unamortized cost totaled
approximately $375,000. Management intended to sell an available for sale
security rather than the held-to-maturity security. As such, management does
not believe the sale taints the remaining held-to-maturity portfolio.
-------------------------------------------------------------------------------
NOTE C--LOAN SERVICING
Loans serviced for others are not included in the accompanying consolidated
statements of financial condition. The unpaid principal balances of loans
serviced for others were $2,859,085 and $4,420,243 at December 31, 1999 and
1998, respectively.
C-12
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE D--LOANS RECEIVABLE
<TABLE>
<CAPTION>
Loans receivable at December 31, are summarized as follows:
1999 1998
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
First mortgage loans (conventional)
Principal balances
Secured by one- to four-family residences $ 13,614,149 $ 11,542,419
Secured by other properties 8,890,000 7,945,035
Construction loans 14,827,808 12,329,363
-----------------------------------------------
37,331,957 31,816,817
Unamortized loan premiums 5,920 6,045
Deferred loan origination fees, net (105,469) (112,674)
-----------------------------------------------
Total first mortgage loans 37,232,408 31,710,188
Consumer and other loans
Principal balances
Consumer 906,015 832,140
Second mortgage 130,295 125,883
Commercial 9,894,594 8,064,964
-----------------------------------------------
Total consumer and other loans 10,930,904 9,022,987
Less allowance for loan losses (481,407) (458,925)
-----------------------------------------------
$ 47,681,905 $ 40,274,250
-----------------------------------------------
</TABLE>
Mortgage loans in the amount of $3,917,094 at December 31, 1999 were pledged
as collateral for borrowings from the Federal Home Loan Bank. No mortgage
loans were pledged as collateral for borrowings from the Federal Home Loan
Bank at December 31, 1998.
Activity in the allowance for loan losses is summarized as follows for the
years ended December 31:
<TABLE>
<CAPTION>
1999 1998
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning of year $ 458,925 $ 401,085
Provisions, charged to operations 130,000 85,000
Loans charged off (172,476) (38,120)
Recoveries 64,958 10,960
-----------------------------------------------
Balance, end of year $ 481,407 $ 458,925
-----------------------------------------------
</TABLE>
C-13
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
-------------------------------------------------------------------------------
December 31, 1999 and 1998
-------------------------------------------------------------------------------
NOTE D--LOANS RECEIVABLE--Continued
Impairment of loans has been recognized in conformity SFAS No. 114, as
amended by SFAS No. 118. The following is a summary of information
pertaining to impaired loans at December 31:
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------------------------------------- ----------------------- -----------------------
<S> <C> <C>
Impaired loans without a valuation allowance $ -- $ --
Impaired loans with a valuation allowance 1,331,032 1,390,500
----------------------- -----------------------
Total impaired loans $ 1,331,032 $ 1,390,500
----------------------- -----------------------
Valuation allowance related to impaired loans $ 133,103 $ 130,755
----------------------- -----------------------
</TABLE>
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------------------------------------- ------------------------ ----------------------
<S> <C> <C>
Average investment in impaired loans $ 1,360,766 $ 819,550
------------------------ ----------------------
Interest income recognized on impaired loans 162,450 118,426
------------------------ ----------------------
Interest income recognized on a cash basis on impaired loans $ 162,450 $ 118,426
------------------------ ----------------------
</TABLE>
Loans having carrying values of $738,518 and $281,645 were transferred to
foreclosed real estate in 1999 and 1998, respectively.
The Institution is not committed to lend additional funds to debtors whose
loans have been modified.
-------------------------------------------------------------------------------
NOTE E--ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows at December 31:
<TABLE>
<CAPTION>
1999 1998
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investments $ 91,249 $ 86,850
Loans receivable 354,061 274,711
---------------------------------------------------
$ 445,310 $ 361,561
---------------------------------------------------
</TABLE>
C-14
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE F--FORECLOSED REAL ESTATE
Foreclosed real estate consists of the following at December 31:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Land $ 7,500 $ 10,000
One- to four-family residences 149,919 --
--------------------------------------------------
$ 157,419 $ 10,000
------------------------------------------------------------------------------==================================================
</TABLE>
NOTE G--PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows at December 31:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Leasehold improvements $ 476,616 $ 475,416
Furniture, fixtures and equipment 593,570 526,368
--------------------------------------------------
1,070,186 1,001,784
Less accumulated depreciation and amortization (558,419) (442,856)
--------------------------------------------------
$ 511,767 $ 558,928
------------------------------------------------------------------------------==================================================
</TABLE>
NOTE H--DEPOSITS
Deposits are summarized as follows at December 31:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Demand and NOW accounts $ 9,354,305 $ 13,254,862
Money market deposit accounts 4,118,167 2,454,337
Statement savings 3,684,890 3,279,300
--------------------------------------------------
17,157,362 18,988,499
Certificates of deposit 37,970,400 39,030,473
--------------------------------------------------
$ 55,127,762 $ 58,018,972
------------------------------------------------------------------------------==================================================
</TABLE>
C-15
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE H--DEPOSITS--Continued
The aggregate amount of short-term certificates of deposit with a minimum
denomination of $100,000 was approximately $6,521,813 and $7,093,300 at
December 31, 1999 and 1998, respectively.
