As filed with the Securities and Exchange Commission on March 20, 2000.
Registration No. 333-94461 and Registration No. 333-94461-01
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
PRE-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
<TABLE>
<CAPTION>
<S> <C>
SOUTHERN FINANCIAL BANCORP, INC. SOUTHERN FINANCIAL CAPITAL TRUST I
(Exact Name of Registrant as Specified In Its Charter) (Exact Name of Registrant as Specified In Its Charter)
Virginia Delaware
(State or Other Jurisdiction of Incorporation or Organization) (State or Other Jurisdiction of Incorporation or Organization)
6022 6022
(Primary Standard Industrial Classification Code Number) (Primary Standard Industrial Classification Code Number)
54-1779978 Applied For
(I.R.S. Employer Identification Number) (I.R.S. Employer Identification Number)
37 East Main Street c/o Southern Financial Bancorp, Inc.
Warrenton, VA 20186 37 East Main Street
(540) 349-3900 Warrenton, VA 20186
(540) 349-3900
(Address, Including Zip Code, and Telephone Number, Including (Address, Including Zip Code, and Telephone Number, Including
Area Code, of Registrant's Principal Executive Offices) Area Code, of Registrant's Principal Executive Offices)
</TABLE>
Georgia S. Derrico
37 East Main Street
Warrenton, VA 20186
(540) 349-3900
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent For Service)
Copies of Communications to:
Wayne A. Whitham, Jr., Esquire
R. Brian Ball, Esquire
Williams, Mullen, Clark & Dobbins
1021 East Cary Street, 16th Floor
Richmond, VA 23219
(804) 643-1991
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. |_|
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. |_|_________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|__________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_|__________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. |_|
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to Section 8(a), may
determine.
================================================================================
<PAGE>
Prospectus Subject to Completion - March __, 2000
March __, 2000
Southern Financial Capital Trust I
Up To 1,200,000 $______ Redeemable Capital Securities
(Due ______ 15, 2030)
Southern Financial Capital Trust
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<CAPTION>
<S> <C>
o Southern Financial Capital Trust will The Offering
use the proceeds from this offering and
the sale of all of its common o Southern Financial Capital Trust is
securities to Southern Financial offering to the public 1,200,000
Bancorp, Inc. to purchase the ____% redeemable capital securities, which
junior subordinated debt securities of will represent preferred interests in
Southern Financial Bancorp, Inc. its assets.
o Southern Financial Capital Trust's only o Best efforts offering: The underwriter
assets will be the ___% junior is not required to sell any minimum
subordinated debt securities of number or dollar amount of redeemable
Southern Financial Bancorp, Inc. capital securities, but will use its
best efforts to sell the redeemable
capital securities offered.
o Closing: March __, 2000
The Redeemable Capital Securities Proposed Symbol and Market
o Cash distributions of $____ per year o No public market exists for the
will be paid quarterly on the redeemable capital securities. Southern
redeemable capital securities each year Financial Capital Trust has applied to
beginning on _________ 15, 2000. We may list the redeemable capital securities
defer distributions at any time for a on the NASDAQ National Market under the
period of up to five years. You will be symbol "SFFBP".
required to pay income taxes on
deferred distributions even if you are
a cash basis taxpayer.
o The redeemable capital securities
mature on _________ 15, 2030. Southern
Financial Capital Trust may, however,
redeem the redeemable capital
securities without the holder's consent
at any time on or after _______ 15,
2005, or earlier if a change in the tax
or regulatory treatment of Southern
Financial Capital Trust or the
redeemable capital securities occurs or
is likely to occur.
</TABLE>
<TABLE>
<CAPTION>
Per Share Total
------------------- --------------------
<S> <C> <C>
Public offering price and proceeds to Southern Financial
Capital Trust: $10.00 $12,000,000
</TABLE>
Southern Financial Bancorp, Inc. will pay the underwriter, McKinnon &
Company, Inc., $____ for each redeemable capital security sold, or a total of
$________ if all of the redeemable capital securities are sold, and the expenses
of the offering. If Southern Financial Capital Trust exercises its right to
increase the size of the offering by up to $1.8 million, Southern Financial
Bancorp, Inc. will pay the underwriter additional compensation.
This investment involves risks. See "Risk Factors" beginning on Page ___.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense. We have not registered the redeemable capital securities under
any state's securities laws, and you may not be able to resell your securities
without an exemption under the applicable state's securities laws.
These securities are not deposits or other obligations of a bank and
are not insured by the Federal Deposit Insurance Corporation or any other
governmental agency.
McKinnon & Company, Inc.
<PAGE>
The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
<PAGE>
Southern Financial Bank
Branch Locations
[MAP OF SOUTHERN FINANCIAL BANK BRANCH LOCATIONS]
<PAGE>
TABLE OF CONTENTS
<TABLE>
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Page
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Prospectus Summary...............................................................................2
Ratio of Earnings To Fixed Charges...............................................................7
Summary Financial Information....................................................................8
Risk Factors.....................................................................................9
Where You Can Find More Information.............................................................12
Use of Proceeds.................................................................................13
Southern Financial Capital Trust I..............................................................13
Selected Historical Financial Information.......................................................15
Capitalization..................................................................................16
Accounting Treatment............................................................................16
Regulatory Treatment............................................................................17
Business........................................................................................17
Management's Discussion And Analysis............................................................35
Management......................................................................................42
Description of Redeemable Capital Securities....................................................50
Description of Junior Subordinated Debt Securities..............................................66
Description of Guarantee........................................................................74
Relationship Among The Redeemable Capital Securities, The Junior Subordinated
Debt Securities And The Guarantee............................................................76
United States Federal Income Tax Consequences...................................................78
Erisa Considerations............................................................................82
Forward Looking Statements......................................................................83
Underwriting....................................................................................83
Validity of Securities..........................................................................85
Accountants.....................................................................................85
Index of Significant Terms......................................................................86
</TABLE>
<PAGE>
Prospectus Summary
This summary highlights some of the more detailed information appearing
elsewhere in this prospectus.
Southern Financial Bancorp, Inc.
Southern Financial Bancorp, Inc., a Virginia corporation, is
headquartered in Warrenton, Virginia. We own Southern Financial Bank, a
Virginia-chartered commercial bank. We conduct virtually all of our business
through Southern Financial Bank.
Southern Financial Bank dates to 1986, when Georgia S. Derrico formed
Southern Financial Federal Savings Bank, a Warrenton, Virginia-based thrift. In
December 1995, we converted the thrift to a commercial bank.
Both Ms. Derrico, our Chairman and chief executive officer, and her
husband, R. Roderick Porter, our President and chief operating officer, were
former senior officers with Chemical Bank in New York. Five of our current top
officers had extensive senior banking experience together at Chemical Bank in
the 1970's and 80's before the merger of Chemical and Manufacturers Hanover
Corporation and Chemical's subsequent merger with Chase Manhattan Corp.
Over our fourteen year existence, we have become the second largest
independent bank with offices exclusively in northern Virginia. On October 1,
1999 we acquired a bank based in Vienna, Virginia that had $128.1 million in
total assets and four banking offices. At December 31, 1999, we had $406.2
million in assets, $234.1 million in loans, and $28.9 million in equity.
Our market area is a semi-circle of Virginia counties immediately south
and west of Washington, D.C. Please refer to the map on the inside front cover
of this prospectus. Our market area includes a large concentration of
telecommunications and internet firms, as well as government and defense
industry contractors, primarily in Fairfax County. Fairfax County's population
exceeds 900,000 and rapid population and economic growth has spread west to
Loudoun and Fauquier Counties and south to Stafford, Spotsylvania and Prince
William Counties.
Our customers include individuals and small and medium sized
businesses. However, we specialize in loans and other banking services to small
and medium sized businesses. We actively lend to businesses through Small
Business Administration programs. The Small Business Administration is a U.S.
Government agency that finances the expansion of small businesses in cooperation
with banks and other lenders. The great majority of our income is interest on
loans and investments.
We are having this offering because the redeemable capital securities
will be treated as capital for bank regulatory purposes. This means that we will
be able to grow our total assets faster than our anticipated retained earnings
would permit. The cash proceeds from this offering are not needed for our
operations or liquidity.
We are a legal entity separate and distinct from Southern Financial
Bank. Our right, and thus your right, to receive any of the assets of Southern
Financial Bank is subject to the claims of creditors of Southern Financial Bank.
Our principal source of revenues is dividends from Southern Financial Bank.
2
<PAGE>
Because we own a bank, Southern Financial Bank, we are known as a bank
holding company. As a bank holding company, we are registered with the Board of
Governors of the Federal Reserve System under the Bank Holding Company Act of
1956, as amended. Our executive offices and mailing address are 37 E. Main
Street, Warrenton, VA 20186 and our telephone number is (540) 349-3900. This is
also the address and telephone number for Southern Financial Capital Trust.
Southern Financial Capital Trust I
We formed Southern Financial Capital Trust under Delaware law on
December 28, 1999. We and the trustees of Southern Financial Capital Trust will
sign an agreement, which will contain the terms and conditions for Southern
Financial Capital Trust to issue and sell its redeemable capital securities, as
well as its common securities. This agreement is called the amended and restated
declaration of trust and it also governs the duties of the trustees.
Southern Financial Capital Trust exists solely to:
o sell the redeemable capital securities and the common
securities;
o use the money it receives from the sale of the redeemable
capital securities and common securities to purchase our
junior subordinated debt securities, which will be the only
assets of Southern Financial Capital Trust; and
o engage in other activities that are related to these purposes.
We will purchase all of the common securities of Southern Financial
Capital Trust. The common securities will entitle us to receive 3% of Southern
Financial Capital Trust's cash distributions. The redeemable capital securities
will entitle you and the other owners to the remaining 97% of Southern Financial
Capital Trust's cash distributions. If we default on the junior subordinated
debt securities, we will not receive cash distributions on the common securities
until you have received your cash distributions on the redeemable capital
securities.
Southern Financial Capital Trust has a term of approximately 40 years,
but may be dissolved earlier if the redeemable capital securities are paid off.
We have appointed the following trustees to conduct Southern Financial Capital
Trust's business and affairs:
o Wilmington Trust Company is the property trustee and the
Delaware trustee;
o Two individuals who are employees and officers of Southern
Financial Bancorp, Inc., Georgia S. Derrico and R. Roderick
Porter are the administrative trustees;
As the sole holder of the common securities, we can replace or remove
any of the trustees, unless we default on the junior subordinated debt
securities. A default, for example, would include failing to make required
payments on the junior subordinated debt securities. If we default and do not
cure our default, the property trustee and the Delaware trustee can only be
replaced and removed by the holders of at least a majority of the redeemable
capital securities. As owner of all of Southern Financial Capital Trust's common
securities, only we can remove or replace the administrative trustees.
3
<PAGE>
Southern Financial Capital Trust has no separate financial statements.
The statements would not be meaningful to you because Southern Financial Capital
Trust has no independent operations. It exists solely for the reasons summarized
above.
<TABLE>
<CAPTION>
The Offering
<S> <C>
Securities offered Southern Financial Capital Trust is offering for
sale 1,200,000 redeemable capital securities.
Southern Financial Capital Trust has the right to
increase the number of redeemable capital
securities offered for sale to 1,380,000.
Offering price The offering price is $10.00 for each redeemable
capital security.
No interest on escrowed You will not receive interest on any funds you
funds deposit before this offering closes.
Quarterly distributions You will be entitled to receive cash distributions
are payable to you on the of $______ per year on each capital security.
redeemable capital Distributions will be payable quarterly on the
securities 15th of January, April, July and October of each
year, beginning on _____ 15, 2000. Your first cash
distribution will be less than the regular
quarterly amount because you are buying your
redeemable capital securities after _________15,
2000.
We have the option to defer We have the right to defer interest payments on
interest payments the junior subordinated debt securities for up to
20 consecutive quarters. If we pay all deferred
interest at the end of an interest deferral
period, we can begin a new interest deferral
period at any time. No interest deferral period
may last beyond ______ 15, 2030. We may not defer
interest payments if we have defaulted on the
junior subordinated debt securities. However,
electing to defer interest payments, by itself, is
not a default.
If we defer interest payments, If we defer interest payments on the junior
cash distributions to you will subordinated debt securities, Southern Financial
be deferred Capital Trust also will defer cash distributions
on your redeemable capital securities. During any
period when cash distributions are deferred, your
right to receive cash distributions will
accumulate. You also will accumulate the right to
receive additional distributions at ____% per
year, compounded quarterly, on any deferred
distributions.
You will have taxable income You will be required to pay income taxes on
even if we defer cash deferred distributions even if you are a cash
distributions basis taxpayer.
Our obligations are We are unconditionally obligated to pay
unconditional distributions and all other amounts on the
redeemable capital securities. However, this does
not mean that we may not exercise our right, as
described above, to defer interest payments on the
junior subordinated debt securities.
4
<PAGE>
Ranking of redeemable If we default, payments to you on the redeemable
capital securities capital securities will be made before any
payments to us on the common securities. This does
not give you any significant protection, however,
because the common securities only are entitled to
three percent of the distributions by Southern
Financial Capital Trust. As long as we are not in
default, payments on the redeemable capital
securities and common securities will be made
proportionately.
The junior subordinated debt The junior subordinated debt securities will be
securities are unsecured and unsecured and subordinate to all our senior debt.
subordinate to all our senior This means that there will be no collateral for
debt our obligations to you. It also means that if we
default, all of our senior debt will be paid
before you are paid. Although we currently have no
senior debt, any debts we incur in the future are
likely to be senior debt. There is no limit on the
amount of senior debt that we may incur. We will
guarantee that you will receive cash distributions
if Southern Financial Capital Trust has the funds
available to pay you. Our guarantee also will be
unsecured and subordinate to all senior debt. In
addition, the junior subordinated debt securities
and the guarantee will be subordinate to all
existing and future liabilities of our
subsidiaries, including Southern Financial Bank's
deposit liabilities.
The junior subordinated debt We have fully, irrevocably and unconditionally
securities are scheduled to guaranteed on a subordinated basis that Southern
mature on _________ 15, Financial Capital Trust will pay you $10.00 per
2030 redeemable capital security, plus accrued
distributions, when the junior subordinated debt
securities are paid-off at or before maturity. The
stated maturity of the junior subordinated debt
securities is _______ 15, 2030.
We can pay-off the junior We have the right at any time on or after _____15,
subordinated debt securities 2005 to pay-off the junior subordinated debt
any time after _______ 15, securities. We also have the right at any time
2005 before _____ 15, 2005 to pay-off the junior
subordinated debt securities if any of three
things happen. We can pay-off the junior
subordinated debt securities before_____ 15, 2005
if tax law changes prevent us from deducting
interest payments or if changes in banking
regulations prevent us from counting Southern
Financial Capital Trust's assets as capital. A
change in the Investment Company Act of 1940 that
requires Southern Financial Capital Trust to
register under that law also would permit us to
pay-off the junior subordinated debt securities
before______ 15, 2005.
We must pay a premium to Southern Financial
Capital Trust if we pay-off the junior
subordinated debt securities before_____ 15, 2015.
As a holder of redeemable capital securities, you
will receive your share of any premium we pay to
Southern Financial Capital Trust.
Limited Voting Rights on the You will have no voting rights on the redeemable
Redeemable Capital Securities capital securities, except in limited
circumstances.
No Rating We do not expect the redeemable capital securities
to be rated by any rating service. None of the
other securities that we issue are so rated.
5
<PAGE>
ERISA Considerations Please carefully consider the information set
forth in "ERISA Considerations", which begins on
page __.
Use of Proceeds Southern Financial Capital Trust will use all of
the proceeds from the sale of the common
securities and redeemable capital securities to
purchase the junior subordinated debt securities
from us. We intend to use the net proceeds from
the sale of the junior subordinated debt
securities for general corporate purposes,
including making advances to Southern Financial
Bank to support its continued growth. Pending any
such application, we may invest the net proceeds
in interest-bearing assets.
Proposed Nasdaq National We have applied to have the redeemable capital
Market Symbol securities approved for quotation on the Nasdaq
National Market Symbol under the symbol "SFFBP".
Risk Factors An investment in the redeemable capital securities
involves a number of risks. Some of these risks
relate to the redeemable capital securities and
other risks relate to us. We urge you to carefully
consider the information contained in "Risk
Factors" set forth on page __ of this prospectus,
as well as the other information contained in this
prospectus, before you buy any redeemable capital
securities.
</TABLE>
6
<PAGE>
RATIO OF EARNINGS TO FIXED CHARGES
The following table contains our consolidated ratios of earnings to
fixed charges for each of the periods indicated. For purposes of computing these
ratios, earnings represent net income, plus total taxes based on income, plus
fixed charges. Fixed charges include interest expense, the estimated interest
component of net rental expense and amortization of debt expense.
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Year Ended December 31,
-----------------------------------------------------------------------------------
1999 1998 1997 1996 1995
--------------- --------------- ---------------- --------------- ----------------
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Ratio of earnings to fixed charges:
Excluding interest on deposits 3.14 18.76 13.40 6.96 7.43
Including interest on deposits 1.11 1.34 1.33 1.18 1.29
</TABLE>
7
<PAGE>
SUMMARY FINANCIAL INFORMATION
The following consolidated summary contains selected financial data for
Southern Financial Bancorp, Inc. and its subsidiaries for the periods and at the
dates indicated. You should also read the detailed information and the financial
statements included elsewhere in this prospectus.
<TABLE>
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Year Ended December 31
------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Gross interest income $29,756 $27,857 $25,536 $22,295 $19,634
Gross interest expense 14,308 14,220 12,626 11,343 10,157
Net interest income 15,448 13,637 12,910 10,952 9,477
Provision for loan losses 2,130 1,301 1,265 906 383
Net interest income after provision
for loan losses 13,318 12,336 11,645 10,046 9,094
Non-interest income 2,834 3,145 2,257 1,593 1,279
Non-interest expense 14,589 10,687 9,762 9,599 7,414
Income before income taxes 1,563 4,794 4,140 2,040 2,959
Income taxes 602 1,442 1,332 680 1,078
Net income 961 3,352 2,808 1,360 1,881
Per Share Data:
Net income, basic $0.36 $1.28 $1.10 $0.54 $0.76
Net income, diluted $0.35 $1.22 $1.06 $0.52 $0.73
Cash dividends $0.33 $0.22 $0.17 $0.14 $0.12
Book value at period end $10.87 $11.62 $10.69 $9.72 $10.05
Tangible book value at period end
Period-End Balance Sheet Data:
Total assets $406,222 $404,254 $354,016 $310,169 $269,948
Total loans (net of unearned income) 234,086 206,355 204,560 178,262 165,178
Total deposits 367,188 366,905 320,364 274,971 240,892
Stockholders' equity 28,864 30,626 27,508 24,750 23,572
Performance Ratios:
Return on average assets 0.24% 0.92% 0.88% 0.48% 0.78%
Return on average stockholders'
equity 3.11% 11.62% 10.92% 5.66% 8.38%
Average stockholders' equity to
average total assets 7.11% 7.58% 7.77% 7.98% 8.73%
Efficiency ratio 79.80% 63.68% 64.36% 76.52% 68.93%
Net interest margin 4.07% 3.97% 4.26% 4.12% 4.21%
Dividend payout ratio 92.09% 17.78% 16.20% 26.54% 13.34%
Asset Quality Ratios:
Net charge-offs to average loans 0.79% 0.48% 0.46% 0.34% 0.22%
Allowance to period-end loans 1.45% 1.46% 1.32% 1.31% 1.22%
Allowance to nonperforming loans 661.30% 105.37% 113.95% 83.86% 165.80%
Nonaccrual loans to loans 0.22% 1.39% 1.16% 1.57% 0.74%
Nonperforming assets to loans and
foreclosed properties 1.18% 1.62% 1.50% 2.27% 1.55%
Capital Ratios:
Risk-based capital ratios
Tier 1 capital 10.93% 12.77% 12.98% 13.44% 13.70%
Total capital 12.18% 14.09% 14.19% 14.64% 14.89%
Leverage capital ratio 7.50% 7.84% 8.14% 8.48% 9.37%
Total equity to total assets 7.11% 7.58% 7.77% 7.98% 8.73%
</TABLE>
8
<PAGE>
RISK FACTORS
An investment in the redeemable capital securities involves a number of
risks. Some of these risks relate to the redeemable capital securities and
others relate to us. Please carefully consider the following information,
together with the other information in this prospectus before you buy any
redeemable capital securities.
Risks Related To The Redeemable Capital Securities
Because our obligations to you are unsecured and subordinated to senior
debt, if we have financial difficulties, any senior debt will have to be paid in
full before you receive any payment.
Our obligations under the junior subordinated debt securities and the
guarantee are unsecured and subordinate to all of our present and future senior
debt. This means that there will be no collateral for our obligations to you. It
also means that if we default, all of our senior debt will be paid before you
are paid. As of December 31, 1999 we had no senior debt. However, any debts we
incur in the future are likely to be senior debt. There is no limit to our
ability or Southern Financial Bank's ability to incur additional debts,
including senior debt. For additional information, please refer to "Description
of Junior Subordinated Debt Securities - What Does Subordination Mean to You?",
which begins on page ___.
The ability of Southern Financial Capital Trust to make payments on the
redeemable capital securities depends solely upon our making payments on the
junior subordinated debt securities as and when required. If we default on our
obligation to make required payments on the junior subordinated debt securities,
Southern Financial Capital Trust will not have sufficient funds to make cash
distributions to you. You will not be able to rely upon the guarantee for
payment of these amounts. Instead, you or the property trustee may sue us
directly for payment under the junior subordinated debt securities.
Our right, and thus your right, to receive any assets of Southern
Financial Bank is subject to the claims of Southern Financial Bank's creditors,
including depositors. At December 31, 1999 Southern Financial Bank, had total
liabilities, including deposits, of $377.4 million. Because the junior
subordinated debt securities will be subordinated to all existing and future
liabilities of our subsidiaries, including Southern Financial Bank's deposit
liabilities, you should look only to our assets, and not assets of our
subsidiaries, for payments on the junior subordinated debt securities.
If banking regulations prohibit Southern Financial Bank from paying
dividends to us, we would probably defer interest payments on the junior
subordinated debt securities.
Because we own Southern Financial Bank, we are regulated by the Board
of Governors of the Federal Reserve System. The Federal Reserve also regulates
Southern Financial Bank. Almost all of our consolidated assets are owned by
Southern Financial Bank. We will rely almost entirely on dividends from Southern
Financial Bank to satisfy our obligations to pay principal and interest on the
junior subordinated debt securities. There are legal limits on the amount of
dividends that a bank such as Southern Financial Bank is permitted to pay. We
cannot assure you that Southern Financial Bank will be able to pay dividends at
past levels, or at all, in the future. For additional information, please refer
to "Description of Guarantee - General", which begins on page ___.
9
<PAGE>
If we defer interest payments on the junior subordinated debt
securities, you will be required to pay taxes on distributions you have not
received.
As long as we do not default on the junior subordinated debt
securities, we have the right to defer interest payments on the junior
subordinated debt securities for up to 20 consecutive quarters. If we pay all
deferred interest at the end of an interest deferral period, we can begin a new
interest deferral period at any time. No interest deferral period may last
beyond ______15, 2030. If we defer interest payments on the junior subordinated
debt securities, Southern Financial Capital Trust will defer cash distributions
on the redeemable capital securities until we resume interest payments. For
additional information, please refer to "Description of Redeemable Capital
Securities - Distributions", which begins on page __.
If Southern Financial Capital Trust defers distributions on the
redeemable capital securities, you will be required to pay income taxes on the
deferred distribution and accrue interest income even if you are a cash basis
taxpayer. That is, you must include the deferred interest in your gross income
for U.S. federal income tax purposes regardless of whether you receive cash
distributions. You will not receive the cash related to any accrued and unpaid
interest from Southern Financial Capital Trust if you sell your redeemable
capital securities before all deferred distributions have been brought current.
Deferred distributions that are included in your gross income will increase your
tax basis in the redeemable capital securities. If you sell your redeemable
capital securities before all deferred distributions have been brought current,
your increased tax basis will decrease the amount of any capital gain or will
create a capital loss or increase the amount of any capital loss that you
realize on the sale. A capital loss, except in certain limited circumstances,
cannot be applied to offset ordinary income.
If we defer interest payments on the junior subordinated debt
securities, the market price of the redeemable capital securities is likely to
fall.
We have no current intention of exercising our right to defer interest
payments on the junior subordinated debt securities. However, if we exercise
this right in the future, the market price of the redeemable capital securities
is likely to be adversely affected, because many people will not want to hold a
security that is creating a tax liability, but yielding no cash. If you sell
your redeemable capital securities during a time when distributions have been
deferred, you may not receive the same return on your investment as someone else
who continues to hold the redeemable capital securities.
You have limited rights against us if we default on our obligations to
you.
If we default on our obligation to pay principal or interest on the
junior subordinated debt securities, Southern Financial Capital Trust will not
have sufficient funds to make payments on the redeemable capital securities. You
would not be able to rely on the guarantee for payment. Instead, if we default
in the payment of the principal or interest on the junior subordinated debt
securities, then you may sue us directly to enforce payment. Except as described
in this prospectus, you will not be able to exercise directly any other remedy
available to holders of junior subordinated debt securities. For additional
information, please refer to "Description of Junior Subordinated Debt Securities
- - Enforcement of Rights by Holders of Redeemable Capital Securities", which
begins on page ___.
If we cause an early redemption of the redeemable capital securities,
you may not be able to reinvest the proceeds at the same or a higher rate of
return.
We have the right to redeem the junior subordinated debt at any time
after ________ 15, 2005. Moreover, we also have the right at any time before
_______ 15, 2005 to pay off the junior subordinated debt securities if any of
three things happen. We can pay off the junior subordinated debt securities
before
10
<PAGE>
_______ 15, 2005 if tax law changes prevent us from deducting interest payments
or if changes in banking regulations prevent us from counting Southern Financial
Capital Trust's assets as capital. A change in the Investment Company Act of
1940 that requires Southern Financial Capital Trust to register under that law
also would permit us to pay off the junior subordinated debt securities before
_________ 15, 2005.
Within 90 days of a redemption of the junior subordinated debt
securities, the redeemable capital securities also must be redeemed. It is
possible, perhaps likely, that we would not pay-off the junior subordinated debt
securities unless we could reborrow at a lower rate. If we can reborrow at a
lower rate, it is probable that you could reinvest only at a lower rate. For
additional information, please refer to "Description of Redeemable capital
securities - Events That Will Cause Redemption of Redeemable Capital
Securities", which begins on page ___.
If we liquidate Southern Financial Capital Trust and distribute the
junior subordinated debt securities to you, those securities might trade at a
lower price than you pay for your redeemable capital securities.
We will have the right at any time to terminate Southern Financial
Capital Trust and cause the junior subordinated debt securities to be
distributed to you. Under current United States federal income tax law, a
distribution of junior subordinated debt securities would not be a taxable event
to you. If, however, Southern Financial Capital Trust were taxable as a
corporation at the time of dissolution of Southern Financial Capital Trust, the
distribution of the junior subordinated debt securities may be a taxable event
to you. For additional information, please refer to a "Description of Redeemable
Capital Securities - Liquidation of Southern Financial Capital Trust and
Distribution of Junior Subordinated Debt Securities", which begins on page ___.
We give no assurance about the market prices for redeemable capital
securities or junior subordinated debt securities that may be distributed in
exchange for redeemable capital securities if a liquidation of Southern
Financial Capital Trust occurs. The redeemable capital securities or the junior
subordinated debt securities may trade at a discount to the price that you pay
to purchase the redeemable capital securities. Because you may receive junior
subordinated debt securities on a termination of Southern Financial Capital
Trust, you are also making an investment decision about the junior subordinated
debt securities and should carefully review all the information regarding the
junior subordinated debt securities in this prospectus.
Because you have limited voting rights, we can amend important
agreements in ways that adversely affect you without your consent.
As a holder of redeemable capital securities, you will have limited
voting rights. These voting rights will relate only to the modification of the
redeemable capital securities, the termination of Southern Financial Capital
Trust, and the exercise of Southern Financial Capital Trust's rights as a holder
of the junior subordinated debt securities. In general, only we can replace or
remove any of the trustees.
Even if it would affect you adversely, we and the trustees may modify
the amended and restated declaration of trust without your consent to ensure
that Southern Financial Capital Trust will maintain the federal income tax
treatment that we desire. We also can modify the amended and restated
declaration of trust to ensure that Southern Financial Capital Trust will not be
required to register as an "investment company" under the Investment Company Act
of 1940, as amended, even if such action adversely affects your interests. You
will have no voting rights on any matters submitted to a vote of our
stockholders. For additional information, please refer to "Description of
Redeemable Capital Securities - Voting Rights of Redeemable Capital Securities;
Amendment of the Declaration", which begins on page ___.
11
<PAGE>
Because there has been no public market for the redeemable capital
securities, you cannot be sure that you will be able to sell your redeemable
capital securities at or above the price you pay.
There is no existing market for the redeemable capital securities. We
can give no assurance about the liquidity of any markets that may develop for
the redeemable capital securities, your ability to sell your redeemable capital
securities or at what price you will be able to sell your redeemable capital
securities. Future trading prices of the redeemable capital securities will
depend on many factors including, among other things, prevailing interest rates,
our operating results and the market for similar securities. The underwriter has
informed us that it intends to make a market in the redeemable capital
securities. However, the underwriter is not obligated to do so and any such
market making activity may be terminated at any time without notice to the
holders of the redeemable capital securities.
Risks Related To Us
We plan to grow rapidly and there are risks associated with rapid
growth.
We intend to expand our asset base. In particular, we hope to use the
funds raised in this offering to support anticipated increases in our deposits
and loans. Additional capital also would increase our legal lending limit under
federal law, which in turn would allow us to compete more actively in our market
area for larger loans. Our ability to manage growth successfully will depend on
our ability to maintain cost controls and asset quality while attracting
additional loans and deposits, as well as on factors beyond our control, such as
economic conditions and interest rate trends. If we grow too quickly and are not
able to control costs and maintain asset quality, growth could materially
adversely affect our financial performance.
If we lost the services of our senior management, it would adversely
affect our business.
Our future performance will depend largely on the contributions of a
few senior executive officers of Southern Financial Bank, including Georgia S.
Derrico, the Chairman and chief executive officer and R. Roderick Porter, the
President, and chief operating officer. The loss of the services of one or more
of those individuals could have a material adverse effect on our business and
development.
WHERE YOU CAN FIND MORE INFORMATION
Southern Financial Bancorp, Inc., which we will refer to as we, us or
our, 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 we file 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 http://www.sec.gov that contains reports, proxy and
information statements and other information regarding issuers, including
Southern Financial Bancorp, Inc., that file documents with the Commission
electronically through the Commission's electronic data gathering, analysis and
retrieval system known as EDGAR. Our common stock is traded on the Nasdaq
National Market under the symbol "SFFB." Our 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 prospectus is part of a registration statement filed by Southern
Financial Capital Trust I and Southern Financial Bancorp, Inc. with the
Commission. Because the rules and regulations of the Commission
12
<PAGE>
allow us to omit certain portions of the registration statement from this
prospectus, this 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
us, Southern Financial Capital Trust and the redeemable capital securities being
sold by this prospectus. The registration statement and its exhibits may be
inspected at the public reference facilities of the Commission at the addresses
mentioned above.
You should rely only on the information provided in this prospectus or
any supplement. We have not authorized anyone else to provide you with different
information. Neither Southern Financial Bancorp, Inc. nor Southern Financial
Capital Trust I is making an offer of the redeemable capital securities in any
state where the offer is not permitted. You should not assume that the
information in this prospectus or any supplement is accurate as of any date
other than the date on the front of those documents because our financial
condition and results may have changed since that date.
Please refer to page ___ for an index of significant terms used in this
prospectus.
USE OF PROCEEDS
Southern Financial Capital Trust will use all of the proceeds from the
sale of the common securities and redeemable capital securities to purchase the
junior subordinated debt securities. We intend to apply the net proceeds from
the sale of the junior subordinated debt securities to our general funds to be
used for general corporate purposes, including, from time to time, making
advances to Southern Financial Bank to support its continued growth. Pending any
such application by us, the net proceeds may be invested in interest-bearing
assets. Our intention is to grow our total assets faster than our capital base
and anticipated retained earnings for the next several years would permit. The
redeemable capital securities will be treated as capital for bank regulatory
purposes, which means that the proceeds of this offering will allow us to grow
without selling additional shares of common stock. If the redeemable capital
securities were not treated as capital for bank regulatory purposes, we would
not be having this offering, because we can raise cash to fund loans and
investments at much lower rates of interest.
SOUTHERN FINANCIAL CAPITAL TRUST I
We formed Southern Financial Capital Trust under Delaware law on
December 28, 1999. Wilmington Trust Company is the Delaware trustee and the
property trustee. Georgia S. Derrico and R. Roderick Porter, officers of
Southern Financial Bancorp, Inc., are the administrative trustees.
Southern Financial Capital Trust exists for the exclusive purposes of:
o issuing and selling the common securities and redeemable
capital securities;
o using the proceeds from the sale of the common securities and
redeemable capital securities to purchase the junior
subordinated debt securities; and
o engaging in other activities that are related to these
purposes.
The junior subordinated debt securities will be the sole assets of
Southern Financial Capital Trust, and payments under the junior subordinated
debt securities will be the sole revenues of Southern Financial Capital Trust.
All of the common securities will be owned by us. We will receive distributions
on the common
13
<PAGE>
securities in proportion to the distributions that you and other holders receive
on the redeemable capital securities. However, if we default, our rights as
holder of the common securities to distributions and payments upon liquidation,
redemption or otherwise will be subordinated to the rights of the holders of the
redeemable capital securities.
We will acquire common securities in an aggregate liquidation amount
equal to 3% of the total capital of Southern Financial Capital Trust. Southern
Financial Capital Trust has a term of approximately 40 years, but may terminate
earlier as provided in the amended and restated declaration of trust. Southern
Financial Capital Trust's business and affairs are conducted by its trustees,
each appointed by us as holder of the common securities.
Wilmington Trust Company, as property trustee, will act as sole
indenture trustee under the amended and restated declaration of trust.
Wilmington Trust Company will also act as trustee under the guarantee agreement
and the indenture. The holder of the common securities, or the holders of a
majority in liquidation amount of the redeemable capital securities if we
default, will be entitled to appoint, remove or replace the property trustee
and/or Delaware trustee. In no event will the holders of the redeemable capital
securities have the right to vote to appoint, remove or replace the
administrative trustees. Such voting rights are ours exclusively. The duties and
obligations of each trustee are governed by the amended and restated declaration
of trust. We will pay all fees and expenses related to Southern Financial
Capital Trust and the offering of the redeemable capital securities and will
pay, directly or indirectly, all ongoing costs, expenses and liabilities of
Southern Financial Capital Trust. The address and telephone number of the
principal executive office of Southern Financial Capital Trust is c/o:
Southern Financial Bank
37 E. Main Street
Warrenton, VA 20186
Attention: David deGive
(540) 349-3900
14
<PAGE>
SELECTED HISTORICAL FINANCIAL INFORMATION
The following consolidated summary sets forth selected financial data
for Southern Financial Bancorp, Inc. and its subsidiaries for the periods and at
the dates indicated. You should read the detailed information and the financial
statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Gross interest income $29,756 $27,857 $25,536 $22,295 $19,634
Gross interest expense 14,308 14,220 12,626 11,343 10,157
Net interest income 15,448 13,637 12,910 10,952 9,477
Provision for loan losses 2,130 1,301 1,265 906 383
Net interest income after provision
for loan losses 13,318 12,336 11,645 10,046 9,094
Non-interest income 2,834 3,145 2,257 1,593 1,279
Non-interest expense 14,589 10,687 9,762 9,599 7,414
Income before income taxes 1,563 4,794 4,140 2,040 2,959
Income taxes 602 1,442 1,332 680 1,078
Net income 961 3,352 2,808 1,360 1,881
Per Share Data:
Net income, basic $0.36 $1.28 $1.10 $0.54 $0.76
Net income, diluted $0.35 $1.22 $1.06 $0.52 $0.73
Cash dividends $0.33 $0.22 $0.17 $0.14 $0.12
Book value at period end $10.87 $11.62 $10.69 $9.72 $10.05
Tangible book value at period end
Period-End Balance Sheet Data:
Total assets $406,222 $404,254 $354,016 $310,169 $269,948
Total loans (net of unearned income) 234,086 206,355 204,560 178,262 165,178
Total deposits 367,188 366,905 320,364 274,971 240,892
Stockholders' equity 28,864 30,626 27,508 24,750 23,572
Performance Ratios:
Return on average assets 0.24% 0.92% 0.88% 0.48% 0.78%
Return on average stockholders'
equity 3.11% 11.62% 10.92% 5.66% 8.38%
Average stockholders' equity to
average total assets 7.11% 7.58% 7.77% 7.98% 8.73%
Efficiency ratio 79.80% 63.68% 64.36% 76.52% 68.93%
Net interest margin 4.07% 3.97% 4.26% 4.12% 4.21%
Dividend payout ratio 92.09% 17.78% 16.20% 26.54% 13.34%
Asset Quality Ratios:
Net charge-offs to average loans 0.79% 0.48% 0.46% 0.34% 0.22%
Allowance to period-end loans 1.45% 1.46% 1.32% 1.31% 1.22%
Allowance to nonperforming loans 661.30% 105.37% 113.95% 83.86% 165.80%
Nonaccrual loans to loans 0.22% 1.39% 1.16% 1.57% 0.74%
Nonperforming assets to loans and
foreclosed properties 1.18% 1.62% 1.50% 2.27% 1.55%
Capital Ratios:
Risk-based capital ratios
Tier 1 capital 10.93% 12.77% 12.98% 13.44% 13.70%
Total capital 12.18% 14.09% 14.19% 14.64% 14.89%
Leverage capital ratio 7.50% 7.84% 8.14% 8.48% 9.37%
Total equity to total assets 7.11% 7.58% 7.77% 7.98% 8.73%
</TABLE>
15
<PAGE>
CAPITALIZATION
The following table sets forth our consolidated capitalization at
December 31, 1999. This table is based on, and is qualified in its entirety by,
our historical consolidated financial statements, including the related notes
thereto, which are included in documents incorporated by reference herein, and
should be read in conjunction therewith.
<TABLE>
<CAPTION>
December 31, 1999
------------------------------
(amounts in thousands)
<S> <C>
Long-term debt $ 5,000
Capitalized lease obligations
-
Shareholders' equity:
6% cumulative convertible preferred
stock, $.01 par value, 500,000 shares
authorized, 13,621 shares outstanding -
Common stock, $.01 par value, 5,000,000
shares authorized, 2,656,196 shares
outstanding 27
Capital in excess of par value 23,663
Retained earnings 6,898
Accumulated other comprehensive income (loss) (1,724)
--------------
Total shareholders' equity 28,864
--------------
Total capitalization 33,864
==============
Consolidated capital ratios:
Equity to assets 7.50%
Tier I capital 10.93%
Total capital 12.18%
</TABLE>
ACCOUNTING TREATMENT
The financial statements of Southern Financial Capital Trust will be
consolidated into our consolidated financial statements, with the redeemable
capital securities treated as debt and shown in our consolidated balance sheet
as "long term debt." The distributions payable on the redeemable capital
securities will be treated as interest expense in the consolidated statements of
income. Our financial statement footnotes will reflect that the sole asset of
Southern Financial Capital Trust will be the amount of the junior subordinated
debt securities maturing on _________ 15, 2030. All future reports we file under
the Securities Exchange Act of 1934 will present information regarding Southern
Financial Capital Trust and any other similar trusts in the manner described
above.
16
<PAGE>
REGULATORY TREATMENT
As a registered bank holding company, we are required by the Federal
Reserve to maintain certain levels of capital for bank regulatory purposes. We
expect that the redeemable capital securities will be treated as "tier 1
capital" for such purposes; provided that the redeemable capital securities can
only comprise 25% of our tier 1 capital. Based on our tier 1 capital at December
31, 1999, approximately $10.1 million of the redeemable capital securities would
be initially included in tier 1 capital. To the extent that the redeemable
capital securities are not included in our tier 1 capital, they will be included
in our tier 2 capital.
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.
17
<PAGE>
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.
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.
Merger
On October 1, 1999, Southern Financial completed its merger with The
Horizon Bank of Virginia. The merger qualified as a tax-free exchange and was
accounted for as a pooling of interests. All financial statements included
herein have been restated due to the merger.
Lending Activities
Our lending focus and the composition of our loan portfolio have
changed dramatically over the past five years. The growth of our loan portfolio
and the change in its composition reflects our growth strategy and the shift in
our 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 December 31, 1999, residential mortgage loans had declined to
20% 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 December
31, 1999 they had grown to 23% and 47%, 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 December 31, 1999, commercial real estate loans totaled $118
million, of which $110 million were permanent loans and $8.3 million were
construction loans. Of Southern Financial's permanent commercial real estate
loans, $52.2 million were made under the Small Business Administration 7(a) and
504 loan programs. 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
18
<PAGE>
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 $110 million in permanent commercial real estate loans at
December 31, 1999, $49 million were 504 loans. During the year ended December
31, 1999, Southern Financial originated $6.4 million in loans under the 504 loan
program.
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 December 31, 1999, Southern Financial had $3.2 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 $57.6 million at December 31, 1999, serve 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 December 31, 1999,
Southern Financial had $54 million in commercial business loans, which represent
23% of Southern Financial's total loans receivable. Of our $54 million in
commercial business loans, 26% are Small Business Administration 7(a) loans.
During the year ended December 31, 1999, Southern Financial originated and
closed $13.9 million in loans under the Small Business Administration 7(a) loan
program and sold $9.1 million on the secondary market.
Residential Lending
Southern Financial makes fixed and adjustable rate, first mortgage
loans with terms up to 30 years. It offers second mortgages in conjunction with
its own first mortgages or those of other lenders. Southern Financial makes
construction loans and permanent loans on individual single family residences
and on other residential properties. Construction loans generally have interest
rates of prime plus one to two percent and fees of one to three points,
loan-to-value ratios of 80% or less based on current appraisals and terms of
generally nine months or less. In the case of conventional loans, Southern
Financial typically lends up to 80% of the appraised value of single-family
residences. Southern Financial requires private mortgage insurance for loans
exceeding 80% of the appraised value.
Residential mortgage loans are secured by single-family homes. At
December 31, 1999, loans secured by residential property, both permanent and
construction, totaled $56.5 million, which represented approximately
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<PAGE>
24% 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 December 31, 1999, Southern Financial had $10.0 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 66% of Southern Financial's total revenue for
the year ended December 31, 1999. Income from loan origination fees and other
fees are sources of income which vary with the volume and type of loans and
commitments made and with competitive and economic conditions.