At December 31, 1998 the scheduled maturities of certificates of deposit are
as follows:
Year ending December 31,
--------------------------------------------------------------------------------
2000 $ 28,346,502
2001 4,455,499
2002 2,134,007
2003 2,123,496
2004 910,896
------------------------
$ 37,970,400
------------------------
NOTE I--BORROWED FUNDS
Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB),
advances are secured by all stock in the FHLB, qualifying first mortgage
loans and certain investment securities. Advances of $3,000,000 at December
31, 1999 are scheduled to mature in March 2000.
Securities sold under agreements to repurchase are classified as secured
borrowings. The Institution has a repurchase agreement with a correspondent
bank. Borrowings under this repurchase agreement generally mature within 90
days or on demand. Securities collateralizing the agreement have been
delivered to the counter party. The rate of interest on these borrowings
fluctuates in response to market conditions. The available credit is based
on the collateral provided by the Bank when the borrowing is initiated.
Interest expense on borrowed funds is summarized as follows for the years
ended December 31:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Advances from the FHLB $ 53,550 $ 1,762
Securities sold under agreement to repurchase 398,504 108,891
--------------------------------------------------
$ 452,054 $ 110,653
--------------------------------------------------
</TABLE>
C-16
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE J--INCOME TAXES
Income tax (benefit) expense at December 31, 1999 and 1998 comprises the
following:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Federal
Current $ 33,379 $ --
Deferred 163,498 137,641
Adjustment of valuation reserve for net operating
loss utilization -- (78,641)
---------------------------------------------------
196,877 59,000
State
Current -- --
Deferred 26,323 25,810
Adjustment of valuation reserve for net operating
loss utilization -- (21,810)
---------------------------------------------------
26,323 4,000
---------------------------------------------------
Net provision $ 223,200 $ 63,000
---------------------------------------------------
</TABLE>
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities give rise to significant portions of the
deferred tax (liability) asset at December 31:
<TABLE>
<CAPTION>
1999 1998
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Accrual to cash $ (173,706) $ (90,414)
Deferred loan fees (48,031) (63,336)
FHLB stock dividends (62,773) (45,446)
Loan loss reserve 172,758 106,672
Net operating loss carryforwards -- 180,007
Other (11,509) (15,483)
---------------------------------------------------
Deferred tax (liability) asset (123,261) 72,000
---------------------------------------------------
</TABLE>
The deferred tax asset at December 31, 1998 is reflected as a component of
other assets in the consolidated statement of financial condition.
C-17
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE J--INCOME TAXES--Continued
Prior to 1996, the Institution had qualified under the Internal Revenue Code
(the Code) provisions which permitted it to deduct from taxable income an
allowance for bad debts based on a percentage of taxable income before such
deduction. As an alternative, the Code allowed a bad debt deduction to be
computed based on actual experience.
During 1996, legislation was passed requiring the Institution to recapture
as taxable income the portion of its bad debt reserve in excess of its
experienced-based reserve. The Institution will be unable to utilize the
percentage of taxable income method to compute its reserve addition in the
future. The Institution must amortize the portion of its bad debt reserve
subject to recapture over six years.
Retained earnings at December 31, 1999 included earnings of approximately
$113,000 representing such bad debt deductions for which no provision for
federal income taxes had been made. If, in the future, this portion of
retained earnings is used for any purpose other than to absorb bad debt
losses, federal income taxes may be imposed at the then applicable rate.
--------------------------------------------------------------------------------
NOTE K--REGULATORY MATTERS
The Institution is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a
material effect on the Institution's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective
action, the Institution must meet specific capital guidelines that involve
quantitative measures of the Institution's assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices.
The Institution's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings
and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Institution to maintain minimum amounts and ratios (set forth in
the table below) as defined by regulation. Management believes, as of
December 31, 1999, the Institution met all capital adequacy requirements to
which it is subject.
As of December 31, 1999, the most recent notification from the Office of
Thrift Supervision categorized the Institution as well capitalized under the
regulatory framework for prompt corrective action. There are no conditions
or events since that notification that management believes have changed the
Institution's category.
C-18
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE K--REGULATORY MATTERS--Continued
<TABLE>
<CAPTION>
Minimum to be
Well Capitalized
Under
Minimum for Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
------------------------------------------------------------ ---------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31,
1999:
Total risk-based
capital to
risk-weighted
assets $ 5,223,715 12.96% $ 3,225,619 8.00% $ 4,032,023 10.00%
Tier 1 capital to
risk-weighted
assets 4,718,817 11.70% 1,612,809 4.00% 2,419,214 6.00%
Core capital to
adjusted tangible
assets 4,718,817 6.84% 2,761,798 4.00% 3,452,248 5.00%
Tangible capital to
tangible assets 4,718,817 6.84% 1,035,674 1.50% N/A N/A
As of December 31,
1998:
Total risk-based
capital to
risk-weighted
assets 4,776,287 14.01% 2,726,875 8.00% 3,409,593 10.00%
Tier 1 capital to
risk-weighted
assets 4,349,807 12.76% 1,363,437 4.00% 2,045,156 6.00%
Core capital to
adjusted tangible
assets 4,349,807 6.69% 2,602,554 4.00% 3,253,083 5.00%
Tangible capital to
tangible assets 4,349,807 6.69% 975,925 1.50% N/A N/A
</TABLE>
C-19
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE K--REGULATORY MATTERS--Continued
The following is a reconciliation of the Institution's generally accepted
accounting principles capital, to its regulatory capital, at December 31,
1999:
<TABLE>
<CAPTION>
Regulatory
-----------------------------------------------------------------------------------------------
Tangible Core Risk-Based
Capital Percentage Capital Percentage Capital Percentage
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
GAAP capital $ 4,727,693 6.85% $ 4,727,693 6.85% $ 4,727,693 11.73%
Accumulated
comprehensive
income (8,876) (0.01) (8,876) (0.01) (8,876) (0.02)
General valuation
allowances 504,898 1.25
-----------------------------------------------------------------------------------------------
Regulatory capital--
computed $ 4,718,817 6.84% $ 4,718,817 6.84% $ 5,223,715 12.96%
-----------------------------------------------------------------------------------------------
</TABLE>
--------------------------------------------------------------------------------
NOTE L--COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Institution has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. In addition, the Institution
is involved in certain claims and legal actions arising in the ordinary
course of business. In the opinion of management, after consultation with
legal counsel, the ultimate disposition of these matters is not expected to
have a material, adverse effect on the consolidated financial position of
the Institution.
The principal commitments of the Institution are as follows:
Lease Commitments
At December 31, 1999 the Institution was obligated under non-cancelable
operating leases for office space. The Institution entered into a land lease
with an unrelated party with an initial term expiring in 2003 and two
additional 15-year options thereafter. The Institution has entered into an
office lease with a related party. The lease has a term expiring in 2004.
Annual rent expense under the lease is $81,900 for fiscal years 1999 and
2000. The lease contains a rent escalation beginning in fiscal year 2001.
The amount paid to the related party in 1999 was $73,856. Net rent expense
under operating leases, included in occupancy and equipment expense, was
$101,306 and $84,546 for the years ended December 31, 1999 and 1998,
respectively.
C-20
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE L--COMMITMENTS AND CONTINGENCIES--Continued
The projected minimum rental payments under the initial terms of the leases
at December 31, 1999 are as follows:
Year ending December 31,
--------------------------------------------------------------------------------
2000 $ 126,532
2001 152,007
2002 149,516
2003 128,275
2004 19,175
Thereafter --
------------------------
$ 575,505
------------------------
Loan Commitments
In the normal course of business, the Institution makes various commitments
and incurs certain contingent liabilities that are not presented in the
accompanying consolidated financial statements. The commitments and
contingent liabilities include various guarantees, commitments to extend
credit and standby letters of credit. At December 31, 1999, commitments
under standby letters of credit aggregated $828,256. Unfunded loan
commitments totaled $11,603,893.
The amount of collateral obtained, if it is deemed necessary by the
Institution, is based on management's credit valuation of the customer.