Loan Portfolio Composition
The following table sets forth the composition of Southern Financial's
loan portfolio at the dates indicated:
<TABLE>
<CAPTION>
1999 1998 1997
----------------------------- ----------------------------- -------------------------------
Amount Percent Amount Percent Amount Percent
------------- ------------- ------------- ------------- --------------- -------------
(amounts in thousands)
<S> <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>
20
<PAGE>
<TABLE>
<CAPTION>
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>
The following table sets forth the scheduled maturity of selected loans
as of December 31, 1999:
<TABLE>
<CAPTION>
Over 1 Year
Through 5 Years Over 5 Years
------------------------------------------------ -----------------------------
One Year Fixed Floating Fixed Floating
or Less Rate Rate Rate Rate Total
--------------- ----------- ------------ ------------ ------------ ------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C>
Construction:
Residential $7,853 $ - $ - $ - $ - $7,853
Nonresidential 8,270 - - - - 8,270
Business 21,885 12,978 3,526 10,319 5,467 54,175
--------------- ----------- ------------ ------------ ------------ ------------
Total $38,008 $12,978 $3,526 $10,319 $5,467 $70,298
=============== =========== ============ ============ ============ ============
</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.
21
<PAGE>
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.
The Credit Committee of the Board consists 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.
22
<PAGE>
Past Due Loans and Nonperforming Assets
The following table sets forth information regarding past due loans and
nonperforming assets as of the periods indicated:
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------
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 8 - - - -
Real Estate Owned:
Nonresidential 2,296 498 722 1,307 1,382
------------- --------------- --------------- -------------- --------------
Total Nonperforming Assets $2,826 $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 Association.
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
23
<PAGE>
considers a review of the loans in Southern Financial's portfolio, conducts an
evaluation of the credit quality and reviews the adequacy of the loan loss
provision, recommending changes as may from time to time be required. In
establishing the appropriate classification for specific assets, management
takes into account, among other factors, the estimated value of the underlying
collateral, the borrower's ability to repay, the borrower's payment history and
the current delinquent status. The remaining loan portfolio is evaluated for
potential loss exposure by examining the growth and composition of the
portfolio, previous loss experience, current delinquency levels, industry
concentration and the general economic condition.
The allowance for loan losses represents management's estimate of an
amount adequate to provide for potential losses inherent in the loan portfolio
in the normal course of business. However, there are additional risks of future
losses that cannot be quantified precisely or attributed to particular loans or
classes of loans. Because those risks include general economic trends as well as
conditions affecting individual borrowers, management's judgement of the
allowance necessary is approximate. Southern Financial 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>
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 294 - 12 - -
Nonresidential - - - - -
Construction
Residential - - - - -
Nonresidential - - - -
Nonmortgage:
Business 6 13 18 11 -
Consumer 6 10 8 8 46
--------------- --------------- ---------------- -------------- ---------------
Total Recoveries 307 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>
24
<PAGE>
The following table summarizes the composition of the allowance for
loan losses.
<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.
25
<PAGE>
Investment Activities
The following table sets forth the investment portfolio as of the
periods indicated:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------
1999 1998 1997
-------------- ------------- -------------
(amounts in thousands)
<S> <C> <C> <C>
Available-for-sale securities, at fair value:
FHLMC preferred stock $ - $3,889 $3,908
FHLMC MBS 16,369 12,006 -
GNMA MBS 2,589 3,771 -
FNMA MBS 25,678 29,814 785
Collateralized mortgage obligations 25,303 1,529 -
Commercial MBS 22,495 18,246 -
Obligations of counties and municipalities 3,572 3,220 -
Corporate obligations 945 992 -
U.S. Treasury and other Government agency obligations 770 10,608 12,017
-------------- ------------- -------------
$97,721 $84,075 $16,710
============== ============= =============
Held-to-maturity securities, at amortized cost:
FHLMC MBS $3,837 $4,091 $6,078
GNMA MBS 17,177 24,305 42,471
FNMA MBS 6,764 6,780 27,075
Collateralized mortgage obligations 4,073 1,015 4,203
Commercial MBS 2,865 - -
Obligations of counties and municipalities 2,395 1,960 -
U.S. Treasury and other Government agency obligations - 19,532 8,741
-------------- ------------- -------------
$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.
26
<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>
Year Ended December 31,
--------------------------------------------------------------------------------------
1999 1998 1997
--------------------------- -------------------------- --------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------ ------------ ------------- ----------- ------------- ------------
(dollars 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 209,995 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 December 31,
1999:
<TABLE>
<CAPTION>
Time Deposits of
Maturity Period $100,000 or More
--------------------------------------------------- -----------------------------------------
(amounts in thousands)
<S> <C>
Three months or less $50,800
Over three months through twelve months 37,138
Over twelve months 10,162
------
Total $98,100
=======
</TABLE>
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>
Year Ended December 31,
-------------------------------------------------
1999 1998 1997
------------- ------------- -------------
(dollars in thousands)
<S> <C> <C> <C>
Ending Balance $5,000 $3,500 $4,000
Average Balance for the Period 13,159 4,907 5,979
Maximum Month-end Balance During the Period 30,000 13,500 8,500
Average Interest Rate for the Period 5.56% 5.50% 5.59%
Weighted Average Interest Rate at the End of the Period 6.32% 5.15% 5.95%
</TABLE>
27
<PAGE>
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.
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.
28
<PAGE>
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.
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
29
<PAGE>
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 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
30
<PAGE>
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 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.
31
<PAGE>
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.
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.
32
<PAGE>
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.
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 December 31, 1999, 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 December 31, 1999:
<TABLE>
<CAPTION>
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Home Office:
37 E. Main Street Leased September February
Warrenton, VA 2003 1989
Branch Offices:
362 Elden Street Leased June April
Herndon, VA 2000 1986
101 W. Washington Street Leased June November
Middleburg, VA 2002 1987
33 W. Piccadilly Street Owned N/A November
Winchester, VA 1990
526 E. Market Street Leased June March
Leesburg, VA 2002 1992
33
<PAGE>
Owned or Lease Expiration Date Facility
Office Location Leased Date Opened
- ------------------------------------------------------------------------------------------------------------------------------------
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>
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.
34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview
Net Income. 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 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 we reinvested 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. 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, we continued to emphasize loan originations connected with various
lending programs of the U.S. Small Business Administration. In addition, we
continued to sell the guaranteed portion of some of our Small Business
Administration loans. These sales totaled $9.1 million. In 1999, we continued to
de-emphasize our 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. After the consummation of the merger with The
Horizon Bank on October 1, 1999, we sold Horizon's entire investment securities
portfolio and incurred a portfolio restructuring loss of $781,000. Following the
sale, we purchased other investment securities with the proceeds that had a
higher yield and were in accordance with our 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. 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.
35
<PAGE>
Results of Operations
Our 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
(in thousands)
<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.
36
<PAGE>
Rate/Volume Analysis
(in thousands)
<TABLE>
<CAPTION>
Year ended December 31, 1999 Year ended December 31, 1998
compared to compared to
year ended December, 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 Year Ended December 31, 1999 with the Year Ended December 31,
1998
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 of Virginia 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 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.
37
<PAGE>
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 of
Virginia 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. We have 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. Our
opinion is that the allowance for loan losses at December 31, 1999 remains
adequate. Although we believe 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 our 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 of Virginia 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.
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.
38
<PAGE>
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.
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 our 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 borrowing. Southern Financial, to the extent that its
interest-bearing liabilities do not reprice or mature at the same time as its
interest-bearing assets, is subject to interest rate risk and corresponding
fluctuations in its net interest income. Asset/liability management policies
have been employed in an effort to manage Southern Financial's interest-earning
assets and interest-bearing liabilities, thereby controlling the volatility of
net interest income, without having to incur unacceptable levels of credit risk.
39
<PAGE>
With respect to the our 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, our 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.
Our interest rate sensitivity is primarily monitored by management
through the use of a model which generates estimates of the change in our 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 our 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 December 31,
1999.
Sensitivity of Market Value of Portfolio Equity
(amounts in thousands)
<TABLE>
<CAPTION>
Change in Market Value of Portfolio Equity Market Value of
Interest Rates Amount $ Change % Change Portfolio Equity as a % of
In Basis Points From From Total Portfolio
(Rate Shock) Base Base Assets Equity
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Book Value
Up 300 $37,391 (7,235) -16.21% 9.20% 128.60%
Up 200 39,806 (4,820) -10.80% 9.80% 136.91%
Up 100 42,343 (2,283) -5.12% 10.42% 145.63%
Base 44,626 - 0.00% 10.99% 153.49%
Down 100 46,758 1,952 4.37% 11.47% 160.20%
Down 200 48,580 3,954 8.86% 11.96% 167.09%
Down 300 51,150 6,524 14.62% 12.59% 175.92%
</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 our 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.
40
<PAGE>
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 $14,620 -1.73% 3.60% -1.64%
Up 200 14,837 -0.27% 3.65% -0.27%
Up 100 14,989 0.75% 3.69% 0.82%
Base 14,877 0.00% 3.66% 0.00%
Down 100 14,645 -1.56% 3.61% -1.37%
Down 200 14,449 -2.88% 3.56% -2.73%
Down 300 14,431 -3.00% 3.55% -3.01%
</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 us 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 our 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 our 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.
At December 31, 1999, Southern Financial had $8.2 million of
undisbursed loan funds and $11.9 million of approved loan commitments. The
amount of certificate of deposit accounts maturing in calendar year 2000 is
$183.0 million. Southern Financial anticipates that most maturing certificates
of deposit will renew. Other sources of liquidity include payments on loans,
securities available for sale, which totaled $97.7 million at December 31, 1999,
and available lines of credit with the Federal Home Loan Bank of Atlanta, which
total approximately $81 million.
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 December 31,
1999, the Bank's capital ratios were 7.5% leverage capital; 10.9% tier 1
capital; and 12.2% 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.
41
<PAGE>
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 our
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.
MANAGEMENT
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. These directors
serve for the terms of their respective classes, which expire in 2000, 2001 and
2002. The following table sets forth the composition of the board of directors.
<TABLE>
<CAPTION>
<S> <C> <C>
Class I Class II Class III
(Term Expiring in 2002) (Term Expiring in 2000) (Term Expiring in 2001)
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
</TABLE>
The following paragraphs set forth certain information, as of December
31, 1999,for the 12 directors of Southern Financial. 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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<PAGE>
Class II
(Term Expiring in 2000)
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, 56, has been Senior Vice President of Southern Financial
since 1992. Mr. de Give has served as a director of Southern Financial since
1986.
R. Roderick Porter, 54, has been President and Chief Operating Officer
of Southern Financial since April 1998. From 1994 to 1998, he was President of
FX Concepts, Ltd., an international money management firm in New York, New York.
Mr. Porter has served as a director of Southern Financial since 1986.
Class III
(Term Expiring in 2001)
Fred L. Bollerer, 57, 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.
Senior Officers of Southern Financial
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
National Bank in Washington, DC where he managed the Bank's commercial real
estate and single 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.
Jacqueline E. Fitterer, 36, joined Southern Financial in 1999 as Senior
Vice President/Loan Administration when the former Horizon Bank of Virginia was
merged to join with Southern Financial. Ms. Fitterer began her career with
Horizon Bank in 1990 as the manager of the loan department, promoted to
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<PAGE>
Assistant Vice President/Loan Manager in 1991, promoted to Vice President/Loan
Administrator in 1992 and promoted to her current position, Senior Vice
President/Loan Administrator in 1997.
David M. Goldman, 52, joined Southern Financial in 1999 as Senior Vice
President/Branch Operations when the former Horizon Bank of Virginia was merged
to join with Southern Financial. Mr. Goldman began his career with Horizon Bank
in 1990 as Senior Vice President/Cashier.
William H. Lagos, 49, joined Southern Financial in 1986 as Vice
President. In 1993, he was promoted to Senior Vice President of Operations; in
1996, he became Senior Vice President/Controller.
Linda W. Sandridge, 46, joined Southern Financial in 1987. In 1995, she
was promoted to Vice President/Commercial Lending; in 1997, she was promoted to
Senior Vice President/Commercial Lending.
Richard P. Steele, 52, 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.
Laura L. Vergot, 41, joined Southern Financial in 1989. In 1995 she was
promoted to Vice President/Branch Development. In 1997, she was promoted to
Senior Vice President/Branch Development. In 1999 she moved to Senior Vice
President/Systems Administration and Human Resources.
Security Ownership of Management
The following table sets forth, based on information as of December 31,
1999, the beneficial ownership of Southern Financial common stock by each
director of Southern Financial and by each person named in the "Summary
Compensation Table" on page __.
Number Percent
of Shares(1) of Class (%)
--------- ------------
Fred L. Bollerer 2,000 *
Neil J. Call 41,495 (2) 1.6
David de Give 82,868 (3) 3.1
Georgia S. Derrico 240,515 (4) 9.1
Alfonso G. Finocchiaro 5,192 *
Virginia Jenkins 2,275 *
William H. Lagos 30,548 1.2
John L. Marcellus, Jr. 15,808 (5) *
R. Roderick Porter 240,515 (4) 9.1
Michael P. Rucker 80,396 (6) 3.0
John C. Belotti 23,562 1.0
Robert P. Warhurst 14,206 *
Richard E. Smith 29,000 1.1
All Directors and Executive
Officers as a group (13 persons) 567,865 21.4
_____________
* Percentage of ownership will be less than one percent of the outstanding
shares of Southern Financial common stock.
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<PAGE>
(1) The amounts in this column include shares of Southern Financial common
stock with respect to which certain persons have the right to acquire
beneficial ownership within sixty days after December 31, 1998, pursuant to
Southern Financial's 1993 Stock Option and Incentive Plan, as amended: Mr.
de Give: 46,403 shares; Ms. Derrico: 97,176 shares; Mr. Lagos: 26,802
shares; Mr. Porter: 25,000; and the directors and officers as a group:
195,381 shares.
(2) Includes 35,529 shares of Southern Financial common stock and 4,354 shares
of Southern Financial convertible preferred stock.
(3) Includes 2,353 shares owned by Mr. de Give's spouse over which she has sole
voting and investment power.
(4) Includes (a) 84,373 shares owned individually by Ms. Derrico over which she
has sole voting and investment power and 97,176 shares that Ms. Derrico may
acquire pursuant to the exercise of stock options; (b) 23,404 shares of
Southern Financial common stock and 4,039 shares of Southern Financial
convertible preferred stock owned individually by Mr. Porter over which he
has sole investment power and 25,000 shares that Mr. Porter may acquire
pursuant to the exercise of stock options; and (c) 4,100 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 11,627 shares of Southern Financial common stock and 991 shares of
Southern Financial convertible preferred stock owned by Michael Rucker,
5,973 shares of Southern Financial common stock and 2,402 shares of
convertible preferred stock owned by Derek Rucker, 8,378 shares of Southern
Financial common stock owned by Lucy Jones, 5,025 shares of Southern
Financial common stock owned by Susan Jones Cooper, 4,832 shares of
Southern Financial common stock owned by David Dodrill and 37,755 shares of
Southern Financial common stock owned by Rucker Realty Corp. and persons
associated with Rucker Realty Corp. Southern Financial makes no
representation as to whether any of these persons, individually or in any
combination, share voting or investment power with any other or with Rucker
Realty with respect to their shares.
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<PAGE>
Security Ownership of Certain Beneficial Owners
The following table sets forth, to the knowledge of Southern Financial
and based on information as of December 31, 1999, the beneficial ownership of
each person who owns more than five percent of the outstanding shares of
Southern Financial common stock common stock.
<TABLE>
<CAPTION>
Number Percent
of Shares (1) of Class (%)
------------- ------------
<S> <C> <C>
Georgia S. Derrico (2), (3) 240,515 9.1
R. Roderick Porter
2954 Burrland Lane
The Plains, Virginia 20171
Financial Institution Partners II, L.P. (4) 178,800 6.7
Hovde Capital, L.L.C.
Eric D. Hovde
Steven D. Hovde
1824 Jefferson Place, N.W.
Washington, D.C. 20036
</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) 84,373 shares owned individually by Ms. Derrico over which she
has sole voting and investment power and 97,176 shares that Ms. Derrico may
acquire pursuant to the exercise of stock options; (b) 23,404 shares of
Southern Financial common stock and 4,039 shares of Southern Financial
convertible preferred stock owned individually by Mr. Porter over which he
has sole investment power and 25,000 shares that Mr. Porter may acquire
pursuant to the exercise of stock options; and (c) 4,100 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 October 25, 1999 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.
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.
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<PAGE>
Executive Officer Compensation
The following table presents information concerning the compensation of
Ms. Derrico and Messrs. Porter and Lagos. This table presents compensation for
services rendered in all capacities to Southern Financial by Ms. Derrico and
Messrs. Porter and Lagos in 1999, 1998 and 1997.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long-Term Compensation
------------------- ----------------------
Securities
Underlying
Name and Other Annual Options All Other
Principal Position Year Salary Bonus Compensation(1) (#) Compensation(2)
- ------------------ ---- ------ ----- --------------- --- ---------------
<S> <C> <C> <C> <C> <C> <C>
Georgia S. Derrico 1999 $195,000 $240,000 -- 10,000 $4,800
Chairman of the Board 1998 193,226 200,000 -- 10,000 4,800
and Chief Executive 1997 175,000 175,000 -- 10,000 4,500
Officer
R. Roderick Porter 1999 $175,000 $72,000 -- 15,000 $4,800
President and Chief 1998(3) 100,000 -- -- 10,000 2,505
Operating Officer
William H. Lagos 1999 $100,000 $26,000 -- 5,000 $1,200
Senior Vice President 1998 91,589 25,000 -- 5,000 1,200
and Controller 1997 87,125 12,500 -- 8,000 2,913
</TABLE>
______________
(1) None of the named executive officers received Other Annual Compensation in
excess of the lesser of $50,000 or 10% of combined salary and bonus for the
years indicated.
(2) The amounts set forth in this column constitute contributions to Southern
Financial's 401(k) Plan.
(3) Mr. Porter joined Southern Financial on April 1, 1998.
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<PAGE>
Option Grants in Last Fiscal Year
The following table sets forth for the year ended December 31, 1999,
the grants of stock options to the executive officers named in the "Summary
Compensation Table."
Option Grants in Year Ended December 31, 1999
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants(1) Option Term
-------------------------------------------------------------------------------- -----------
Percent of
Number of Securities Total Options Granted
Underlying to Employees in Exercise or Base
Options Fiscal Year Price Expiration
Granted (#) (%)(2) ($/Share) Date 5% ($) 10% ($)
----------- ------ --------- ---- ------ -------
Name
- ----
<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
William H. Lagos 5,000 5.43 21.00 2/2/09 171,034 272,343
</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
Set forth in the table below is information concerning each exercise of
stock option during the fiscal year ended December 31, 1999 by each of the named
executive officers and the year end value of unexercised options.
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<PAGE>
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)
William H. Lagos -- -- 21,802 5,000 35,924 --(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.
(3) None of 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
Agreement for cause. Cause includes personal dishonesty, incompetence, willful
misconduct, breach of fiduciary duty involving personal profit, intentional
failure to
49
<PAGE>
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.
Southern Financial entered into an employment agreement with Mr. Lagos
in 1997 for a term of 18 months with automatic one-year extensions. If, during
the term of the employment agreement, Mr. Lagos' employment is terminated in
connection with or subsequent to a change of control of Southern Financial by
(i) Southern Financial other than for cause or as a result of Mr. Lagos' death,
disability or retirement, or (ii) Mr. Lagos for good reason (as provided in the
employment agreement), Mr. Lagos shall be entitled to receive severance pay
equal to 150% of the total cash compensation paid to him during the previous 12
months. The term "change in control" as used in his agreement shall refer
generally to:
o the acquisition of 40% or more of the voting securities of
Southern Financial by any "person" or "group" (within the
definition of Section 13(d) and 14(d) of the Securities
Exchange Act of 1934, as amended);
o a change in the composition of the board to less than a
majority of incumbent directors (as defined in the agreement);
or
o the approval by Southern Financial's shareholders of either a
business combination with any other person or group, other
than a merger or consolidation that would result in the
Southern Financial common stock outstanding immediately prior
thereto representing at least 50% of the Southern Financial
common stock of the surviving entity outstanding immediately
thereafter, or a plan of liquidation or sale or disposition of
all or substantially all of Southern Financial's assets.
Certain Relationships and Related Transactions
Georgia S. Derrico, Chairman of the Board and Chief Executive Officer
and a director of Southern Financial, and R. Roderick Porter, President and
Chief Operating Officer and a director of Southern Financial, are married to
each other.
DESCRIPTION OF REDEEMABLE CAPITAL SECURITIES
Under the amended and restated declaration of trust, Southern Financial
Capital Trust will issue the redeemable capital securities and the common
securities, which will represent ownership interests in Southern Financial
Capital Trust. The amended and restated declaration of trust will be qualified
under the Trust Indenture Act of 1939. This is a summary of the redeemable
capital securities, the common securities and the amended and restated
declaration of trust. It is not exhaustive. It is subject to, and is qualified
in its entirety by reference to, all the provisions of the amended and restated
declaration of trust. The form of the amended and restated declaration of trust
is available upon request from the trustees.
General
The redeemable capital securities will be limited to $12.0 million
aggregate liquidation amount at any one time outstanding. Southern Financial
Capital Trust reserves the right to increase the aggregate liquidation amount by
not more than $1.8 million. The liquidation amount for each redeemable capital
security is $10.00. The redeemable capital securities will rank equally with the
common securities except as described under "Subordination of Common Securities"
on page __. Legal title to the junior subordinated debt securities will be
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<PAGE>
held by the property trustee on behalf of Southern Financial Capital Trust for
the benefit of the holders of the redeemable capital securities and common
securities. The guarantee agreement we will execute for the benefit of the
holders of the redeemable capital securities will guarantee the redeemable
capital securities on a subordinated basis. However, it will not guarantee
payment of distributions or amounts payable on redemption of the redeemable
capital securities or on liquidation of Southern Financial Capital Trust when
Southern Financial Capital Trust does not have funds on hand available to make
those payments.
Distributions
The redeemable capital securities represent ownership interests in
Southern Financial Capital Trust. Distributions on each capital security will be
payable at _____% per annum of the stated liquidation amount of $10.00.