Stock Option Plan
The Institution adopted a stock option plan and reserved 90,000 shares for
issuance. The plan expired in September 1996; granted options expired in
1999. In April 1998, the Institution adopted a new stock option plan and
reserved 100,000 shares for issuance. As of December 31, 1999, 20,000
options were outstanding under the new plan. The options granted in 1999
expire in 2006. The following table summarizes certain information regarding
outstanding options under both plans:
C-21
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE L--COMMITMENTS AND CONTINGENCIES--Continued
<TABLE>
<CAPTION>
Number of
Shares Exercise Price
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at January 1, 1998 42,000
Granted 8,250 $ 4.00-5.00
Exercised (22,325) $ 2.00-3.00
Canceled --
-----------------
Balance at December 31, 1998 27,925
Granted 22,500 $ 5.00
Exercised (1,500) $ 3.00
Canceled (2,500) $ 5.00
Expired (26,425) $ 3.00-5.00
-----------------
Balance at December 31, 1999 20,000
-----------------
</TABLE>
The pro forma disclosures of the fair value method for stock-based
compensation required by SFAS No. 123 have been omitted, as the amounts are
considered immaterial.
--------------------------------------------------------------------------------
NOTE M--RELATED PARTY TRANSACTIONS
Certain directors, officers, employees and stockholders of the Institution
were loan customers of the Institution during 1999 and 1998. In the opinion
of management, these loans are consistent with sound banking practices, are
within regulatory lending limitations, and do not involve more than normal
risk of collectibility. At December 31, 1999 and 1998, these loans totaled
approximately $1,044,876 and $683,900, respectively. In addition, related
party deposits held totaled approximately $776,697 and $498,243 at December
31, 1999 and 1998, respectively.
--------------------------------------------------------------------------------
NOTE N--STATEMENT OF CASH FLOWS SUPPLEMENTAL DISCLOSURES
The Institution paid the following amounts during the years ended December
31:
1999 1998
--------------------------------------------------------------------------------
Interest $ 2,845,663 $ 2,529,092
--------------------------------------------------
Income taxes $ 40,000 $ --
--------------------------------------------------
C-22
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
--------------------------------------------------------------------------------
December 31, 1999 and 1998
--------------------------------------------------------------------------------
NOTE O--RETIREMENT PLAN
The Institution has a defined contribution retirement plan which covers
substantially all full-time employees who have completed six months of
service. The Institution will contribute 50 percent of employee
contributions up to 2 percent of pre-tax income. The employer contribution
vests immediately. The Institution contributed approximately $8,613 and
$10,087 to the plan during the years ended December 31, 1999 and 1998,
respectively.
--------------------------------------------------------------------------------
NOTE P--SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
The Institution is primarily engaged in originating one- to four-family
residential and construction real estate loans in Northern Virginia. The
concentration of loans receivable by type of loan is reflected in Note D.
The Institution offers both fixed and adjustable rates of interest on these
loans, which have amortization terms ranging to 30 years. A significant
percentage of Northern Virginia borrowers are employed by service firms and
government agencies. Adverse changes in economic conditions could have a
direct effect on the timing and amount of payments by borrowers, as well as
impairing collateral values. However, management believes residential real
estate values are presently stable in its primary lending area, and loan
loss allowances have been provided for in amounts commensurate with its
current perception of the foregoing risks in the portfolio.