Distributions will be payable quarterly in arrears on the 15th day of January,
April, July and October of each year to the holders of the redeemable capital
securities at the close of business on the business day immediately preceding
each distribution date. A business day is any day other than a Saturday or a
Sunday, or a day on which banks in Richmond, Virginia are authorized or required
by law or executive order to remain closed, or a day on which the corporate
trust office of the property trustee or the debenture trustee is closed for
business.
Distributions on the redeemable capital securities will be cumulative.
Distributions will accumulate from the issue date. The first distribution date
for the redeemable capital securities will be______ 15, 2000. The amount of
distributions payable for any period will be computed on the actual number of
days elapsed in a year of twelve 30-day months. If any date on which
distributions are payable on the redeemable capital securities is not a business
day, payment of the distributions payable on such date will be made on the next
business day with the same force and effect as if made on the date such payment
was originally payable.
An agreement known as the junior subordinated indenture contains our
obligations on the junior subordinated debt securities. It also contains
Southern Financial Capital Trust's rights as the holder of the junior
subordinated debt securities. As long as we have not defaulted under the
indenture, we have the right under the indenture to defer the payment of
interest on the junior subordinated debt securities at any time or from time to
time for a period not exceeding 20 consecutive quarterly periods. However, no
interest deferral period may extend beyond the stated maturity of the junior
subordinated debt securities which is _____ 15, 2030. If we defer interest
payments on the junior subordinated debt securities, quarterly distributions on
the redeemable capital securities by Southern Financial Capital Trust will be
deferred during the interest deferral period. Distributions to which holders of
the redeemable capital securities are entitled will accumulate additional
distributions thereon at ____% per annum thereof, compounded quarterly from the
relevant payment date for such distributions during any interest deferral
period.
During any interest deferral period, we may not:
o declare or pay any cash dividends or distributions on, or
redeem, purchase, acquire or make a liquidation payment on any
of our common or preferred stock;
o make any payment of principal, interest or premium on or
repay, repurchase or redeem any debt securities we issue that
rank equally with or junior to the junior subordinated debt
securities; or
o make any guarantee payments on the debt securities of any
subsidiary we own if our guarantee ranks equally with or
junior to the junior subordinated debt securities.
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<PAGE>
However, during an interest deferral period, we may:
o pay dividends or make distributions in our own common stock;
o declare a dividend in connection with a stockholders' rights
plan, issue stock under any shareholder rights plan in the
future, or redeem or repurchase any rights issued under any
shareholder rights plan;
o make payments under our guarantee of the redeemable capital
securities;
o purchase or acquire shares of our own common stock to satisfy
our obligations under any employee benefit plan or any other
contractual obligation, other than a contractual obligation
ranking equally with or junior to the junior subordinated debt
securities;
o make a distribution as a result of a reclassification of our
capital stock or the exchange or conversion of one class or
series of our capital stock for another class or series of our
capital stock; or
o purchase fractional interests in shares of our stock under the
conversion or exchange provisions of our capital stock or the
security being converted or exchanged.
Before the end of any interest deferral period, we may further extend
the interest deferral period. However, no interest deferral period may exceed 20
consecutive quarterly periods or extend beyond _______ 15, 2030. When any
interest deferral period ends and we pay of all amounts then accrued and unpaid
on the junior subordinated debt securities, together with interest at _____% per
annum, compounded quarterly, we may begin a new interest deferral period. No
interest or other amounts are due and payable during an interest deferral
period.
We must give the property trustee, the administrative trustees and the
debenture trustee notice of our election to begin an interest deferral period at
least three business days prior to the earlier of the date the distributions on
the redeemable capital securities would have been payable or the date the
administrative trustees are required to give notice to any automated quotation
system or to holders of such redeemable capital securities of the record date or
the date such distributions are payable, but in any event not less than three
business days prior to such record date. The debenture trustee will give notice
of our election to begin or extend an interest deferral period to the holders of
the redeemable capital securities. There is no limit on the number of times that
we may elect to begin an interest deferral period.
We have no current intention of exercising our right to defer payments
of interest on the junior subordinated debt securities.
The revenue of Southern Financial Capital Trust available for
distribution to holders of the redeemable capital securities will be limited to
payments under the junior subordinated debt securities. If we do not make
interest payments on the junior subordinated debt securities, the property
trustee will not have funds available to pay distributions on the redeemable
capital securities.
Events That Will Cause Redemption of Redeemable Capital Securities
If we redeem any of the junior subordinated debt securities, the
proceeds from the redemption will be applied to redeem a like amount of the
common securities and redeemable capital securities. The price paid to a holder
of capital securities will equal to the aggregate liquidation amount of the
redeemable capital securities
52
<PAGE>
plus accumulated but unpaid distributions to the date of redemption and the
related amount of any premium we pay upon the concurrent redemption of the
junior subordinated debt securities. If less than all the junior subordinated
debt securities are to be repaid or redeemed, then the proceeds from the
redemption will be allocated to the proportionate redemption of the redeemable
capital securities and the common securities.
We have the right to redeem the junior subordinated debt securities on
or after____ 15, 2005, in whole at any time or in part from time to time. We
also can redeem the junior subordinated debt securities, in whole, but not in
part, at any time within 90 days after a tax event, investment company event or
capital treatment event, each as defined below.
In the case of a redemption on or after ________ 15, 2005, the
redemption price will equal the following prices, expressed in percentages of
the $10.00 liquidation amount together with accumulated distributions to the
date fixed for redemption, if redeemed during the 12-month period beginning
______ 15:
Year redemption price
---- ----------------
2005 ___% ($ )
2006
2007
2008
2009
2010
2011
2012
2013
2014
and at 100% on or after ____15, 2015
In the case of a redemption prior to _______ 15, 2005 following a tax
event, investment company event or capital treatment event, the redemption price
will equal the make-whole amount for a corresponding $10.00 principal amount of
junior subordinated debt securities together with accumulated distributions to
but excluding the date fixed for redemption. The "make-whole amount" will be
equal to the greater of:
o 100% of the principal amount of such junior subordinated debt
securities, and
o as determined by a quotation agent, as defined below, the sum
of the present values of the principal amount and premium
payable as part of the redemption price with respect to an
optional redemption of such junior subordinated debt
securities on _______ 15, 2005 together with the present
values of scheduled payments of interest, excluding the
portion of any payments of interest accrued as of the
redemption date, from the redemption date to _____15, 2005, in
each case discounted to the redemption date on a quarterly
basis, assuming a 360-day year consisting of 30-day months, at
the adjusted treasury rate.
"Adjusted treasury rate" means the treasury rate plus (i) 2.00% if such
redemption date occurs on or before April 15, 2001 or (ii) 1.25% if such
redemption date occurs after April 15, 2001.
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<PAGE>
"Treasury rate" means:
o the yield, under the heading which represents the average for
the week immediately prior to the calculation date, appearing
in the most recently published statistical release designated
"H.15 (519)" or any successor publication which is published
weekly by the Federal Reserve and which establishes yields on
actively traded United States Treasury securities adjusted to
constant maturity under the caption "Treasury Constant
Maturities," for the maturity corresponding to the period of
time from the redemption date to _________ 15, 2005. If no
maturity is within three months before or after the period of
time from the redemption date to _________ 15, 2005, yields
for the two published maturities most closely corresponding
to the period of time from the redemption date to _________
15, 2005 shall be determined and the treasury rate shall be
interpolated or extrapolated from such yields on a
straight-line basis, rounding to the nearest month; or
o if that release, or any successor release, is not published
during the week preceding the calculation date or does not
contain such yields, the rate per annum equal to the
semi-annual equivalent yield to maturity of the comparable
treasury issue, calculated using a price for the comparable
treasury issue, expressed as a percentage of its principal
amount, equal to the comparable treasury price for such
redemption date. The treasury rate shall be calculated on the
third business day preceding the redemption date.
"Like amount" means common securities and redeemable capital securities
having a liquidation amount equal to that portion of the principal amount of
junior subordinated debt securities to be contemporaneously redeemed in
accordance with the indenture, allocated to the common securities and to the
redeemable capital securities based upon the relative liquidation amounts of
each. When junior subordinated debt securities are distributed to holders of
common securities and redeemable capital securities in connection with a
dissolution or liquidation of Southern Financial Capital Trust, "like amount"
means junior subordinated debt securities having a principal amount equal to the
liquidation amount of the common securities and redeemable capital securities of
the holder to whom the junior subordinated debt securities are distributed.
"Tax event" means the receipt by Southern Financial Capital Trust of an
opinion of our counsel that, as a result of any amendment to, or change,
including any announced prospective change, in, the laws or regulations of the
United States or any political subdivision, or as a result of any official or
administrative pronouncement or action or judicial decision interpreting or
applying those laws or regulations, which is effective or announced on or after
the date that the redeemable capital securities are issued, there is more than
an insubstantial risk that:
o Southern Financial Capital Trust is, or will be within 90 days
of the delivery of the opinion, subject to United States
federal income tax on the income received or accrued on the
junior subordinated debt securities;
o interest payable by us on the junior subordinated debt
securities is not, or within 90 days of the delivery of the
opinion, will not be, deductible, in whole or in part, for
United States federal income tax purposes; or
o Southern Financial Capital Trust is, or will be within 90 days
of the delivery of the opinion, subject to more than a de
minimis amount of other taxes, duties or other governmental
charges.
"Investment company event" means the receipt by Southern Financial
Capital Trust of an opinion of our counsel experienced in such matters that, as
a result of a change in law or regulation or a written change, including any
announced prospective change, in interpretation or application of law or
regulation by any
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legislative body, court, governmental agency or regulatory authority, there is
more than an insubstantial risk that Southern Financial Capital Trust is or will
be considered an investment company that is required to be registered under the
Investment Company Act, which becomes effective or would become effective, as
the case may be, on or after the date that the redeemable capital securities are
issued.
"Capital treatment event" means the reasonable determination by us
that, as a result of any amendment to, or change, including any announced
prospective change, in, the laws or regulations of the United States or any
political subdivision, or as a result of any official or administrative
pronouncement or action or judicial decision interpreting or applying such laws
or regulations, which is effective or announced on or after the date that the
redeemable capital securities are issued, there is more than an insubstantial
risk that we will not be entitled to treat an amount equal to the liquidation
amount of the redeemable capital securities as tier 1 capital, or the
equivalent, for purposes of the risk-based capital adequacy guidelines of the
Federal Reserve, as then in effect and applicable to us.
Payment of additional sums. If a tax event involving the payment of
taxes by Southern Financial Capital Trust has occurred and is continuing and
Southern Financial Capital Trust is the holder of all the junior subordinated
debt securities, we will pay additional sums, if any, on the junior subordinated
debt securities.
"Additional sums" means the additional amounts as may be necessary in
order that the amount of distributions then due and payable by Southern
Financial Capital Trust on the outstanding redeemable capital securities and
common securities of Southern Financial Capital Trust will not be reduced as a
result of any additional taxes, duties and other governmental charges to which
Southern Financial Capital Trust has become subject as a result of a tax event.
Procedures for Redeeming Redeemable Capital Securities
Common securities and redeemable capital securities will be redeemed
with the proceeds from the contemporaneous repayment or redemption of the junior
subordinated debt securities. Redemptions of the common securities and
redeemable capital securities will be made and the redemption price shall be
payable only to the extent that Southern Financial Capital Trust has funds on
hand available for the payment of the redemption price. See also "Subordination
of Common Securities" on page __.
If Southern Financial Capital Trust gives a notice of redemption, then,
by 12:00 noon, Richmond, Virginia time, on the date fixed for redemption, to the
extent funds are available, the property trustee will deposit irrevocably with
The Depository Trust Company funds sufficient to pay the redemption price. The
property trustee will give The Depository Trust Company irrevocable instructions
and authority to pay the redemption price to the holders of the redeemable
capital securities. However, if you hold redeemable capital securities held in
certificated form, the property trustee, to the extent funds are available, will
irrevocably deposit with the paying agent for the redeemable capital securities
funds sufficient to pay the redemption price. It will give the paying agent
irrevocable instructions and authority to pay the redemption price upon
surrender of certificates evidencing the redeemable capital securities.
Distributions payable on or prior to the redemption date are payable to
the holders of the redeemable capital securities on the relevant record dates
for the related distribution dates.
If notice of redemption is given and funds are deposited as required,
then on the date of the deposit, all rights of the holders of the redeemable
capital securities will cease, except the right to receive the redemption price,
without interest. The redeemable capital securities will cease to be
outstanding. If any date fixed for redemption of redeemable capital securities
is not a business day, then payment of the redemption price will be made on the
next business day, without any interest or other payment on account of the
delay. However, if the
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next business day falls in the next calendar year, the payment will be made on
the immediately preceding business day. If payment of the redemption price is
improperly withheld or refused and not paid either by Southern Financial Capital
Trust or by us, distributions on redeemable capital securities will continue to
accrue, from the redemption date originally established to the date the
redemption price is actually paid. The actual payment date will be the
redemption date for purposes of calculating the redemption price.
We or our subsidiaries may at any time and from time to time purchase
outstanding redeemable capital securities by tender in the open market or by
private agreement.
Notice of any redemption, other than at the stated maturity of the
junior subordinated debt securities, will be mailed at least 30 days but not
more than 60 days before the redemption date to each holder of redeemable
capital securities at its registered address. Unless we default in payment of
the redemption price on, or in the repayment of, the junior subordinated debt
securities, on and after the redemption date, distributions will cease to accrue
on the common securities and redeemable capital securities called for
redemption.
Liquidation of Southern Financial Capital Trust and Distribution of Junior
Subordinated Debt Securities
As the holder of the outstanding common securities, we will have the
right at any time to liquidate Southern Financial Capital Trust and cause a like
amount of the junior subordinated debt securities to be distributed to the
holders of the common securities and redeemable capital securities. Our right to
terminate is subject to prior approval of the Federal Reserve if then required
under applicable capital guidelines or policies of the Federal Reserve. For a
discussion of the income tax consequences of liquidating Southern Financial
Capital Trust, please refer to "United States Federal Income Tax Consequences -
Distribution of the Junior Subordinated Debt Securities to Holders of Redeemable
Capital Securities", which begins on page __.
Southern Financial Capital Trust will automatically terminate and
liquidate upon the first to occur of:
o Our bankruptcy, dissolution or liquidation;
o the distribution of a like amount of the junior subordinated
debt securities to the holders of the common securities and
redeemable capital securities if we have given written
direction to the property trustee to terminate Southern
Financial Capital Trust;
o redemption of all of the common securities and redeemable
capital securities as described under "Events That Will Cause
Redemption of Redeemable Capital Securities" above;
o the end of the term of Southern Financial Capital Trust; and
o the entry of an order for the dissolution of Southern
Financial Capital Trust by a court of competent jurisdiction.
If an early termination occurs, unless the common securities and
redeemable capital securities are redeemed, Southern Financial Capital Trust
will be liquidated by the trustees as expeditiously as the trustees determine to
be possible. After satisfaction of liabilities to creditors of Southern
Financial Capital Trust, the holders of such common securities and redeemable
capital securities will receive a like amount of the junior subordinated debt
securities. If a distribution of junior subordinated debt securities would not
be practical, the holders will be entitled to receive out of the assets of
Southern Financial Capital Trust available for distribution, after satisfaction
of liabilities to creditors, a liquidating distribution equal to the aggregate
of the liquidation amount plus accumulated and unpaid distributions thereon to
the date of payment.
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If the liquidation distribution can be paid only in part because
Southern Financial Capital Trust has insufficient assets to pay the aggregate
liquidation distribution, then the amounts payable on the redeemable capital
securities will be paid on a proportionate basis. As the holder of the common
securities, we will be entitled to receive distributions in any liquidation
proportionate with the holders of the redeemable capital securities. However, if
we are in default, or an event that, with notice or passage of time, would
become such a default has occurred and is continuing, the redeemable capital
securities will have a priority over the common securities. If an early
termination occurs as the result of a court order, the junior subordinated debt
securities will be redeemable in whole, but not in part.
If we elect not to redeem the junior subordinated debt securities prior
to maturity and Southern Financial Capital Trust is not liquidated and the
junior subordinated debt securities are not distributed to holders of the common
securities and redeemable capital securities, the redeemable capital securities
will remain outstanding until the repayment of the junior subordinated debt
securities at the stated maturity.
On and after the liquidation date is fixed for any distribution of
junior subordinated debt securities to holders of the common securities and
redeemable capital securities:
o the redeemable capital securities will no longer be deemed to
be outstanding;
o The Depository Trust Company or its nominee, as the record
holder of the redeemable capital securities, will receive a
registered global certificate or certificates representing the
junior subordinated debt securities to be delivered in
exchange for the redeemable capital securities held by The
Depository Trust Company or its nominee; and
o any certificates representing redeemable capital securities
not held by The Depository Trust Company or its nominee will
be deemed to represent junior subordinated debt securities
with a principal amount equal to the liquidation amount of
those redeemable capital securities and bearing accrued and
unpaid interest in an amount equal to the accumulated and
unpaid distributions on the redeemable capital securities
until the certificates are presented to the administrative
trustees or their agent for cancellation. After cancellation
we will issue to the holder a certificate representing such
junior subordinated debt securities.
Subordination of Common Securities
Payments on the redeemable capital securities and common securities
will be made proportionately to the holders of redeemable capital securities and
common securities. However, if on any distribution date or redemption date we
are in default, or an event that, with notice or passage of time, would become
such a default has occurred and is continuing, our rights to distributions is
subordinated to your rights. In that case, no payment to us as the holder of the
common securities may be made unless payment in full in cash of all accumulated
and unpaid distributions on all of the outstanding redeemable capital
securities, or, in the case of payment of the redemption price, the full amount
of the redemption price on all of the outstanding redeemable capital securities,
has been made or provided for. All funds available to the property trustee shall
first be applied to the payment in full in cash of all distributions on, or the
redemption price of, the redeemable capital securities then due and payable.
If we default, we as holder of the common securities will be deemed to
have waived any right to act with respect to any such default under the amended
and restated declaration of trust until the effect of all events of default have
been cured, waived or otherwise eliminated. Until all such events of default
under the amended and restated declaration of trust have been so cured, waived
or otherwise eliminated, the property trustee shall act
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solely on behalf of the holders of such redeemable capital securities and not on
our behalf as holder of the common securities, and only the holders of the
redeemable capital securities will have the right to direct the property trustee
to act on their behalf.
Events That Are a Default Under the Declaration
Any one of the following events constitutes an event of default under
the amended and restated declaration of trust:
o an event of default under the indenture, as described on page
__; or
o default by Southern Financial Capital Trust in the payment of
any distribution when it becomes due and payable, and
continuation of such default for a period of 30 days; or
o default by Southern Financial Capital Trust in the payment of
any redemption price of any common security or redeemable
capital security when it becomes due and payable; or
o default in the performance, or breach, in any material
respect, of any covenant or warranty of the trustees in the
amended and restated declaration of trust, other than a
covenant or warranty, a default in the performance of which or
the breach of which is addressed in the second and third
points above, and continuation of such default or breach for a
period of 60 days after there has been given, by registered or
certified mail, to the defaulting trustee or trustees by the
holders of at least 25% in aggregate liquidation amount of the
outstanding redeemable capital securities, a written notice
specifying such default or breach and requiring it to be
remedied and stating that such notice is a notice of default
under the declaration; or
o the bankruptcy or insolvency of the property trustee and our
failure to appoint a successor property trustee within 60
days.
Within five business days after any event of default is actually known
to the property trustee, it must transmit notice of the event of default to the
holders of the redeemable capital securities, the administrative trustees and to
us, unless the event of default has been cured or waived. We and the
administrative trustees are required to file annually with the property trustee
a certificate as to whether or not they are in compliance with all the
conditions and covenants applicable to them under the declaration.
Removal of Trustees
Unless a default under the indenture has occurred and is continuing, we
may remove any trustee at any time. If a default under the indenture has
occurred and is continuing, the property trustee and the Delaware trustee may be
removed by the holders of a majority in liquidation amount of the outstanding
redeemable capital securities. Holders of the redeemable capital securities will
not have the right to vote to appoint, remove or replace the administrative
trustees. No resignation or removal of a trustee and no appointment of a
successor trustee is effective until the acceptance of appointment by the
successor trustee in accordance with the provisions of the declaration.
Co-trustees and Separate Property Trustee
Unless an event of default has occurred and is continuing, at any time
or times, for the purpose of meeting the legal requirements of the Trust
Indenture Act or of any jurisdiction in which any part of Southern Financial
Capital Trust's property may at the time be located, we, as the holder of the
common securities, and
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the administrative trustees have power to appoint one or more persons either to
act as a co-trustee, jointly with the property trustee, of all or any part of
Southern Financial Capital Trust's property, or to act as separate trustee of
any such property. In either case the co-trustees will have whatever powers
provided in the instrument of appointment. We can give a co-trustee any
property, title, right or power we deem necessary or desirable. In case a
default under the indenture has occurred and is continuing, the property trustee
alone shall have power to make such appointment.
Merger or Consolidation of Trustees
Any person into which the property trustee, the Delaware trustee or any
administrative trustee that is not a natural person may be merged or converted
or with which it may be consolidated, or any person resulting from any merger,
conversion or consolidation to which the trustee shall be a party, or any person
succeeding to all or substantially all the corporate trust business of the
trustee, shall be the successor of such trustee under the declaration, if such
person is otherwise qualified and eligible.
Mergers, Consolidations, Amalgamations or Replacements of Southern Financial
Capital Trust
Southern Financial Capital Trust may not merge with or into,
consolidate, amalgamate or be replaced by, or convey, transfer or lease its
properties and assets substantially as an entirety to any corporation or other
person, except as described below.