C-23
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Financial Condition (unaudited)
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
2000 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Assets
Cash and due from banks $ 2,930,207 $ 1,498,144
Federal Home Loan Bank overnight investments 6,603,890 6,104,409
Investment securities available for sale 1,039,585 1,244,160
Investment securities held to maturity 11,192,223 10,981,544
Federal Home Loan Bank stock 241,500 241,500
Loans receivable, net 48,087,567 47,681,905
Foreclosed real estate, net 7,500 157,419
Accrued interest receivable 377,860 445,310
Premises and equipment, net 489,646 511,767
Other assets 146,433 178,803
---------------------------------------------------
$ 71,116,411 $ 69,044,961
---------------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Liabilities
Deposits $ 54,043,822 $ 55,127,762
Advances from Federal Home Loan Bank 3,000,000 3,000,000
Securities sold under agreement to repurchase 8,860,751 5,860,751
Accrued interest payable 65,850 73,943
Advances from borrowers for taxes and insurance 108,533 37,292
Deferred income taxes 117,821 123,261
Other liabilities 116,953 94,259
---------------------------------------------------
Total Liabilities 66,313,730 64,317,268
Stockholders' Equity
Common stock ($1 par value, 12,000,000
shares authorized, 931,605 shares issued
and outstanding) 931,605 931,605
Additional paid-in capital 3,276,339 3,276,339
Retained earnings 587,386 510,873
Accumulated other comprehensive income 7,351 8,876
---------------------------------------------------
Total Stockholders' Equity 4,802,681 4,727,693
---------------------------------------------------
$ 71,116,411 $ 69,044,961
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-24
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Income (unaudited)
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2000 1999
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest Income
Loans $ 1,148,315 $ 913,279
Investments 264,320 287,685
--------------------------------------------------
Total Interest Income 1,412,635 1,200,964
Interest Expense
Deposits 583,107 626,342
Borrowed funds 165,271 52,224
--------------------------------------------------
Total Interest Expense 748,378 678,566
--------------------------------------------------
Net Interest Income 664,257 522,398
Provision for Loan Losses 225,000 10,000
--------------------------------------------------
Interest Income After Provision for Loan Losses 439,257 512,398
Non-interest Income
Service charges 115,878 139,015
Gain on sale of real estate owned 4,356 --
Gain on sale of loans 139,050 --
Other 6,646 4,904
--------------------------------------------------
Total Non-interest Income 265,930 143,919
Non-interest Expense
Compensation and related benefits 278,610 252,794
Occupancy expense 30,710 22,495
Property and equipment expense including depreciation
and amortization 59,824 60,284
Professional fees 65,679 25,106
Federal deposit insurance premium and regulatory fees 13,463 19,422
Data processing expense 49,060 42,091
Other 84,528 94,536
--------------------------------------------------
Total Non-interest Expense 581,874 516,728
--------------------------------------------------
Income Before Income Taxes 123,313 139,589
Income Tax Expense 46,800 53,100
--------------------------------------------------
Net Income $ 76,513 $ 86,489
---------------------------------------------------------------------------------------------------------------------------
Basic Earnings Per Share of Common Stock $ .08 $ .09
---------------------------------------------------------------------------------------------------------------------------
Diluted Earnings Per Share of Common Stock $ .08 $ .09
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-25
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements of Stockholders' Equity and Comprehensive Income
(unaudited)
Three months ended March 31, 2000 and year ended December 31, 1999
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income Total
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1999 $ 930,105 $ 3,273,339 $ 146,363 $ -- $ 4,349,807
Net Income for the Year -- -- 364,510 -- $ 364,510
Other Comprehensive Income
Unrealized holding gain during
the period, net of tax of $5,440 -- -- -- 8,876 8,876
Total Comprehensive Income 373,386
Options Exercised 1,500 3,000 -- -- 4,500
Balance, December 31, 1999 931,605 3,276,339 510,873 8,876 4,727,693
Net Income for the Quarter -- -- 76,513 -- 76,513
Other Comprehensive Income
Unrealized holding loss during
the period, net of tax benefit
of $935 -- -- -- (1,525) (1,525)
Total Comprehensive Income 74,988
Balance, March 31, 2000 $ 931,605 $ 3,276,339 $ 587,386 $ 7,351 $ 4,802,681
</TABLE>
The accompanying notes are an integral part of these statements.
C-26
<PAGE>
First Savings Bank of Virginia and Subsidiary
Consolidated Statements Cash Flows (unaudited)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Cash Flows from Operating Activities
Net income $ 76,513 $ 86,489
-----------------------------------------------------
Adjustments to reconcile net income to net cash from
operating activities
Depreciation and amortization 31,871 27,140
Amortization of loan fees (14,800) (18,768)
Amortization of premiums and discounts from
Investment purchases 8,456 25,327
Provision for possible loan losses 225,000 10,000
Deferred income taxes -- 53,100
Gain on sale of loans (139,050) --
Gain on sale of real estate owned (4,356) --
Decrease (increase) in accrued interest receivable 67,450 (55,311)
Decrease (increase) in other assets 32,370 (58,919)
(Decrease) increase in accrued interest payable (8,093) 53,069
Increase in advances from borrowers
for taxes and insurance 71,241 37,608
Increase in other liabilities 18,190 13,609
-----------------------------------------------------
Total adjustments 288,279 86,855
-----------------------------------------------------
Net Cash Provided by Operating Activities 364,792 173,344
-----------------------------------------------------
Cash Flows from Investing Activities
Proceeds from sale of loans 2,282,931 --
Proceeds from sale of real estate owned 154,275 --
Purchases of equipment (9,750) (5,812)
Net increase in loans (2,759,743) (2,474,411)