Southern Financial Capital Trust may, at our request, with the consent
of the administrative trustees but without the consent of the holders of the
redeemable capital securities, the property trustee or the Delaware trustee,
merge with or into, consolidate, amalgamate or be replaced by, or convey,
transfer or lease its properties and assets substantially as an entirety to, a
trust organized under the laws of any State. However, in connection with any
transaction:
o the successor entity either must expressly assume all of the
obligations of Southern Financial Capital Trust on the
redeemable capital securities or substitute for the redeemable
capital securities successor securities having substantially
the same terms as the redeemable capital securities, so long
as the successor securities rank the same as the redeemable
capital securities with respect to distributions and payments
upon liquidation, redemption and otherwise;
o we must appoint a trustee of the successor entity possessing
the same powers and duties as the property trustee as the
holder of the junior subordinated debt securities;
o the successor securities must be listed or traded, or any
successor securities will be listed or traded upon
notification of issuance, on any national securities exchange
or other organization on which the redeemable capital
securities are then listed or traded;
o the merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease may not adversely affect the
rights, preferences and privileges of the holders of the
redeemable capital securities, including any successor
securities, in any material respect;
o the successor entity must have a purpose identical and limited
to that of Southern Financial Capital Trust;
o before any transaction, we must receive an opinion from
independent counsel to Southern Financial Capital Trust
experienced in such matters that the transaction does not
adversely affect the rights, preferences and privileges of the
holders of the redeemable capital securities,
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including any successor securities, in any material respect.
The opinion also must state that after the transaction,
neither Southern Financial Capital Trust nor its successor
entity will be required to register as an investment company
under the Investment Company Act of 1940; and
o we or our successor must own all of the common securities of
the successor entity and guarantee its obligations under the
successor securities at least to the extent provided by the
guarantee.
Southern Financial Capital Trust may not, however, except with the
consent of holders of 100% in liquidation amount of the common securities and
redeemable capital securities, consolidate, amalgamate, merge with or into, or
be replaced by or convey, transfer or lease its properties and assets
substantially as an entirety to any other entity, if such action would cause
Southern Financial Capital Trust or the successor entity to be classified as an
association taxable as a corporation or as other than a grantor trust for United
States federal income tax purposes.
Voting Rights of Redeemable Capital Securities; Amendment of the Declaration
Except as provided below and under "Description of Guarantee -
Amendments and Assignment", the holders of the redeemable capital securities
will have no voting rights.
The amended and restated declaration of trust may be amended from time
to time by us, the property trustee and the administrative trustees, without the
consent of the holders of the redeemable capital securities, to:
o cure any ambiguity, correct or supplement any provision that
may be inconsistent with any other provision, or to make any
other provisions, which are not inconsistent with the other
provisions of the amended and restated declaration of trust,
or
o modify, eliminate or add to any provisions necessary to ensure
that Southern Financial Capital Trust will be classified for
United States federal income tax purposes as a grantor trust
or as other than an association taxable as a corporation or to
ensure that Southern Financial Capital Trust will not be
required to register as an investment company under the
Investment Company Act.
However, any amendment made under the first point above may not
adversely affect in any material respect the interests of any holder of
redeemable capital securities. Any amendments of the amended and restated
declaration of trust become effective when notice is given to the holders of the
common securities and redeemable capital securities.
The amended and restated declaration of trust also may be amended with
the consent of holders representing a majority of the outstanding redeemable
capital securities. The trustees, however, must first receive an opinion of
counsel that neither the amendment nor the exercise of any power granted to the
trustees under the amendment will adversely affect the tax status of Southern
Financial Capital Trust or its exemption from investment company status under
the Investment Company Act.
However, without the consent of each holder of common securities and
redeemable capital securities, the amended and restated declaration of trust may
not be amended to change the amount or timing of any distribution on the common
securities and redeemable capital securities or otherwise adversely affect the
amount of any distribution required to be made on the common securities and
redeemable capital securities as of a specified date or restrict the right of a
holder of common securities and redeemable capital securities to institute suit
for the enforcement of any such payment on or after that date.
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As long as any junior subordinated debt securities are held by Southern
Financial Capital Trust, the trustees may not:
o direct the time, method and place of conducting any proceeding
for any remedy available to the debenture trustee, or
executing any trust or power conferred on the property trustee
with respect to the junior subordinated debt securities;
o waive any past default that is waivable under Section 5.13 of
the indenture;
o exercise any right to rescind or annul a declaration that the
principal of all the junior subordinated debt securities shall
be due and payable or
o consent to any amendment, modification or termination of the
indenture or the junior subordinated debt securities, where
such consent shall be required, without, in each case,
obtaining the prior approval of the holders of a majority in
aggregate liquidation amount of all outstanding redeemable
capital securities.
Where a consent under the indenture would require the consent of each
holder of junior subordinated debt securities, no consent may be given by the
property trustee without the prior consent of each holder of the redeemable
capital securities. The trustees may not revoke any action previously authorized
or approved by a vote of the holders of the redeemable capital securities except
by subsequent vote of the holders. The property trustee must notify each holder
of redeemable capital securities of any notice of default on the junior
subordinated debt securities. In addition to obtaining the foregoing approvals
of holders of the redeemable capital securities, prior to taking any of the
foregoing actions, the trustees must obtain an opinion of counsel experienced in
such matters to the effect that Southern Financial Capital Trust will not be
classified as an association taxable as a corporation for United States federal
income tax purposes as a result of such action and such action would not cause
Southern Financial Capital Trust to be classified as other than a grantor trust
for United States federal income tax purposes.
Any required approval of holders of redeemable capital securities may
be given at a meeting of holders or by written consent. The property trustee
will cause a notice of any meeting at which holders of redeemable capital
securities are entitled to vote, or of any matter upon which action by written
consent of holders is to be taken, to be given to each holder of record of
redeemable capital securities in the manner set forth in the amended and
restated declaration of trust.
No vote or consent of the holders of redeemable capital securities will
be required for Southern Financial Capital Trust to redeem and cancel the
redeemable capital securities in accordance with the amended and restated
declaration of trust.
Any of the redeemable capital securities that are owned by us, the
trustees or any affiliate of us or any trustees, shall, for purposes of any vote
or consent, will be treated as if they were not outstanding.
Payment of Expenses and Taxes of Southern Financial Capital Trust
We have agreed to pay all debts, expenses and other obligations of
Southern Financial Capital Trust, other than payments of distributions, amounts
payable upon redemption and the liquidation amount of the common securities and
redeemable capital securities. The expenses we will pay include
o costs and expenses of organizing Southern Financial Capital
Trust;
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o the fees and expenses of the trustees, the costs and expenses
of operating Southern Financial Capital Trust;
o costs of offering the redeemable capital securities; and
o all taxes and all costs and expenses with respect to the
foregoing, other than United States withholding taxes, to
which Southern Financial Capital Trust might become subject.
The obligations described above are for the benefit of, and are
enforceable by, any person to whom the obligations are owed, whether or not the
creditor has received notice that we are liable. Any creditor may enforce those
obligations directly against us, and we have irrevocably waived any right or
remedy to require that any creditor take any action against Southern Financial
Capital Trust or any other person before proceeding against us.
Form, Denomination, Book-Entry Procedures and Transfer of Redeemable Capital
Securities
The Depository Trust Company will act as securities depositary for the
redeemable capital securities. The redeemable capital securities will be issued
only as fully-registered securities registered in the name of Cede & Co., The
Depository Trust Company's nominee. One or more fully-registered global
redeemable capital securities certificates, representing the total aggregate
number of the redeemable capital securities, will be issued to and deposited
with The Depository Trust Company.
The Depository Trust Company is a limited-purpose trust company
organized under the New York Banking Law, a "banking organization" within the
meaning of the New York Banking Law, a member of the Federal Reserve System, a
"clearing corporation" within the meaning of the New York Uniform Commercial
Code and a "clearing agency" registered pursuant to the provisions of Section
17A of the Exchange Act. The Depository Trust Company holds securities that its
participants deposit with The Depository Trust Company. The Depository Trust
Company also facilitates the settlement among participants of securities
transactions, such as transfers and pledges, in deposited securities through
electronic computerized book-entry changes in participants' accounts, thereby
eliminating the need for physical movement of securities certificates.
Participants in The Depository Trust Company include securities brokers and
dealers, banks, trust companies, clearing corporations and certain other
organizations. The Depository Trust Company is owned by a number of its
participants and by the New York Stock Exchange, the American Stock Exchange,
Inc., and the National Association of Securities Dealers, Inc. Access to The
Depository Trust Company system is also available to others, such as securities
brokers and dealers, banks and trust companies that clear transactions through
or maintain a direct or indirect custodial relationship with a participant
either directly or indirectly. The rules applicable to The Depository Trust
Company and its participants are on file with the Securities and Exchange
Commission.
Purchases of redeemable capital securities under The Depository Trust
Company system must be made by or through participants, which will receive a
credit for the redeemable capital securities on The Depository Trust Company's
records. The ownership interest of each actual purchaser, or beneficial owner,
of each capital security is in turn to be recorded on the participants' and
indirect participants' records. Beneficial owners will not receive written
confirmation from The Depository Trust Company of their purchases, but
beneficial owners are expected to receive written confirmations providing
details of the transactions, as well as periodic statements of their holdings,
from the participants or indirect participants through which the beneficial
owners purchased redeemable capital securities. Transfers of ownership interests
in redeemable capital securities are to be accomplished by entries made on the
books of participants acting on behalf of beneficial owners. Beneficial owners
will not receive certificates representing their ownership interests in
redeemable capital securities, except
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in the event that use of the book-entry system for redeemable capital securities
is discontinued.
The Depository Trust Company has no knowledge of the actual beneficial
owners of any such redeemable capital securities. The Depository Trust Company's
records reflect only the identity of the participants to whose accounts such
redeemable capital securities are credited, which may or may not be the
beneficial owners. The participants and indirect participants will remain
responsible for keeping account of their holdings on behalf of their customers.
So long as The Depository Trust Company, or its nominee, is the
registered owner or holder of a global capital security, The Depository Trust
Company or such nominee, as the case may be, will be considered the sole owner
or holder of the redeemable capital securities represented thereby for all
purposes under the declaration and the redeemable capital securities. No
beneficial owner of an interest in a global capital security will be able to
transfer that interest except in accordance with The Depository Trust Company's
applicable procedures, in addition to those provided for under the declaration.
The Depository Trust Company has advised us that it will take any
action permitted to be taken by a holder of redeemable capital securities,
including presentation of redeemable capital securities for exchange as
described below, only at the direction of one or more participants to whose
account the interests in global redeemable capital securities are credited and
only in respect of such portion of the aggregate liquidation amount of
redeemable capital securities as to which such participant or participants has
or have given such direction. However, if there is an Event of Default, The
Depository Trust Company will exchange the global redeemable capital securities
representing such redeemable capital securities for certificated securities,
which it will distribute to its participants.
Conveyance of notices and other communications by The Depository Trust
Company to participants, by participants to indirect participants, and by
participants and indirect participants to beneficial owners will be governed by
arrangements among them, subject to any statutory or regulatory requirements as
may be in effect from time to time.
Redemption notices, if applicable, in respect of any redeemable capital
securities held in book-entry form will be sent to Cede & Co. If less than all
of such redeemable capital securities are being redeemed, The Depository Trust
Company will determine the amount of the interest of each participant to be
redeemed in accordance with its procedures.
Although voting with respect to any of the redeemable capital
securities is limited, in those cases where a vote is required, neither The
Depository Trust Company nor Cede & Co. will itself consent or vote with respect
to the redeemable capital securities. Under its usual procedures, The Depository
Trust Company would mail an omnibus proxy to Southern Financial Capital Trust as
soon as possible after the record date. The omnibus proxy assigns Cede & Co.'s
consenting or voting rights to those participants to whose accounts the
redeemable capital securities are credited on the record date (identified in a
listing attached to the omnibus proxy).
Except as provided herein, a beneficial owner of an interest in a
global capital security will not be entitled to receive physical delivery of the
redeemable capital securities represented thereby. Accordingly, each beneficial
owner must rely on the procedures of The Depository Trust Company to exercise
any rights under the redeemable capital securities.
Although The Depository Trust Company has agreed to the foregoing
procedures in order to facilitate transfers of interests in global redeemable
capital securities among participants of The Depository Trust Company, The
Depository Trust Company is under no obligation to perform or continue to
perform such
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procedures, and such procedures may be discontinued at any time. Neither
Southern Financial Bancorp, Inc., Southern Financial Capital Trust nor the
trustees of Southern Financial Capital Trust will have any responsibility for
the performance by The Depository Trust Company or its participants or indirect
participants under the rules and procedures governing The Depository Trust
Company. The Depository Trust Company may discontinue providing its services as
securities depositary with respect to any of the redeemable capital securities
at any time by giving notice to Southern Financial Capital Trust. Under such
circumstances, in the event that a successor securities depositary is not
obtained, capital security certificates are required to be printed and
delivered. Additionally, Southern Financial Capital Trust (with our consent) may
decide to discontinue use of the system of book-entry transfers through The
Depository Trust Company or a successor depositary. In that event, certificates
for the redeemable capital securities will be printed and delivered. In each of
the above circumstances, we will appoint a paying agent with respect to the
redeemable capital securities.
The laws of some states require that certain persons take physical
delivery in certificated form of certain securities, such as the redeemable
capital securities, that they own. Consequently, the ability to transfer
beneficial interests in a global capital security to such persons will be
limited to that extent. Because The Depository Trust Company can act only on
behalf of participants, which in turn act on behalf of indirect participants and
certain banks, the ability of a person having beneficial interests in a global
capital security to pledge such interests to persons or entities that do not
participate in the The Depository Trust Company system, or otherwise take
actions in respect of such interests, may be affected by the lack of a physical
certificate evidencing such interests.
Except as described below, owners of beneficial interests in the global
redeemable capital securities will not be entitled to have redeemable capital
securities registered in their names, will not receive or be entitled to receive
physical delivery of redeemable capital securities in certificated form and will
not be considered the registered owners or holders thereof under the declaration
for any purpose.
Exchange of Book-Entry Redeemable Capital Securities for Certificated Redeemable
Capital Securities
A global redeemable capital security is exchangeable for redeemable
capital securities in registered certificated form only if:
o The Depository Trust Company notifies Southern Financial
Capital Trust that it is no longer willing or able to properly
discharge its responsibilities with respect to the redeemable
capital securities and we are unable to locate a qualified
successor, or has ceased to be a "clearing agency" registered
under the Exchange Act;
o Southern Financial Capital Trust at its sole option elects to
terminate the book-entry system through The Depository Trust
Company; or
o a Debenture Event of Default has occurred and is continuing.
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How Payments Will Be Made on the Redeemable Capital Securities
Distributions on redeemable capital securities held in book-entry form
will be made to The Depository Trust Company in immediately available funds. The
Depository Trust Company's practice is to credit participants' accounts on the
relevant payment date in accordance with their holdings shown on The Depository
Trust Company's records unless The Depository Trust Company has reason to
believe that it will not receive payments on such payment date. Payments by
participants and indirect participants to beneficial owners will be governed by
standing instructions and customary practices and will be the responsibility of
such participants and indirect participants and not of The Depository Trust
Company, Southern Financial Capital Trust or us, subject to any statutory or
regulatory requirements as may be in effect from time to time. Payment of
distributions to The Depository Trust Company is the responsibility of Southern
Financial Capital Trust, disbursement of such payments to participants is the
responsibility of The Depository Trust Company, and disbursement of such
payments to the beneficial owners is the responsibility of participants and
indirect participants.
The paying agent shall initially be the property trustee and any
co-paying agent chosen by the property trustee and acceptable to the
administrative trustees and us. The paying agent shall be permitted to resign as
paying agent upon 30 days' written notice to the property trustee, the
administrative trustees and us. In the event that the property trustee shall no
longer be the paying agent, the administrative trustees shall appoint a
successor, which shall be a bank or trust company acceptable to the
administrative trustees and us, to act as paying agent.
Wilmington Trust Company has informed Southern Financial Capital Trust
that so long as it serves as paying agent for the redeemable capital securities,
it anticipates that information regarding distributions on the redeemable
capital securities, including payment date, record date and redemption
information, will be made available through Wilmington Trust Company at 1100 N.
Market Street, Wilmington, Delaware, Attention: Corporate Trust Administration.
Information About Registrar and Transfer Agent
The property trustee will act as registrar and transfer agent for the
redeemable capital securities.
Registration of transfers of the redeemable capital securities will be
effected without charge by or on behalf of Southern Financial Capital Trust, but
upon payment of any tax or other governmental charges that may be imposed in
connection with any transfer or exchange. Southern Financial Capital Trust will
not be required to register or cause to be registered the transfer or exchange
of the redeemable capital securities after they have been called for redemption.
Information About the Property Trustee
The property trustee, other than during the occurrence and continuance
of an event of default, undertakes to perform only such duties as are
specifically set forth in the declaration and, during the existence of an event
of default, must exercise the same degree of care and skill as a prudent person
would exercise or use in the conduct of his or her own affairs. Subject to this
provision, the property trustee is under no obligation to exercise any of the
powers vested in it by the amended and restated declaration of trust at the
request of any holder of common securities and redeemable capital securities
unless it is offered reasonable indemnity against the costs, expenses and
liabilities that might be incurred thereby. If no event of default has occurred
and is continuing and the property trustee is required to decide between
alternative causes of action, construe ambiguous provisions in the declaration
or is unsure of the application of any provision of the declaration, and the
matter is not one on which holders of the redeemable capital securities or the
common securities are entitled under the amended and restated declaration of
trust to vote, then the property trustee shall take the action we direct and, if
not so directed, shall take whatever action it deems advisable and in the best
interests of the holders
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of the common securities and redeemable capital securities and will have no
liability except for its own bad faith, negligence or willful misconduct.
Miscellaneous
The administrative trustees are authorized and directed to operate
Southern Financial Capital Trust so that Southern Financial Capital Trust will
not be deemed to be an investment company required to be registered under the
Investment Company Act or classified as an association taxable as a corporation
for United States federal income tax purposes or as other than a grantor trust
for United States federal income tax purposes, and so that the junior
subordinated debt securities will be treated as our indebtedness for United
States federal income tax purposes. In this connection, we and the
administrative trustees are authorized to take any action, not inconsistent with
applicable law, the certificate of trust of Southern Financial Capital Trust or
the declaration, that we and the administrative trustees determine in our
discretion to be necessary or desirable for such purposes, as long as such
action does not materially adversely affect the interests of the holders of the
common securities and redeemable capital securities.
Holders of the common securities and redeemable capital securities have
no preemptive or similar rights.
Southern Financial Capital Trust may not borrow money or issue debt or
mortgage or pledge any of its assets.
DESCRIPTION OF JUNIOR SUBORDINATED DEBT SECURITIES
The junior subordinated debt securities are to be issued as a separate
series under the indenture between us and Wilmington Trust Company, as the
debenture trustee. The indenture will be qualified under the Trust Indenture
Act. This is a summary of the material terms and provisions of the junior
subordinated debt securities, but it is not exhaustive. It is qualified by
reference to all of the provisions of the indenture and those terms made a part
of the indenture by the Trust Indenture Act.
General
Southern Financial Capital Trust will invest the proceeds from sale of
the common securities and redeemable capital securities in junior subordinated
debt securities issued by us. The junior subordinated debt securities will bear
interest at ___% per annum, payable quarterly in arrears on the 15th day of
January, April, July and October of each year, commencing ______ 15, 2000.
Interest will be paid to the person in whose name each junior subordinated debt
security is registered at the close of business on the business day next
preceding the interest payment date. We anticipate that, until the liquidation
of Southern Financial Capital Trust, each junior subordinated debt security will
be held in the name of the property trustee in trust for the benefit of the
holders of the common securities and redeemable capital securities.
The amount of interest payable for any period will be computed on the
basis of the actual number of days elapsed in a year of twelve 30-day months. If
any date on which interest is payable on the junior subordinated debt securities
is not a business day, then interest will be paid on the next day that is a
business day, and without any interest or other payment on account of any such
delay. Accrued interest that is not paid on the applicable interest payment date
will bear additional interest at _____% per annum thereof, compounded quarterly
from the relevant interest payment date. The term "interest" includes quarterly
payments, interest on quarterly interest payments not paid on the applicable
interest payment date and additional sums, as applicable.
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Unless previously redeemed or repurchased, the junior subordinated debt
securities will mature on______ 15, 2030.
The junior subordinated debt securities will be unsecured and will rank
junior and be subordinate in right of payment to all senior debt. Because
Southern Financial Bancorp, Inc. is a bank holding company, our right to
participate in any distribution of assets of any subsidiary, including Southern
Financial Bank, upon the subsidiary's liquidation or reorganization or otherwise
and the ability of holders of the redeemable capital securities to benefit
indirectly from such distribution, is subject to the prior claims of creditors
of the subsidiary, except to the extent that we may be recognized as a creditor
of the subsidiary. This means that the junior subordinated debt securities not
only will be subordinated to all senior debt but also effectively subordinated
to all existing and future liabilities of our subsidiaries. Holders of junior
subordinated debt securities should look only to our assets for payments on the
junior subordinated debt securities. The indenture does not limit other secured
or unsecured debt, including senior debt, whether under the indenture or any
existing or other indenture that we may enter into in the future or otherwise.
The junior subordinated debt securities will rank equally with all
other debentures issued under the indenture. As a holding company, we conduct
our operations principally through Southern Financial Bank and our principal
source of cash, is receipt of dividends from Southern Financial Bank. We are a
legal entity separate and distinct from Southern Financial Bank. Federal law
restricts loans from Southern Financial Bank to us. Those restrictions prevent
us from borrowing from Southern Financial Bank unless the loans are secured by
various types of collateral. In addition, dividend payments to us by Southern
Financial Bank are subject to review by banking regulators and are subject to
various statutory limits. Dividend payments that exceed statutory limits require
approval by bank regulatory authorities.
Denominations, Registration and Transfer
The junior subordinated debt securities will be represented by one or
more global certificates registered in the name of Cede & Co. as the nominee of
The Depository Trust Company if, and only if, distributed to the holders of the
common securities and redeemable capital securities. Until then, the junior
subordinated debt securities will be held in the name of the property trustee in
trust for the benefit of the holders of the common securities and redeemable
capital securities. If the junior subordinated debt securities are distributed
to holders of the common securities and redeemable capital securities,
beneficial interests in the junior subordinated debt securities will be shown
on, and transfers will be effected only through, records maintained by
participants in The Depository Trust Company.
A global security will be exchangeable for junior subordinated debt
securities registered in the names of persons other than Cede & Co. only if:
o The Depository Trust Company notifies us that it is unwilling
or unable to continue as a depositary for such global security
and no successor depositary shall have been appointed, or if
at any time The Depository Trust Company ceases to be a
"clearing agency" registered under the Exchange Act, at a time
when The Depository Trust Company is required to be so
registered to act as such depositary;
o we in our sole discretion determine that such global security
will be exchangeable; or
o a debenture event of default has occurred and is continuing.
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Any global security that is exchangeable pursuant to the preceding
sentence shall be exchangeable for certificates registered in the names The
Depository Trust Company directs. It is expected that its instructions will be
based upon directions received by it from its participants.
If junior subordinated debt securities are issued in certificated form,
principal and interest will be payable, the transfer of the junior subordinated
debt securities will be registrable, and junior subordinated debt securities
will be exchangeable for junior subordinated debt securities of other
denominations of a like aggregate principal amount, at the corporate office of
the debenture trustee in Wilmington, Delaware, or at the offices of any paying
agent or transfer agent we appoint.
If the junior subordinated debt securities are distributed to the
holders of the common securities and redeemable capital securities upon the
termination of Southern Financial Capital Trust, the form, denomination,
book-entry and transfer procedures for the redeemable capital securities as
described under "Description of Redeemable Capital Securities - Form,
Denomination, Book-Entry Procedures and Transfer of Redeemable Capital
Securities," will apply to the junior subordinated debt securities.
How Payments Will Be Made on the Junior Subordinated Debt Securities
Payment of principal and interest on junior subordinated debt
securities will be made at the office of the debenture trustee in Wilmington,
Delaware or at the office of any paying agent or paying agents we designate.
Except for junior subordinated debt securities in global form, we may pay
interest by check mailed to the address of the person entitled to payment. We
also may pay by wire transfer to an account specified by the person entitled to
payment. Payment of interest on any junior subordinated debt security will be
made to the person in whose name it is registered at the close of business on
the record date for the interest payment, except in the case of defaulted
interest. At any time we may designate additional paying agents or rescind the
designation of any paying agent. However, we will at all times be required to
maintain a paying agent in each place of payment for the junior subordinated
debt securities.
Any money deposited with the debenture trustee or any paying agent, or
held by us in trust, for the payment of principal of or interest on any junior
subordinated debt security and remaining unclaimed for two years after such
principal or interest has become due and payable shall, at our request, be
repaid to us and the holder of such junior subordinated debt security shall
thereafter look, as a general unsecured creditor, only to us for payment.
Our Option to Defer Interest Payments
So long as we are not in default under the indenture, we have the right
under the indenture to defer the payment of interest on the junior subordinated
debt securities at any time or from time to time for a period not exceeding 20
consecutive quarterly periods. However, no interest deferral period may extend
beyond _____ 15, 2030. At the end of an interest deferral period, we must pay
all interest then accrued and unpaid on the junior subordinated debt securities,
together with interest on the deferred interest at ____% per annum, compounded
quarterly from the relevant interest payment date.
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Our Option to Redeem the Junior Subordinated Debt Securities Before Maturity
We have the right to redeem the junior subordinated debt securities on
or after ___ 15, 2005, in whole at any time or in part from time to time. We
also can redeem the junior subordinated debt securities in whole, but not in
part, at any time within 90 days after a tax event, investment company event or
capital treatment event. The proceeds of any redemption will be used by Southern
Financial Capital Trust to redeem the redeemable capital securities.
The Federal Reserve's risk-based capital guidelines currently provide
that redemptions of permanent equity or other capital instruments before stated
maturity could have a significant impact on a bank holding company's overall
capital structure. Any organization considering such a redemption should consult
the Federal Reserve before redeeming any equity or capital instrument prior to
maturity if the redemption could have a material effect on the level or
composition of the organization's capital base. Because it is likely that a
redemption of the junior subordinated debt securities would materially affect
our capital base, it is likely that we would seek the Federal Reserve's prior
approval. However, the Federal Reserve likely would not object if the junior
subordinated debt securities were redeemed with the proceeds of, or replaced by,
a like amount of a similar or higher quality capital instrument and the Federal
Reserve considers the organization's capital position to be fully adequate after
the redemption.
In the case of a redemption on or after _____ 15, 2005 the redemption
price will equal the following prices, expressed in percentages of the principal
amount, together with accrued interest to but excluding the date fixed for
redemption. If redeemed during the 12-month period beginning April 15:
Year redemption price
---- ----------------
2005 ____% ($ )
2006
2007
2008
2009
2010
2011
2012
2013
2014
and at 100% on or after _____15, 2015
In the case of a redemption prior to_____ 15, 2005 following a tax
event, investment company event or capital treatment event as described above,
the redemption price will equal the make-whole amount. Please refer to
"Description of Redeemable Capital Securities - Events That Will Cause
Redemption of Redeemable Capital Securities", which begins on page __ for a more
complete discussion.
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Additional Sums We Might Have to Pay to Southern Financial Capital Trust
We have agreed in the indenture that as long as Southern Financial
Capital Trust is the holder of all junior subordinated debt securities, if it is
required to pay any additional taxes, duties or other governmental charges as a
result of a tax event, we will pay as additional sums on the junior subordinated
debt securities whatever amounts are necessary so that the distributions payable
by Southern Financial Capital Trust will not be reduced.
How the Indenture Can Be Amended
We and the debenture trustee may, without the consent of the holders of
junior subordinated debt securities, amend, waive or supplement the indenture
for specified purposes, including curing ambiguities, defects or
inconsistencies. None of those actions, however, may adversely affect the
interest of the holders of junior subordinated debt securities or the holders of
the redeemable capital securities. We also can amend the indenture to maintain
its qualification under the Trust Indenture Act. The indenture contains
provisions permitting us and the debenture trustee, with the consent of the
holders of a majority in principal amount of outstanding junior subordinated
debt securities, to modify the indenture in a manner affecting the rights of the
holders of junior subordinated debt securities. However, no modification without
the consent of the holder of each outstanding junior subordinated debt security
so affected, may change the stated maturity, or reduce the principal amount of
the junior subordinated debt securities, or reduce the rate or extend the time
of payment of interest or reduce the percentage of principal amount of junior
subordinated debt securities.
In addition, we and the debenture trustee without the consent of any
holder of junior subordinated debt securities, may execute any supplemental
indenture for the purpose of creating any other debentures.
What Is an Event of Default under the Indentures and What Are the Consequences?
Any one or more of the following described events that has occurred and
is continuing constitutes an event of default under the indenture:
o our failure for 30 days to pay any interest on the junior
subordinated debt securities when due (subject to our right to
defer interest payments for up to 20 consecutive calendar
quarters); or
o our failure to pay any principal on the junior subordinated
debt securities when due, whether at maturity, upon
redemption, by declaration of acceleration or otherwise; or
o our failure to observe or perform in any material respect
other covenants contained in the indenture for 90 days after
written notice to us from the debenture trustee or the holders
of at least 25% in aggregate outstanding principal amount of
the junior subordinated debt securities; or
o our bankruptcy, insolvency or reorganization; or
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o the voluntary or involuntary dissolution, winding-up or
termination of Southern Financial Capital Trust, except in
connection with the distribution of the junior subordinated
debt securities to the holder of common securities and
redeemable capital securities in liquidation of Southern
Financial Capital Trust, the redemption of all of the common
securities and redeemable capital securities of Southern
Financial Capital Trust, or mergers, consolidations or
amalgamations permitted by the amended and restated
declaration of trust.
The holders of a majority in aggregate outstanding principal amount of
the junior subordinated debt securities have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
debenture trustee. The debenture trustee or the holders of not less than 25% in
aggregate outstanding principal amount of the junior subordinated debt
securities may declare the principal due and payable immediately upon a default
under the indenture and, should the debenture trustee or such holders of junior
subordinated debt securities fail to make such declaration, the holders of at
least 25% in aggregate liquidation amount of the redeemable capital securities
have that right. The holders of a majority in aggregate outstanding principal
amount of the junior subordinated debt securities may annul such declaration and
waive the default if the default, other than the nonpayment of the principal of
the junior subordinated debt securities which has become due solely by such
acceleration, has been cured and a sum sufficient to pay all matured
installments of interest and principal due otherwise than by acceleration has
been deposited with the debenture trustee. If the holders of junior subordinated
debt securities fail to annul such declaration and waive such default, the
holders of a majority in aggregate liquidation amount of the redeemable capital
securities have that right.
The holders of a majority in aggregate outstanding principal amount of
the junior subordinated debt securities, on behalf of the holders of all the
junior subordinated debt securities, may waive any past default, except an
uncured default in the payment of principal of or interest on the junior
subordinated debt securities or a default in respect of a covenant or provision
which under the indenture cannot be modified or amended without the consent of
the holder of each outstanding junior subordinated debt security. If the holders
of the junior subordinated debt securities fail to annul such declaration and
waive such default, the holders of a majority in aggregate liquidation amount of
the redeemable capital securities have that right. We are required to file
annually with the debenture trustee a certificate as to whether or not we are in
compliance with all the conditions and covenants applicable to it under the
indenture.
If a default under the indenture occurs and continues, the property
trustee will have the right to declare the principal of and the interest on the
junior subordinated debt securities, and any other amounts payable under the
indenture, to be immediately due and payable and to enforce its other rights as
a creditor with respect to the junior subordinated debt securities.
Enforcement of Rights by Holders of Redeemable Capital Securities
If a default under the indenture occurs and continues and results from
our failure to pay interest or principal on the junior subordinated debt
securities when due, a holder of redeemable capital securities may sue us
directly. We may not amend the indenture to remove the right to sue us directly
without the prior written consent of the holders of all of the redeemable
capital securities. If we make payments to a holder of redeemable capital
securities in connection with a direct action against us, we will remain
obligated to pay all of the principal of and interest on the junior subordinated
debt securities. We will be subrogated to the rights of the holder of redeemable
capital securities to the extent of any payments made by us to the holder in any
direct action against us.
The holders of the redeemable capital securities will not be able to
exercise directly any remedies, other than those set forth in the preceding
paragraph, available to the holders of the junior subordinated debt securities
unless there has been a default under the amended and restated declaration of
trust.
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Consolidation, Merger, Sale of Assets and Other Transactions Involving Us
The indenture provides that we may not consolidate with or merge with
or into any other person or convey, transfer or lease our properties and assets
substantially as an entirety to any person, and no person may consolidate with
or merge with or into us or convey, transfer or lease its properties and assets
substantially as an entirety to us, unless:
o in case we consolidate with or merge with or into another
person or convey or transfer our properties and assets
substantially as an entirety to any person, the successor
person is organized under the laws of the United States or any
state or the District of Columbia, and the successor person
expressly assumes our obligations on the junior subordinated
debt securities;
o immediately after giving effect to the transaction, no default
under the indenture, and no event which, after notice or lapse
of time or both, would become a default under the indenture,
shall have occurred and be continuing;
o if at the time any redeemable capital securities are
outstanding, such transaction is permitted under the
declaration and the guarantee and does not give rise to any
breach or violation of the amended and restated declaration of
trust or the guarantee; and
o other conditions as prescribed in the indenture are met.
The provisions of the indenture do not afford holders of the junior
subordinated debt securities protection in the event of a highly leveraged or
other transaction involving us that may adversely affect holders of the junior
subordinated debt securities.
What Does Subordination Mean to You?
Under the indenture, the junior subordinated debt securities will be
subordinate and junior in right of payment to all senior debt. Upon any payment
or distribution of assets to creditors in any liquidation, dissolution,
winding-up, reorganization, assignment for the benefit of creditors, marshaling
of assets or any bankruptcy, insolvency, debt restructuring or similar
proceedings in connection with any insolvency or bankruptcy proceeding involving
us, the holders of senior debt will first be entitled to receive payment in full
of principal of and interest on the senior debt before the holders of junior
subordinated debt securities, or the property trustee on behalf of the holders,
will be entitled to receive or retain any payment or distribution.
In the event of the acceleration of the maturity of the junior
subordinated debt securities, the holders of all senior debt outstanding at the
time of acceleration will first be entitled to receive payment in full of all
amounts due, including any amounts due upon acceleration, before the holders of
the junior subordinated debt securities will be entitled to receive or retain
any payment of the principal of or interest on the junior subordinated debt
securities.
If we default in the payment of any principal of or interest on any
senior debt when it becomes due and payable, whether at maturity or at a date
fixed for prepayment or by declaration of acceleration or otherwise, then,
unless and until the default has been cured or waived or ceases to exist or all
senior debt has been paid, no direct or indirect payment shall be made or agreed
to for principal or interest on the junior subordinated debt securities, or in
respect of any redemption, repayment, retirement, purchase or other acquisition
of any of the junior subordinated debt securities.
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"Senior debt" means:
o the principal of, and premium, if any, and interest on all our
indebtedness for money borrowed, whether outstanding on the
date of execution of the indenture or thereafter created,
assumed or incurred, except indebtedness that is expressly
stated to rank junior to or equally with the junior
subordinated debt securities;
o all obligations, except those that are expressly stated to
rank junior to or equally with the junior subordinated debt
securities, to make payment pursuant to the terms of financial
instruments, such as,
(i) securities contracts and foreign currency exchange
contracts,
(ii) derivative instruments, such as swap agreements,
including interest rate and foreign exchange rate
swap agreements, cap agreements, floor agreements,
collar agreements, interest rate agreements, foreign
exchange agreements, options, commodity futures
contracts and commodity options contracts, and
(iii) similar financial instruments;
o indebtedness or obligations of others of the kinds described
above for the payment of which we are is responsible or liable
as guarantor or otherwise, and
o any deferrals, renewals or extensions of any such senior debt.
However, senior debt does not include
o any debt of ours which, when incurred and without respect to
any election under Section 1111 (b) of the United States
Bankruptcy Code of 1978, was without recourse to us,
o any debt of ours to any of our subsidiaries,
o debt to any of our employees,
o debt which by its terms is subordinated to trade accounts
payable or accrued liabilities arising in the ordinary course
of business to the extent that payments made to the holders of
such debt by the holders of the junior subordinated debt
securities as a result of the subordination provisions of the
indenture would be greater than such payments otherwise would
have been as a result of any obligation of such holders of
such debt to pay amounts over to the obligees on such trade
accounts payable or accrued liabilities arising in the
ordinary course of business as a result of subordination
provisions to which such debt is subject,
o trade accounts payable or accrued liabilities arising in the
ordinary course of business and
o any other debt securities issued pursuant to the indenture.
The indenture places no limit on the amount of senior debt that we may
incur. We expect from time to time to incur senior debt. At December 31, 1999 we
had no senior debt. The indenture also places no limitation on the indebtedness
of our subsidiaries, which ranks senior in right of payment to the junior
subordinated debt securities.
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Governing Law
The indenture and the junior subordinated debt securities will be
governed by and construed in accordance with the laws of Virginia.
Information About the Debenture Trustee
The debenture trustee has all the duties and responsibilities specified
for an indenture trustee under the Trust Indenture Act. Subject to the Trust
Indenture Act, the debenture trustee is under no obligation to exercise any of
the powers vested in it by the indenture at the request of any holder of junior
subordinated debt securities, unless offered reasonable indemnity against the
costs, expenses and liabilities which might be incurred thereby. The debenture
trustee is not required to expend or risk its own funds or otherwise incur
personal financial liability in the performance of its duties if the debenture
trustee reasonably believes that repayment or adequate indemnity is not
reasonably assured to it.
DESCRIPTION OF GUARANTEE
The guarantee will be executed and delivered by us when Southern
Financial Capital Trust issues the common securities and redeemable capital
securities. The guarantee is for the benefit of the holders of the common
securities and redeemable capital securities. Wilmington Trust Company will act
as the guarantee trustee under the guarantee agreement. The guarantee agreement
will be qualified under the Trust Indenture Act. This summary of the guarantee
is not exhaustive and is subject to, and qualified in its entirety by reference
to, all of the provisions of the guarantee and the Trust Indenture Act. The
guarantee trustee will hold the guarantee for the benefit of the holders of the
common securities and redeemable capital securities.
General
We will irrevocably agree to pay in full on a subordinated basis the
guarantee payments to the holders of the common securities and redeemable
capital securities, as and when due, regardless of any defense, right of set-off
or counterclaim that Southern Financial Capital Trust may have or assert other
than the defense of payment. We guarantee the following payments, if not paid by
or on behalf of Southern Financial Capital Trust:
o any accrued and unpaid distributions required to be paid on
the common securities and redeemable capital securities, to
the extent that Southern Financial Capital Trust has funds on
hand available for distributions,
o the redemption price of common securities and redeemable
capital securities called for redemption, to the extent that
Southern Financial Capital Trust has funds on hand available
for redemption payments, and
o upon a voluntary or involuntary dissolution, winding up or
liquidation of Southern Financial Capital Trust, other than in
connection with the distribution of junior subordinated debt
securities to the holders of the common securities and
redeemable capital securities or the redemption of all of the
redeemable capital securities, the lesser of the liquidation
distribution, to the extent Southern Financial Capital Trust
has funds available and the amount of assets of Southern
Financial Capital Trust remaining available for distribution
to holders of the common securities and redeemable capital
securities upon liquidation of Southern Financial Capital
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Trust after satisfaction of liabilities to creditors of
Southern Financial Capital Trust as required by applicable
law.
Our obligation to make a guarantee payment may be satisfied by direct
payment of the required amounts by us to the holders of the common securities
and redeemable capital securities or by causing Southern Financial Capital Trust
to pay.
The guarantee will be an irrevocable guarantee on a subordinated basis
of Southern Financial Capital Trust's obligations under the common securities
and redeemable capital securities, although it will apply only to the extent
that Southern Financial Capital Trust has funds sufficient to make such
payments.
Status of the Guarantee
The guarantee will constitute our unsecured obligation and will rank
subordinate and junior in right of payment to all senior debt in the same manner
as junior subordinated debt securities.
The guarantee will rank equally with all other guarantees issued by us
under the indenture. The guarantee will be a guarantee of payment and not of
collection. That is, the guaranteed party may institute a legal proceeding
directly against us to enforce its rights under the guarantee without first
instituting a legal proceeding against any other person or entity. The guarantee
will be held for the benefit of the holders of the common securities and
redeemable capital securities. The guarantee will not be discharged except by
payment of the guarantee payments in full to the extent not paid by Southern
Financial Capital Trust or upon distribution to the holders of the common
securities and redeemable capital securities of the junior subordinated debt
securities. The guarantee does not limit the amount of additional senior debt
that we may incur. We expect from time to time to incur senior debt.
How the Guarantee Can Be Amended or Assigned
Except for any changes that do not materially adversely affect the
rights of holders of the common securities and redeemable capital securities, in
which case no vote will be required, the guarantee may not be amended without
the prior approval of the holders of a majority of the aggregate liquidation
amount of the outstanding redeemable capital securities. The manner of obtaining
any such approval will be as set forth under "Description of Redeemable Capital
Securities -Voting Rights; Amendment of the Declaration," which begins on page
__. All guarantees and agreements contained in the guarantee will bind our
successors, assigns, receivers, trustees and representatives and shall inure to
the benefit of the holders of the redeemable capital securities.
Your Rights If We Default
An event of default under the guarantee will occur if and when we fail
to perform any of our payments or other obligations under the guarantee. Except
for a default in payment of any guarantee payment, we are not in default under
the guarantee unless we have received notice of default and do not cure the
default within 60 days after receipt of the notice. Additionally, no event of
default under the guarantee can occur unless an default under the amended and
restated declaration of trust or a default under the indenture has occurred. The
holders of not less than a majority in aggregate liquidation amount of the
redeemable capital securities have the right to direct the time, method and
place of conducting any proceeding for any remedy available to the guarantee
trustee in respect of the guarantee or to direct the exercise of any trust or
power conferred upon the guarantee trustee under the guarantee.
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Any holder of the redeemable capital securities may institute a legal
proceeding directly against us to enforce its rights under the guarantee without
first instituting a legal proceeding against Southern Financial Capital Trust,
the guarantee trustee or any other person or entity.
We, as guarantor, are required to file annually with the guarantee
trustee a certificate as to whether or not we are in compliance with all the
conditions and covenants applicable to us under the guarantee.
Information About the Guarantee Trustee
The guarantee trustee, other than during the occurrence and continuance
of a default by us in performance of the guarantee, undertakes to perform only
such duties as are specifically set forth in the guarantee and, after default
under the guarantee, must exercise the same degree of care and skill as a
prudent person would exercise or use in the conduct of his or her own affairs.
Subject to this provision, the guarantee trustee is under no obligation to
exercise any of the powers vested in it by the guarantee at the request of any
holder of the common securities and redeemable capital securities unless it is
offered reasonable indemnity against the costs, expenses and liabilities that
might be incurred thereby.
Termination of the Guarantee
The guarantee will terminate and be of no further force and effect upon
full payment of the redemption price of the common securities and redeemable
capital securities, upon full payment of the amounts payable upon liquidation of
Southern Financial Capital Trust or upon distribution of junior subordinated
debt securities to the holders of the common securities and redeemable capital
securities. The guarantee will continue to be effective or will be reinstated,
as the case may be, if at any time any holder of the common securities and
redeemable capital securities must restore payment of any sums paid under the
common securities and redeemable capital securities or the guarantee.