Purchases of held-to-maturity securities (500,000) (4,459,658)
Principal repayment on investments 482,979 2,099,122
-----------------------------------------------------
Net Cash Used in Investing Activities (349,308) (4,840,759)
-----------------------------------------------------
Cash Flows from Financing Activities
Net increase in demand deposits, NOW accounts
and savings accounts 1,755,800 3,188,443
Net decrease in certificates (2,839,740) (17,693)
Securities sold under agreement to repurchase 3,000,000 3,969,641
Proceeds from common stock issuance -- 4,500
-----------------------------------------------------
Net Cash Provided by Financing Activities 1,916,060 7,144,891
-----------------------------------------------------
Net Increase in Cash and Cash Equivalents 1,931,544 2,477,467
-----------------------------------------------------
Cash and Cash Equivalents, beginning of period 7,602,553 10,611,478
-----------------------------------------------------
Cash and Cash Equivalents, end of period $ 9,534,097 $ 13,088,954
-----------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
C-27
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements
-------------------------------------------------------------------------------
Three months ended March 31, 2000 and year ended December 31, 1999
-------------------------------------------------------------------------------
NOTE A--BASIS OF PRESENTATION
The accompanying March 31, 2000 unaudited financial statements have been
prepared in accordance with the instructions to Form 10-QSB 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 ending March
31, 2000 are not necessarily indicative of the results to be expected for
the full year. These financial statements should be read in conjunction with
the financial statements and the notes included in First Savings Bank of
Virginia's (the Bank's) Annual Report for the year ended December 31, 1999.
-------------------------------------------------------------------------------
NOTE B--INVESTMENT SECURITIES
Investment securities classified as available for sale are recorded at their
estimated market value. The carrying values and estimated fair values of
such investment securities are summarized as follows:
<TABLE>
<CAPTION>
Estimated
Amortized Fair
March 31, 2000 Cost Value
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage-backed securities $ 1,027,729 $ 1,039,585
--------------------------------------------------
Estimated
Amortized Fair
December 31, 1999 Cost Value
----------------------------------------------------------------------------------------------------------
Mortgage-backed securities $ 1,229,844 $ 1,244,160
--------------------------------------------------
</TABLE>
Investment securities classified as held to maturity are recorded at
amortized cost. The carrying amounts and estimated fair values of such
investment securities are summarized as follows:
<TABLE>
<CAPTION>
Estimated
Amortized Fair
March 31, 2000 Cost Value
----------------------------------------------------------------------------------------------------------
<S> <C> <C>
U.S. government and agency
obligations $ 6,003,047 $ 5,858,851
Mortgage-backed securities 5,189,176 5,144,450
--------------------------------------------------
$ 11,192,223 $ 11,003,301
--------------------------------------------------
</TABLE>
C-28
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
-------------------------------------------------------------------------------
Three months ended March 31, 2000 and year ended December 31, 1999
-------------------------------------------------------------------------------
NOTE B--INVESTMENT SECURITIES--Continued
<TABLE>
<CAPTION>
Estimated
Amortized Fair
December 31, 1999 Cost Value
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
U.S. government and agency
obligations $ 5,515,473 $ 5,397,186
Mortgage-backed securities 5,466,071 5,423,099
---------------------------------------------------------
$ 10,981,544 $ 10,820,285
---------------------------------------------------------
</TABLE>
--------------------------------------------------------------------------------
NOTE C--LOANS RECEIVABLE
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
First mortgage loans (conventional)
Principal balances
Secured by one- to four-family residences $ 15,744,598 $ 13,614,149
Secured by other properties 7,925,846 8,890,000
Construction loans 13,046,261 14,827,808
-----------------------------------------------
36,716,705 37,331,957
Unamortized loan premiums 5,880 5,920
Deferred loan origination fees, net (109,973) (105,469)
-----------------------------------------------
Total first mortgage loans 36,612,612 37,232,408
Consumer and other loans
Principal balances
Consumer 995,807 906,015
Second mortgage 184,729 130,295
Commercial 10,991,148 9,894,594
-----------------------------------------------
Total consumer and other loans 12,171,684 10,930,904
Less allowance for loan losses (696,729) (481,407)
-----------------------------------------------
$ 48,087,567 $ 47,681,905
-----------------------------------------------
</TABLE>
C-29
<PAGE>
First Savings Bank of Virginia and Subsidiary
Notes to Consolidated Financial Statements--Continued
-------------------------------------------------------------------------------
December 31, 1999 and 1998
-------------------------------------------------------------------------------
NOTE C--LOANS RECEIVABLE--Continued
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning of year $ 481,407 $ 458,925
Provisions, charged to operations 225,000 130,000
Loans charged off (15,859) (172,476)
Recoveries 6,181 64,958
----------------------------------------------
Balance, end of year $ 696,729 $ 481,407
----------------------------------------------
</TABLE>
--------------------------------------------------------------------------------
NOTE D--MERGER AGREEMENT
First Savings Bank signed a definitive merger agreement providing for a
merger with Southern Financial Bancorp, Inc. Stockholders of the Bank will
receive .44 shares of Southern Financial Bancorp common stock in exchange
for each share of their common stock. Subject to certain conditions
including receipt of regulatory approval and approval of the shareholders of
the Bank, closing of the merger is anticipated to occur in the third quarter
of 2000.