Governing Law
The guarantee will be governed by and construed in accordance with the
laws of Virginia.
RELATIONSHIP AMONG THE REDEEMABLE CAPITAL SECURITIES,
THE JUNIOR SUBORDINATED DEBT SECURITIES AND THE GUARANTEE
Our Full and Unconditional Guarantee
Payments of distributions and other amounts due on the redeemable
capital securities, to the extent Southern Financial Capital Trust has funds
available for the payment of such distributions, are irrevocably guaranteed by
us as set forth under "Description of Guarantee." Taken together, our
obligations under the junior subordinated debt securities, the indenture, the
declaration and the guarantee provide a full, irrevocable and unconditional
guarantee of payments of distributions and other amounts due on the redeemable
capital securities. No single document standing alone or operating in
conjunction with fewer than all of the other documents constitutes such
guarantee. It is only the combined operation of these documents that has the
effect of providing a full, irrevocable and unconditional guarantee of Southern
Financial Capital Trust's obligations under the redeemable capital securities.
If we do not make payments on the junior subordinated debt securities, Southern
Financial Capital Trust will not pay distributions or other amounts due on the
redeemable capital securities. The guarantee does not cover payment of
distributions when Southern Financial Capital Trust does not have sufficient
funds to make distributions. In that case, the remedy of a holder of redeemable
capital securities is to
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sue us directly. Our obligations under the guarantee are subordinate and junior
in right of payment to all senior debt.
Why Our Payments on the Junior Subordinated Debt Securities Will be Sufficient
As long as payments of interest and other payments are made when due on
the junior subordinated debt securities, those payments will be sufficient to
cover distributions and other payments due on the redeemable capital securities,
because:
o the aggregate principal amount or redemption price of the
junior subordinated debt securities will be equal to the sum
of the aggregate liquidation amount or redemption price, as
applicable, of the common securities and redeemable capital
securities;
o the interest rate and interest and other payment dates on the
junior subordinated debt securities will match the
distribution rate and distribution and other payment dates for
the redeemable capital securities;
o we will pay for all costs, expenses and liabilities of
Southern Financial Capital Trust except Southern Financial
Capital Trust's obligations to make distributions to holders
of common securities and redeemable capital securities; and
o the amended and restated declaration of trust further provides
that Southern Financial Capital Trust will not engage in any
activity that is not consistent with the limited purposes
thereof.
We have the right to set off any payment we are otherwise required to
make under the indenture with and to the extent we have previously made, or are
concurrently on the date of such payment making, any payment under the guarantee
used to satisfy the related payment of indebtedness under the indenture.
Enforcement Rights of Holders of Redeemable Capital Securities
A holder of any redeemable capital security may institute a legal
proceeding directly against us to enforce the guarantee without first
instituting a legal proceeding against the guarantee trustee, Southern Financial
Capital Trust or any other person or entity.
A default or event of default under any senior debt would not
constitute on event of default under the amended and restated declaration of
trust. However, in the event of payment defaults under, or acceleration of,
senior debt, the subordination provisions of the indenture provide that no
payments may be made on the junior subordinated debt securities until the senior
debt has been paid in full or any payment default under the senior debt has been
cured or waived. Failure to make required payments on junior subordinated debt
securities would constitute an event of default under the amended and restated
declaration of trust
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The Purpose of Southern Financial Capital Trust Is Limited
The redeemable capital securities evidence a beneficial interest in
Southern Financial Capital Trust, and Southern Financial Capital Trust exists
for the sole purpose of issuing the redeemable capital securities and common
securities, investing the proceeds of the common securities and redeemable
capital securities in junior subordinated debt securities and engaging in other
activities necessary or incidental thereto.
Your Rights Upon Termination of Southern Financial Capital Trust
Upon any voluntary or involuntary termination, winding-up or
liquidation of Southern Financial Capital Trust involving the liquidation of the
junior subordinated debt securities, after satisfaction of the liabilities of
creditors of Southern Financial Capital Trust, the holders of the common
securities and redeemable capital securities will be entitled to receive, out of
assets held by Southern Financial Capital Trust, the liquidation distribution in
cash.
Upon our voluntary or involuntary liquidation or bankruptcy, the
property trustee, as holder of the junior subordinated debt securities, would be
our subordinated creditor, subordinated in right of payment to all senior debt
as set forth in the indenture, but entitled to receive payment in full of
principal and interest, before any of our stockholders receive payments or
distributions. Since we are the guarantor under the guarantee and have agreed to
pay for all costs, expenses and liabilities of Southern Financial Capital Trust
(other than Southern Financial Capital Trust's obligations to the holders of its
common securities and redeemable capital securities), the positions of a holder
of redeemable capital securities and a holder of junior subordinated debt
securities relative to our other creditors and to stockholders in the event of
our liquidation or bankruptcy are expected to be substantially the same.
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of the material United States federal income
tax consequences of the purchase, ownership and disposition of redeemable
capital securities. Unless otherwise stated, this summary addresses only the tax
consequences to a "U.S. holder", as defined below, that acquires redeemable
capital securities on their original issue at their original offering price. It
does not address the tax consequences to persons that may be subject to special
treatment under United States federal income tax law, such as banks, insurance
companies, thrift institutions, regulated investment companies, real estate
investment trusts, tax-exempt organizations or dealers in securities or
currencies. It also does not address the tax consequences to persons that hold
redeemable capital securities as part of a position in a "straddle" or as part
of a "hedging", "conversion" or other integrated investment transaction for
United States federal income tax purposes. It also does not address the tax
consequences to persons whose functional currency is not the United States
dollar or persons that do not hold redeemable capital securities as capital
assets. For purposes of this summary, a "U.S. holder" is an individual citizen
or resident of the United States, a domestic corporation or partnership
organized under the laws of the United States or any State or the District of
Columbia or an estate or trust the income of which is subject to United States
federal income taxation regardless of source.
The statements of law or legal conclusions set forth in this summary
constitute the opinion of Williams Mullen Clark & Dobbins, tax counsel to us and
Southern Financial Capital Trust as to the material federal income tax
consequences relating to the redeemable capital securities. This summary is
based upon the Internal Revenue Code of 1986, as amended, Treasury Regulations,
Internal Revenue Service rulings and pronouncements and judicial decisions now
in effect, all of which are subject to change at any time. Such changes may be
applied retroactively in a manner that could cause the tax consequences to vary
substantially from the consequences described below, possibly adversely
affecting a beneficial owner of the redeemable
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capital securities. The authorities on which this summary is based are subject
to various interpretations, and it is therefore possible that the United States
federal income tax treatment of the purchase, ownership and disposition of the
redeemable capital securities may differ from the treatment described below.
Prospective investors are advised to consult with their own tax
advisors in light of their own particular circumstances as to the federal tax
consequences of the purchase, ownership and disposition of the redeemable
capital securities, as well as the effect of any state, local or foreign tax
laws.
Classification of the Junior Subordinated Debt Securities and Southern Financial
Capital Trust
Under current law and assuming compliance with the terms of the amended
and restated declaration of trust, Southern Financial Capital Trust will not be
classified as an association taxable as a corporation for United States federal
income tax purposes. Moreover, Southern Financial Capital Trust should be
classified as a grantor trust, and if not so classified will be classified as a
partnership, for United States federal income tax purposes. As a result, each
beneficial owner of redeemable capital securities that is a U.S. holder will be
required to include in its gross income its pro rata share of the interest
income, including original issue discount, paid or accrued with respect to the
junior subordinated debt securities, whether or not cash is actually
distributed. The junior subordinated debt securities will be classified as
indebtedness of Southern Financial Bancorp, Inc. for United States federal
income tax purposes.
Interest Income and Original Issue Discount
Under applicable Treasury Regulations, a remote contingency that stated
interest will not be timely paid will be ignored in determining whether a debt
instrument is issued with original issue discount. We believe that the
likelihood of our exercising our option to defer payments of interest is remote.
Based on the foregoing, we believe that the junior subordinated debt securities
will not be considered to be issued with original issue discount at the time of
their original issuance.
Because the discount at which the junior subordinated debt securities
are being issued is less than 1/4 of 1 percent of the junior subordinated debt
securities stated redemption price at maturity times the number of complete
years to maturity of the junior subordinated debt securities, such discount will
constitute de minimis original issue discount and will not be required to be
taken into account on a current basis. The following discussion assumes that
unless and until we exercise our option to defer interest on the junior
subordinated debt securities, the junior subordinated debt securities will not
be treated as issued with original issue discount other than de minimis original
issue discount.
Under the Treasury Regulations, if we exercised our option to defer any
payment of interest, the junior subordinated debt securities would be treated as
reissued with original issue discount, and, thereafter, all stated interest on
the junior subordinated debt securities would be treated as original issue
discount as long as the junior subordinated debt securities remained
outstanding. In such event, all of a U.S. holder's taxable interest income with
respect to the junior subordinated debt securities would be accounted for as
original issue discount on an economic accrual basis regardless of the U.S.
holder's method of tax accounting, and actual distributions of stated interest
would not be reported separately as taxable income. Consequently, a U.S. holder
would be required to include original issue discount in gross income even though
we would not make any actual cash payments during an interest deferral period.
The Treasury Regulations have not been addressed in any rulings or
other interpretations by the IRS, and it is possible that the IRS could take the
position that the junior subordinated debt securities were issued with original
issue discount at the time of their original issuance.
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Because income on the redeemable capital securities will constitute
interest or original issue discount, corporate U.S. holders will not be entitled
to the dividends-received deduction with respect to any income recognized with
respect to the redeemable capital securities. If any additional distributions
are paid on the redeemable capital securities it is possible that such
additional distributions might constitute original issue discount (whether or
not an interest deferral period has occurred).
Subsequent uses of the term "interest" in this summary shall include
income in the form of original issue discount.
Distribution of the Junior Subordinated Debt Securities to Holders of Redeemable
Capital Securities
Under current law, a distribution by the trust of the junior
subordinated debt securities will be nontaxable and will result in a U.S. holder
receiving directly its pro rata share of the junior subordinated debt securities
previously held indirectly through Southern Financial Capital Trust, with a
holding period and aggregate adjusted tax basis equal to the holding period and
aggregate adjusted tax basis such U.S. holder had in its redeemable capital
securities immediately before such distribution. If, however, the liquidation of
Southern Financial Capital Trust were to occur because Southern Financial
Capital Trust were subject to United States federal income tax with respect to
income accrued or received on the junior subordinated debt securities, the
distribution of junior subordinated debt securities to U.S. holders by Southern
Financial Capital Trust would be a taxable event to Southern Financial Capital
Trust and each U.S. holder, and each U.S. holder would recognize gain or loss as
if the U.S. holder had exchanged its redeemable capital securities for the
junior subordinated debt securities it received upon the liquidation of Southern
Financial Capital Trust. A U.S. holder will include interest in respect of the
junior subordinated debt securities received from Southern Financial Capital
Trust in the manner described above under "Interest Income and Original Issue
Discount."
Sales or Redemption of the Redeemable Capital Securities
Gain or loss will be recognized by a U.S. holder on a sale, exchange,
or other disposition of the redeemable capital securities (including a
redemption for cash) in an amount equal to the difference between the amount
realized and the U.S. holder's adjusted tax basis in the redeemable capital
securities sold or so redeemed. Assuming that we do not exercise our option to
defer payment of interest on the junior subordinated debt securities, a U.S.
holder's adjusted tax basis in the redeemable capital securities generally will
be its initial purchase price. If the junior subordinated debt securities are
deemed to be issued with original issue discount as a result of our deferral of
any interest payment, a U.S. holder's adjusted tax basis in the redeemable
capital securities generally will be its initial purchase price, increased by
original issue discount previously included in such U.S. holder's gross income
to the date of disposition and decreased by distributions or other payments
received on the redeemable capital securities other than payments of stated
interest that are not treated as original issue discount. Gain or loss
recognized by a U.S. holder on the redeemable capital securities generally will
be taxable as capital gain or loss, except to the extent any amount realized is
treated as a payment of accrued interest with respect to such U.S. holder's pro
rata share of the junior subordinated debt securities required to be included in
income, and generally will be long-term capital gain or loss if the redeemable
capital securities have been held for more than one year.
Should we exercise our option to defer any payment of interest on the
junior subordinated debt securities, the redeemable capital securities may trade
at a price that does not fully reflect the value of accrued but unpaid interest
with respect to the underlying junior subordinated debt securities. In the event
of such a deferral, a holder that disposes of its redeemable capital securities
between record dates for payments of distributions and consequently does not
receive a distribution from Southern Financial Capital Trust for the period
prior to such disposition will nevertheless be required to include in income as
ordinary income accrued but unpaid interest on the junior subordinated debt
securities through the date of disposition and to add such
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amount to its adjusted tax basis in its redeemable capital securities disposed
of. Such U.S. holder will recognize a capital loss on the disposition of its
redeemable capital securities to the extent the selling price, which may not
fully reflect the value of accrued but unpaid interest, is less than the U.S.
holder's adjusted tax basis in the redeemable capital securities, which will
include accrued but unpaid interest. Subject to certain limited exceptions,
capital losses cannot be applied to offset ordinary income for United States
federal income tax purposes.
United States Alien Holders
For purposes of this discussion, a United States alien holder is any
corporation, individual, partnership, estate or trust that is, as to the United
States, a foreign corporation, a nonresident alien individual, a foreign
partnership or a nonresident fiduciary of a foreign estate or trust.
Under current United States federal income tax law, and subject to the
discussion of backup withholding below, payments by Southern Financial Capital
Trust or any of its paying agents to any holder who or that is a United States
alien holder will not be subject to United States federal withholding tax;
provided that:
o the holder does not actually or constructively own 10% or more
of the total combined voting power of all classes of stock of
Southern Financial Bancorp, Inc. entitled to vote;
o the holder is not a controlled foreign corporation that is
related to Southern Financial Bancorp, Inc. through stock
ownership; and
o either the holder certifies to Southern Financial Capital
Trust or its agent, under penalties of perjury, that it is not
a United States holder and provides its name and address, or a
securities clearing organization, bank or other financial
institution that holds customers' securities in the ordinary
course of its trade or business, holding the capital security
in such capacity, certifies to Southern Financial Capital
Trust or its agent, under penalties of perjury, that such
statement has been received from the holder by it or by a
financial institution holding such security for the holder and
furnishes Southern Financial Capital Trust or its agent with a
copy thereof.
Additionally, a United States alien holder of a capital security will
not be subject to United States federal withholding tax on any gain realized
upon the sale or other disposition of a capital security.
Information Reporting to Securityholders
Generally, income on the redeemable capital securities will be reported
to holders on Forms 1099, which forms should be mailed to holders by January 31
following each calendar year.
Backup Withholding
Payments made on, and proceeds from the sale of, the redeemable capital
securities may be subject to a "backup" withholding tax of 31% unless the holder
complies with certain certification requirements. Any withheld amounts will be
allowed as a credit against the holder's United States federal income tax,
provided the required information is furnished to the Internal Revenue Service
on a timely basis.
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ERISA CONSIDERATIONS
ERISA pension plans, qualified retirement plans, and IRAs are subject
to transactional restrictions under ERISA and/or the Internal Revenue Code. For
example, a plan fiduciary is prohibited from engaging in transactions in its own
interest or for its own account or from receiving consideration from any party
dealing with a plan with regard to its assets. In addition, a plan may not enter
into purchase, sale, or loan transaction with a disqualified person. A
disqualified person includes a fiduciary, the plan sponsor, and any entity
providing services to a plan. Violation of these transactional restrictions can
trigger federal excise taxes, federal and state income tax on otherwise exempt
retirement trusts, and accelerated federal and state income tax on the otherwise
deferred income accounts of retirement plan participants.
In the usual case, when a retirement plan invests plan assets in a
security, the security purchased replaces the purchase money as a plan asset and
the purchase money becomes an asset of the entity who offered the security for
sale. Because of a concern that some enterprises were in reality acting as
investment managers to plans, but avoiding classification as a fiduciary under
ERISA through the device of issuing participation units in, for example, limited
partnerships, the Department of Labor issued plan asset regulations. The plan
asset regulations provide that when certain equity interests, including a
beneficial interest in a trust, are acquired by a plan, both the equity interest
acquired in the hands of the purchasing plan and the purchase money in the hands
of the issuer of the equity interest constitute plan assets. Since the issuer
has discretionary control over these assets, the issuer becomes a fiduciary
under ERISA with respect to the investing plan.
As a result, unless an exception applies, Southern Financial Capital
Trust's purchase of the junior subordinated debt securities from Southern
Financial Bancorp, Inc. with assets invested by retirement plans would transform
Southern Financial Capital Trust into a fiduciary dealing on its own account and
in its own interest with plan assets or receiving consideration from an entity,
Southern Financial Bancorp, Inc., engaged in a transaction involving plan
assets. The plan asset regulations provide certain exemptions to its plan asset
characterization rules.
One of the exemptions provided by the plan asset regulations, namely,
the publicly-offered exemption, applies to junior subordinated debt securities
purchased by Southern Financial Capital Trust. Because of the exemption, the
purchase money or junior subordinated debt securities will not be deemed to be
plan assets in the hands of the trustee.
Under the plan asset regulations, a publicly-offered equity interest in
a trust purchased by a plan does not constitute a plan asset if the interest is
freely transferable and widely held. The plan asset regulations provide that a
security is publicly-offered if it is sold to a plan as part of an offering of
securities to the public pursuant to an effective registration statement under
the Securities Act of 1933 and the class of securities of which such security is
part is registered under the Securities Exchange Act of 1934 within 120 days, or
such later time as may be allowed by the Securities and Exchange Commission,
after the end of the fiscal year of the issuer during which the offering of such
securities to the public occurred.
We intend to cause the redeemable capital securities to be so
registered under the Securities Exchange Act of 1934. Further, although
ultimately under the plan asset regulations it is a question of fact, a security
will generally be deemed to be freely transferable if its purchase price is
$25,000 or less at the time of the public offering. If, in addition, the
securities when offered initially to the public will be held by 100 or more
persons independent of the issuer or of one another, they will generally be
deemed to be widely held. We anticipate that the redeemable capital securities
will constitute securities which are publicly-offered, widely held, and freely
transferable. Retirement plans should, nevertheless, consult with their own
counsel regarding the application of the plan asset regulations to the purchase
of redeemable capital securities from Southern Financial Capital Trust.
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If we or Southern Financial Bank provide any services to an investing
retirement plan, then it is a disqualified person with respect to that plan
irrespective of whether Southern Financial Capital Trust qualifies under the
publicly-offered securities exemption to the plan asset regulations.
Consequently, the purchase of junior subordinated debt securities by Southern
Financial Capital Trust would be an indirect loan made by the retirement plan to
us and, as such, would constitute a prohibited transaction under ERISA.
FORWARD LOOKING STATEMENTS
Some of the statements contained or incorporated by reference in this
prospectus may be "forward-looking statements." Statements which use words such
as "believes," "expects," "may," "will," "should," "projected," "contemplates"
or "anticipates" or the negative of those terms or other variations may be
forward-looking statements. These statements are subject to known and unknown
risks, uncertainties and other factors that could cause actual results to differ
materially from those contemplated by the statements.
Some important factors that may cause actual results to differ from
that projected in a forward-looking statement, include for example,
o our ability to implement our business strategy;
o a decline in economic condition in our market areas;
o a tightening in the difference between our cost of funds and
what we earn on the loans we make;
o changes in governmental regulations affecting our business.
There are several other factors spelled out in "Risk Factors" beginning
on page 9 of this prospectus.
UNDERWRITING
The underwriter, McKinnon & Company, Inc., 555 Main Street, Norfolk,
Virginia, has agreed, subject to the terms and conditions contained in an
underwriting agreement with Southern Financial Capital Trust and us, to sell, as
selling agent, on a best efforts basis, up to $12.0 million (aggregate
liquidation amount) of redeemable capital securities. Southern Financial Capital
Trust has, however, reserved the right to increase the aggregate liquidation
amount by not more than $1.8 million. The underwriter is not obligated to
purchase the redeemable capital securities if they are not sold to the public.
The terms and conditions contained in the underwriting agreement include, as
examples, the effectiveness of the registration statement filed with the
Securities and Exchange Commission, the accuracy of our representations to the
underwriter and the absence of any materially adverse changes to our business.
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The underwriter has informed Southern Financial Capital Trust and us
that it proposes to sell the redeemable capital securities as selling agent for
Southern Financial Capital Trust, subject to prior sale, when, as and if issued
by Southern Financial Capital Trust, in part to the public at the public
offering price set forth on the cover page of this prospectus and, in part,
through certain selected dealers, who are members of the National Association of
Securities Dealers, Inc., to customers of such selected dealers at the public
offering price, for which each selected dealer will receive a commission of
$0.__, for each $10 of redeemable capital securities that it sells. The
underwriter reserves the right to reject any order for the purchase of
redeemable capital securities through it in whole or in part.
The public offering is not contingent upon any event or the sale of a
minimum or maximum number of redeemable capital securities. Although we have no
expectation of doing so, we may, in our discretion, close this offering if only
a small amount of redeemable capital securities are sold. Funds received by the
underwriter from investors in the public offering will be deposited with and
held by the escrow agent in a non-interest bearing account until the closing of
the public offering. Closing is expected to occur on or about ________ __, 2000.
If closing does not occur for any reason, funds held in escrow will be returned
promptly to investors.
As the proceeds of the sale of the redeemable capital securities will
ultimately be used to purchase the junior subordinated debt securities, the
underwriting agreement provides that we will pay as underwriter's compensation
an amount directly to the underwriter of $0.__ per capital security (or up to
$_________ in the aggregate). We will reimburse expenses incurred by the
underwriter up to $2,000, excluding blue sky fees and expenses. In addition, we
will be responsible for the expenses of issuance and distribution of the
redeemable capital securities, including registration fees, legal and accounting
fees and printing expenses, which we estimate will total approximately $134,000.