As a result of the definitive merger agreement, provisions of employment
agreements with certain employees provide for severance payments and
additional compensation as incentives for these employees to continue
employment with the Bank through completion of the merger. The total
compensation provided in these agreements, payable at the completion of the
merger, approximates $321,000.
C-30
<PAGE>
Appendix D
RP FINANCIAL, LC.
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Financial Services Industry Consultant
July 17, 2000
Board of Directors
First Savings Bank of Virginia
6551 Loisdale Court, Suite 150
Springfield, Virginia 22150-1808
Members of the Board:
You have requested RP Financial, LC. ("RP Financial") to provide you
with its opinion as to the fairness from a financial point of view to the
stockholders of First Savings Bank of Virginia, Springfield, Virginia ("FSBV"),
of the Agreement and Plan of Reorganization (the "Agreement"), by and between
Southern Financial Bancorp, Inc., Warrenton, Virginia ("SFB"), a Virginia
banking corporation with its principal subsidiary being Southern Financial Bank
(the "Bank"), hereinafter referred to as the "Merger". Unless otherwise defined,
all capitalized terms incorporated herein have the meanings ascribed to them in
the Agreement, which is incorporated herein by reference.
Summary Description of Consideration
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At the Effective Date, FSBV shall be merged into Bank, and the separate
operations of FSBV shall cease. Concurrently, each share of FSBV common stock
issued and outstanding immediately prior to the Effective Date (except for
Dissenters' Shares) shall cease to be outstanding and shall be converted into
and exchanged for 0.44 shares (the "Exchange Ratio") of common stock of SFB
("SFB Common Stock"). Cash will be paid in lieu of fractional shares on the
basis of the average of the closing prices of SFB Common Stock as reported by
NASDAQ for trades reported during the ten (10) trading days immediately
preceding the Effective Date. In the event SFB changes the number of shares of
SFB Common Stock issued and outstanding prior to the Effective Date as a result
of any stock split, stock dividend, recapitalization or similar transaction with
respect to the outstanding SFB Common Stock and the record date therefor shall
be prior to the Effective Date, the Exchange Ratio shall be proportionately
adjusted. On the Effective Date, all rights with respect to FSBV Common Stock
pursuant to stock options ("FSBV Options") granted by FSBV under a FSBV stock
option plan which are outstanding on the Effective Date, whether or not they are
exercisable, shall be converted into and become rights with respect to SFB
Common Stock, and SFB shall assume each FSBV Option in accordance with the terms
of the stock option plan under which it was issued and the stock options
agreement by which it is evidenced. From the Effective Date forward, (i) each
FSBV Option assumed by SFB may be exercised solely for shares of SFB Common
Stock, (ii) the number of shares of SFB Common Stock subject to each FSBV option
shall be equal to the number of shares of FSBV Common Stock subject to such
option immediately prior to the Effective Date multiplied by the Exchange Ratio
and (iii) the per share exercise price under each such option by the Exchange
Ratio and rounding down to the nearest cent; provided, however, that the terms
of
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Washington Headquarters
Rosslyn Center Telephone: (703) 528-1700
1700 North Moore Street, Suite 2210 Fax No.: (703) 528-1788
Arlington, VA 22209 E-Mail: [email protected]
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Board of Directors
July 17, 2000
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each FSBV Option shall, in accordance with its terms, be subject to further
adjustment as appropriate to reflect any stock split, stock dividend,
recapitalization or other similar transaction after the Effective Date.
RP Financial Background and Experience
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RP Financial, as part of its financial institution valuation and
consulting practice, is regularly engaged in the valuation of financial
institution securities in connection with mergers and acquisitions of commercial
banks and thrift institutions, initial and secondary offerings, mutual-to-stock
conversions of thrift institutions, and business valuations for other corporate
purposes for financial institutions. As specialists in the securities of
financial institutions, RP Financial has experience in, and knowledge of, the
Virginia and Mid-Atlantic markets for thrift and bank securities and financial
institutions operating in Virginia.
Materials Reviewed
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In rendering this fairness opinion, RP Financial reviewed the following
material: (1) the Agreement, dated March 31, 2000, including exhibits; (2)
financial and other information for FSBV, all with regard to balance and
off-balance sheet composition, profitability, interest rates, volumes,
maturities, trends, credit risk, interest rate risk, liquidity risk and
operations: (a) audited and unaudited financial statements for the fiscal years
ended December 31, 1996 through 1999, and for the quarter ended March 31, 2000,
(b) stockholder, regulatory and internal financial and other reports through
March 31, 2000, (c) the proxy statements for the last three years and the joint
merger proxy pertaining to the Merger, and (d) FSBV's management and Board
comments regarding past and current business, operations, financial condition,
and future prospects; and (3) financial and other information for SFB including:
(a) unaudited and audited financial statements for the fiscal years ended
December 31, 1996 through 1999, and for the quarter ended March 31, 2000, (b)
stockholder, regulatory and internal financial and other reports through March
31, 2000, (c) the annual proxy statement for the last three years, (d) the
registration statement and proxy statement for the completed share exchange
merger with Horizon Bank of Virginia in 1999, which was accounted for as a
pooling of interests, (e) the pending registration statement for the issuance of
trust preferred stock by SFB, (f) SFB's management comments regarding past and
current business, operations, financial condition, and future prospects.
RP Financial reviewed financial, operational, market area and stock
price and trading characteristics for FSBV and SFB (on a historical and pro
forma basis) relative to publicly-traded savings institutions and commercial
banking institutions, respectively, with comparable resources, financial
condition, earnings, operations and markets. RP Financial also considered the
economic and demographic characteristics in the local market area, and the
potential impact of the regulatory, legislative and economic environments on
operations for FSBV and SFB and the public perception of the savings institution
and commercial banking industries. RP Financial also considered: (1) the
financial terms, financial and operating condition and market area of other
recently completed acquisitions of comparable savings institutions both
regionally and
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Board of Directors
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nationally; (2) discounted cash flow analyses incorporating future prospects for
FSBV; (3) the future prospects for SFB; (4) the pro forma impact on SFB of the
acquisition of FSBV, which is expected to be accounted for as a pooling of
interests; and (5) the market for SFB's common stock.
In rendering its opinion, RP Financial relied, without independent
verification, on the accuracy and completeness of the information concerning
FSBV and SFB furnished by the respective institutions to RP Financial for
review, as well as publicly available information regarding other financial
institutions and economic and demographic data. FSBV and SFB did not restrict RP
Financial as to the material it was permitted to review. RP Financial did not
perform or obtain any independent appraisals or evaluations of the assets and
liabilities and potential and/or contingent liabilities of FSBV or SFB.
RP Financial expresses no opinion on matters of a legal, regulatory,
tax or accounting nature or the ability of the merger as set forth in the
Agreement to be consummated. In rendering its opinion, RP Financial assumed
that, in the course of obtaining the necessary regulatory and governmental
approvals for the proposed Merger, no restriction will be imposed on SFB that
would have a material adverse effect on the ability of the Merger to be
consummated as set forth in the Agreement.
Opinion
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It is understood that this letter is directed to the Board of Directors
of FSBV in its consideration of the Agreement, and does not constitute a
recommendation to any stockholder of FSBV as to any action that such stockholder
should take in connection with the Agreement, or otherwise.
It is understood that this opinion is based on market conditions and
other circumstances existing on the date hereof.
It is understood that this opinion may be included in its entirety in
any communication by FSBV or its Board of Directors to the stockholders of FSBV.
It is also understood that this opinion may be included in its entirety in any
regulatory filing by FSBV or SFB, and that RP Financial consents to the summary
of the opinion in the proxy materials of FSBV, and any amendments thereto.
Except as described above, this opinion may not be summarized, excerpted from or
otherwise publicly referred to without RP Financial's prior written consent.
Based upon and subject to the foregoing, and other such matters
considered relevant, it is RP Financial's opinion that, as of the date hereof,
the Merger Consideration to be received by FSBV's stockholders, as described in
the Agreement, is fair to such stockholders from a financial point of view.
Respectfully submitted,
RP FINANCIAL, LC.
/s/ RP FINANCIAL, LC.
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