The underwriting agreement provides that we and Southern Financial
Capital Trust will indemnify the underwriter against certain liabilities,
including liabilities under the Securities Act or contribute to payments the
underwriter may be required to make in respect thereof.
Because the National Association of Securities Dealers, Inc. may view
the redeemable capital securities as interests in a direct participation
program, the offering is being made in compliance with the applicable provisions
of its Conduct Rules.
The redeemable capital securities are a new issue of securities with no
established trading market. Southern Financial Capital Trust has applied to list
the redeemable capital securities on the NASDAQ National Market under the symbol
"SFFBP". We and Southern Financial Capital Trust have been advised by the
underwriter that it will make a market in the redeemable capital securities. The
underwriter, however, is not obligated to make a market in the redeemable
capital securities and it can discontinue market making at any time without
notice. Neither we nor Southern Financial Capital Trust can provide any
assurance that an active trading market for the redeemable capital securities
will develop.
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VALIDITY OF SECURITIES
Delaware law relating to the validity of the redeemable capital
securities, the enforceability of the declaration and the formation of Southern
Financial Capital Trust will be passed upon by Richards, Layton & Finger,
special Delaware counsel to us and Southern Financial Capital Trust. The
validity of the guarantee and the junior subordinated debt securities, as well
as material United States federal income tax considerations relating to the
redeemable capital securities, will be passed upon for us by Williams Mullen
Clark & Dobbins. Williams Mullen Clark & Dobbins will rely on the opinion of
Richards, Layton & Finger as to matters of Delaware law.
ACCOUNTANTS
The consolidated financial statements of Southern Financial Bancorp,
Inc. 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 in reliance upon
the report of KPMG LLP, independent auditors, 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
accoutants, for 1998 and 1997 with respect to The Horizon Bank of Virginia.
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INDEX OF SIGNIFICANT TERMS
Additional Sums.....................55 Like Amount.........................54
Adjusted Treasury Rate..............53 Make-Whole Amount...................53
Capital Treatment Event.............55 Tax Event...........................54
Investment Company Event............54 Treasury Rate.......................54
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INDEX TO FINANCIAL STATEMENTS
SOUTHERN FINANCIAL BANCORP, INC.
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report.......................................................................................F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1999 and 1998.................................................F-3
Consolidated Statements of Income for the years ended December 31, 1999, 1998 and 1997.......................F-4
Consolidated Statements of Comprehensive Income for the years ended December 31,
1999, 1998 and 1997..........................................................................................F-5
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997.............................................................................F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997...................F-7
Notes to Consolidated Financial Statements..................................................................F-8 - F-27
</TABLE>
F-1
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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.
Richmond, Virginia
February 10, 2000
F-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.
F-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.
F-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 0 0
Reclassification adjustment for net interest
income included in net income (4,165) 0 0
Available-for-sale securities:
Unrealized holding gain/(loss) (4,303,729) 215,803 188,091
Unrealized gain on transfer of held-to-
maturity securities 0 229,612 0
Reclassification adjustment for net (gains)/losses
included in net income 1,175 (67,817) 0
------------------ -------------------- ------------------
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.
F-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 ($0.2175 per
common stock preferred share) (455,344) (455,344)
($0.17 per common
share)
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 ($0.2175 per
common stock preferred share) (596,127) (596,127)
($0.22 per common
share)
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 ($0.2175 per
common stock preferred share) (884,599) (884,599)
($0.33 per common
share)
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
================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-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.
F-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
F-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
F-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.
F-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.
F-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>
F-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.
F-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.
F-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 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 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.
F-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.
F-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%.
F-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.
F-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 51,000 32,850
20.31 22.47 15.35
Exercised 27,618 12,415 27,591
6.40 9.05 10.21
Expired 7,082
7,711 17.94 3,000 19.50 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.
F-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>
F-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>
F-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.
F-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>
F-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.
F-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.
F-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>
F-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>
F-27
<PAGE>
================================================================================
March __, 2000
$12,000,000
SOUTHERN FINANCIAL CAPITAL TRUST I
$_______Redeemable Capital Securities
(liquidation amount $10 per capital security)
Fully and unconditionally guaranteed, as described herein, by
SOUTHERN FINANCIAL BANCORP, INC.
-------------------
PROSPECTUS
-------------------
McKinnon & Company, Inc.
- --------------------------------------------------------------------------------
We have not authorized any dealer, salesperson or other person to give you
written information other than this prospectus or to make representations as to
matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy the securities in any jurisdiction where that
would not be permitted or legal. Neither the delivery of this prospectus nor any
sales made hereunder after the date of this prospectus shall create an
implication that the information contained herein or the affairs of the company
have not changed since the date hereof.
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 16. Exhibits and Financial Statement Schedules
(a) The following exhibits are filed on behalf of the Registrant as part of
this Registration Statement:
EXHIBIT NO. DESCRIPTION
----------- -----------
1.1 Form of Underwriting Agreement for offering of Capital
Securities.*
3.1 Amended and Restated Articles of Incorporation of Southern
Financial Bancorp, Inc. (incorporated herein by reference to
Exhibit 3.1 to Southern Financial Bancorp, Inc.'s Registration
Statement on Form S-4, Registration No. 33-95246, filed with
the Securities and Exchange Commission on August 4, 1995).
3.2 Bylaws of Southern Financial Bancorp, Inc. (incorporated
herein by reference to Exhibit 3.2 to Southern Financial
Bancorp, Inc.'s Registration Statement on Form S-4,
Registration No. 33-95246 filed with the Securities and
Exchange Commission on August 4, 1995).
4.1 Certificate of Trust of Southern Financial Capital Trust I.*
4.2 Trust Agreement between Southern Financial Bancorp, Inc. and
Wilmington Trust Company.*
4.3 Form of Amended and Restated Declaration of Trust for Southern
Financial Capital Trust I.*
4.4 Form of Junior Subordinated Indenture between Southern
Financial Bancorp, Inc. and Wilmington Trust Company, as
Trustee.*
4.5 Form of Capital Security (included in Exhibit 4.3 above).
4.6 Form of Junior Subordinated Debt Security (included in Exhibit
4.4 above).
4.7 Form of Guarantee Agreement with respect to Trust Securities
issued by Southern Financial Capital Trust I.*
4.8 Form of Escrow Agreement among McKinnon & Company, Inc.,
Southern Financial Capital Trust I, Southern Financial
Bancorp, Inc. and Wilmington Trust Company.*
5.1 Opinion of Williams, Mullen, Clark & Dobbins, P.C.**
5.2 Opinion of Richards, Layton & Finger.**
8.1 Opinion of Williams, Mullen, Clark & Dobbins, P.C. as to tax
matters.**
12.1 Calculation of Ratio of Earnings to Fixed Charges.**
23.1 Consent of KPMG, LLP.***
23.2 Consent of Thompson, Greenspon & Co., P.C.***
II-1
<PAGE>
EXHIBIT NO. DESCRIPTION
----------- -----------
23.3 Consent of Williams, Mullen, Clark & Dobbins, P.C. (included
in Exhibit 5.1 above).
23.4 Consent of Richards, Layton & Finger (included in Exhibit 5.2
above).
24.1 Powers of Attorney (included on signature page).*
25.1 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Trustee
under the Junior Subordinated Indenture.*
25.2 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Property
Trustee under the Amended and Restated Declaration of Trust of
Southern Financial Capital Trust I.*
25.3 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Guarantee
Trustee under the Guarantee Agreement for the benefit of
holders of Trust Securities of Southern Financial Capital
Trust I.*
- ---------------
* Previously filed.
** Filed herewith. Replaces exhibit previously filed under same exhibit number.
*** Filed herewith.
(b) Financial Statement Schedules:
All financial statement schedules for which provision is made in the
applicable accounting regulation of the Securities and Exchange Commission are
either included in the financial information set forth in the Prospectus or are
inapplicable and therefore have been omitted.
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Warrenton,
Commonwealth of Virginia, on March 8, 2000.
SOUTHERN FINANCIAL BANCORP, INC.
By: /s/ Georgia S. Derrico
------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Georgia S. Derrico Chairman, Chief Executive Officer March 8, 2000
- ------------------------------------------- and Director
Georgia S. Derrico (Principal Executive Officer)
/s/ R. Roderick Porter President, Chief Operating Officer March 7, 2000
- ------------------------------------------- and Director
R. Roderick Porter
/s/ William H. Lagos Senior Vice President and Controller March 8, 2000
- ------------------------------------------- (Principal Financial Officer)
William H. Lagos (Principal Accounting Officer)
* Director March 8, 2000
- -------------------------------------------
Alfonso G. Finocchiaro
* Director March 8, 2000
- -------------------------------------------
Virginia Jenkins
Director
- -------------------------------------------
Michael P. Rucker
<PAGE>
Signature Title Date
--------- ----- ----
* Director March 8, 2000
- -------------------------------------------
Robert P. Warhurst
* Director March 8, 2000
- -------------------------------------------
John C. Belotti
Director
- -------------------------------------------
Neil J. Call
* Director March 8, 2000
- -------------------------------------------
David de Give
* Director March 8, 2000
- -------------------------------------------
Fred L. Bollerer
* Director March 8, 2000
- -------------------------------------------
John L. Marcellus, Jr.
* Director March 8, 2000
- -------------------------------------------
Richard E. Smith
</TABLE>
* Georgia S. Derrico, by signing her name hereto, signs this document
on behalf of each of the persons indicated by an asterisk above pursuant to
powers of attorney duly executed by such persons and previously filed with the
Securities and Exchange Commission as part of the registration statement.
Date: March 8, 2000 /s/ Georgia S. Derrico
-----------------------------------
Georgia S. Derrico
Attorney-in-Fact
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, as amended,
the registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Warrenton,
Commonwealth of Virginia, on March 8, 2000.
SOUTHERN FINANCIAL CAPITAL TRUST I
By: Southern Financial Bancorp, Inc.,
as Depositor
By: /s/ Georgia S. Derrico
------------------------------------
Georgia S. Derrico
Chairman and Chief Executive Officer
<PAGE>
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
1.1 Form of Underwriting Agreement for offering of Capital
Securities.*
3.1 Amended and Restated Articles of Incorporation of Southern
Financial Bancorp, Inc. (incorporated herein by reference to
Exhibit 3.1 to Southern Financial Bancorp, Inc.'s
Registration Statement on Form S-4, Registration No.
33-95246, filed with the Securities and Exchange Commission
on August 4, 1995).
3.2 Bylaws of Southern Financial Bancorp, Inc. (incorporated
herein by reference to Exhibit 3.2 to Southern Financial
Bancorp, Inc.'s Registration Statement on Form S-4,
Registration No. 33-95246 filed with the Securities and
Exchange Commission on August 4, 1995).
4.1 Certificate of Trust of Southern Financial Capital Trust I.*
4.2 Trust Agreement between Southern Financial Bancorp, Inc. and
Wilmington Trust Company.*
4.3 Form of Amended and Restated Declaration of Trust for
Southern Financial Capital Trust I.*
4.4 Form of Junior Subordinated Indenture between Southern
Financial Bancorp, Inc. and Wilmington Trust Company, as
Trustee.*
4.5 Form of Capital Security (included in Exhibit 4.3 above).
4.6 Form of Junior Subordinated Debt Security (included in
Exhibit 4.4 above).
4.7 Form of Guarantee Agreement with respect to Trust Securities
issued by Southern Financial Capital Trust I.*
4.8 Form of Escrow Agreement among McKinnon & Company, Inc.,
Southern Financial Capital Trust I, Southern Financial
Bancorp, Inc. and Wilmington Trust Company.*
5.1 Opinion of Williams, Mullen, Clark & Dobbins, P.C.**
5.2 Opinion of Richards, Layton & Finger.**
8.1 Opinion of Williams, Mullen, Clark & Dobbins, P.C. as to tax
matters.**
12.1 Calculation of Ratio of Earnings to Fixed Charges.**
23.1 Consent of KPMG, LLP.***
23.2 Consent of Thompson, Greenspon & Co., P.C.***
23.3 Consent of Williams, Mullen, Clark & Dobbins, P.C. (included
in Exhibit 5.1 above).
23.4 Consent of Richards, Layton & Finger (included in Exhibit 5.2
above).
24.1 Powers of Attorney (included on signature page).*
25.1 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Trustee
under the Junior Subordinated Indenture.*
<PAGE>
EXHIBIT NO. DESCRIPTION
----------- -----------
25.2 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Property
Trustee under the Amended and Restated Declaration of Trust
of Southern Financial Capital Trust I.*
25.3 Statement of Eligibility under the Trust Indenture Act of
1939, as amended, of Wilmington Trust Company, as Guarantee
Trustee under the Guarantee Agreement for the benefit of
holders of Trust Securities of Southern Financial Capital
Trust I.*
- ---------------
* Previously filed.
** Filed herewith. Replaces exhibit previously filed under same exhibit number.
*** Filed herewith.
Exhibit 5.1
[WILLIAMS, MULLEN, CLARK & DOBBINS LETTERHEAD]
March ___, 2000
Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, VA 20186
Re: Southern Financial Capital Trust I
Ladies and Gentlemen:
We have acted as counsel to Southern Financial Bancorp, Inc. (the
"Corporation") in connection with the registration by the Corporation of (i) an
aggregate of $13,800,000 of its junior subordinated debt securities (the "Debt
Securities") and (ii) the guarantee of the Capital Securities of Southern
Financial Capital Trust I (the "Guarantee"), a business trust created under the
laws of the State of Delaware (the "Trust"), to be executed and delivered by the
Corporation for the benefit of the holders of the Capital Securities, each as
set forth in the Registration Statement on Form S-1, File Nos. __________ and
__________ (the "Registration Statement") filed with the Securities and Exchange
Commission (the "Commission") by the Corporation and the Trust pursuant to the
Securities Act of 1933, as amended. This opinion letter is Exhibit 5.1 to the
Registration Statement.
We have relied upon an officer's certificate as to corporate action
heretofore taken with respect to the Debt Securities and the Guarantee.
We have also assumed (i) the due incorporation and valid existence of
the Corporation, (ii) that the Corporation has the requisite corporate power and
authority to enter into and perform its obligations under the Trust Agreement,
dated December 28, 1999 as amended by the Amended and Restated Declaration of
Trust, dated __________, 2000 (collectively, the "Declaration") among the
Corporation, as Depositor, the individuals named therein as Administrative
Trustees and Wilmington Trust Company, as Property Trustee and Delaware Trustee,
and the holders from time to time of undivided beneficial interests in the
assets of the Trust, the form of Indenture (the "Indenture") between the
Corporation and Wilmington Trust Company, as trustee, the Debt Securities and
the Guarantee and (iii) the due authorization, execution and delivery of the
Declaration, the Indenture, the Debt Securities and the Guarantee by the
Corporation.
<PAGE>
Based on the foregoing, and subject to the qualifications herein
stated, we are of the opinion that when (i) the Registration Statement is
declared effective by order of the Commission and (ii) the Declaration, the
Indenture and the Guarantee have been executed and delivered by the parties
thereto:
1. The Debt Securities, when duly authenticated by the Trustee
pursuant to the terms of the Indenture, and delivered and paid for in accordance
with the terms of the Indenture and as contemplated by the Registration
Statement, will be validly issued and will constitute the legally binding
obligations of the Corporation, subject to applicable bankruptcy, insolvency,
fraudulent conveyance, reorganization, moratorium and similar laws affecting
creditors' rights and remedies generally, and subject, as to enforceability, to
general principles of equity, including principles of commercial reasonableness,
good faith and fair dealing (regardless of whether enforcement is sought in a
proceeding at law or in equity).
2. The Guarantee will constitute the legally binding obligation
of the Corporation, subject to applicable bankruptcy, insolvency, fraudulent
conveyance, reorganization, moratorium and similar laws affecting creditors'
rights and remedies generally, and subject, as to enforceability, to general
principles of equity, including principles of commercial reasonableness, good
faith and fair dealing (regardless of whether enforcement is sought in a
proceeding at law or in equity).
In rendering this opinion, we are not expressing an opinion as to the
laws of any jurisdiction other than the Commonwealth of Virginia and we express
no opinion as to the applicability of the laws of any other jurisdiction to the
subject matter hereof or to the effects of such laws thereon.
This opinion is rendered to you and for your benefit solely in
connection with the transactions described herein. This opinion may not be
relied on by you for any other purpose. We hereby consent to be named in the
Registration Statement and in each of the Prospectuses as attorneys who passed
upon the legality of the Debt Securities and the Guarantee and to the filing of
a copy of this opinion as Exhibit 5.1 to the Registration Statement. Our opinion
is expressed as of the date hereof, and we do not assume any obligation to
update or supplement our opinion to reflect any fact or circumstance
subsequently arising or any change in law subsequently occurring. Our opinion is
limited to the matters expressly stated; no opinion is implied or may be
inferred beyond such matters. Unless the prior written consent of our firm is
obtained, this opinion is not to be quoted or otherwise referred to in any
written report, proxy statement or other registration statement, nor is it to be
filed with or furnished to any other governmental agency, except as otherwise
required by law.
<PAGE>
Very truly yours,
WILLIAMS, MULLEN, CLARK & DOBBINS
By________________________________________
A Shareholder
Exhibit 5.2
[RICHARDS, LAYTON & FINGER LETTERHEAD]
________ ____, 2000
Southern Financial Capital Trust I
c/o Southern Financial Bancorp, Inc.
37 East Main Street
Warrenton, VA 20186
Re: Southern Financial Capital Trust I
Ladies and Gentlemen:
We have acted as special Delaware counsel for Southern Financial
Bancorp, Inc., a Virginia corporation (the "Company) and Southern Financial
Capital Trust I, a Delaware business trust (the "Trust"), in connection with the
matters set forth herein. At your request, this opinion is being furnished to
you.
For purposes of giving the opinions hereinafter set forth, our
examination of documents has been limited to the examination of originals or
copies of the following:
(a) The Certificate of Trust of the Trust (the "Certificate"), as
filed in the office of the Secretary of State of the State of Delaware (the
"Secretary of State") on December 28, 1999;
(b) The Trust Agreement of the Trust, dated as of December 28,
1999, between the Company and the Trustee;
(c) The Registration Statement (the "Registration Statement") on
Form S-1, including a preliminary prospectus with respect to the Trust (the
"Prospectus"), relating to the Capital Securities of the Trust representing
preferred interests in the Trust (each, a "Capital Security" and collectively,
the "Capital Securities"), as filed by the Company and the Trust with the
Securities and Exchange Commission on or about January 10, 2000;
<PAGE>
(d) A form of Amended and Restated Declaration of Trust for the
Trust, to be entered into among the Company, the trustees of the Trust, and the
holders, from time to time, of undivided beneficial interests in the assets of
such Trust (including the exhibits) (the "Declaration"), attached as an exhibit
to the Registration Statement; and
(e) A Certificate of Good Standing for the Trust, dated January
10, 2000; obtained from the Secretary of State.
Initially capitalized terms used herein and not otherwise defined are
used as defined in the Declaration.
For purposes of this opinion, we have not reviewed any documents other
than the documents listed in paragraphs (a) through (e) above. In particular, we
have not reviewed any document (other than the documents listed in paragraphs
(a) through (e) above) that is referred to in or incorporated by reference into
the documents reviewed by us. We have assumed that there exists no provision in
any document that we have not reviewed that is inconsistent with the opinions
stated herein. We have conducted no independent factual investigation of our own
but rather have relied solely upon the foregoing documents, the statements and
information set forth therein and the additional matters recited or assumed
herein, all of which we have assumed to be true, complete and accurate in all
material respects.
With respect to all documents examined by us, we have assumed (i) the
authenticity of all documents submitted to us as authentic originals, (ii) the
conformity with the originals of all documents submitted to us as copies or
forms, and (iii) the genuineness of all signatures.
For purposes of this opinion, we have assumed (i) that the Declaration
constitutes the entire agreement among the parties thereto with respect to the
subject matter thereof, including with respect to the creation, operation and
termination of the Trust, and that the Declaration and the Certificate of Trust
are in full force and effect and have not been amended, (ii) except to the
extent provided in paragraph 1 below, the due creation or due organization or
due formation, as the case may be, and valid existence in good standing of each
party to the documents examined by us under the laws of the jurisdiction
governing its creation, organization or formation, (iii) the legal capacity of
natural persons who are parties to the documents examined by us, (iv) that each
of the parties to the documents examined by us has the power and authority to
execute and deliver, and to perform its obligations under, such documents, (v)
the due authorization, execution and delivery by all parties thereto of all
documents examined by us, (vi) the receipt by each Person to whom a Capital
Security is to be issued by the Trust (collectively, the "Capital Security
Holders") of a Capital Security Certificate for such Capital Security and the
payment for the Capital Security, in accordance with the Declarations and the
Registration Statement, and (vii) that the Capital Securities are issued and
sold to the Capital Security Holders in accordance with the Declaration
<PAGE>
and the Registration Statement. We have not participated in the preparation of
the Registration Statement and assume no responsibility for its contents.
This opinion is limited to the laws of the State of Delaware (excluding
the securities laws of the State of Delaware), and we have not considered and
express no opinion on the laws of any other jurisdiction, including federal laws
and rules and regulations relating thereto. Our opinions are rendered only with
respect to Delaware laws and rules, regulations and orders thereunder which are
currently in effect.
Based upon the foregoing, and upon our examination of such questions of
law and statutes of the State of Delaware as we have considered necessary or
appropriate, and subject to the assumptions, qualifications, limitations and
exceptions set forth herein, we are of the opinion that:
1. The Trust has been duly created and is validly existing in
good standing as a business trust under the Delaware Business Trust Act, 12 Del.
C. ss. 3801, et seq.
2. The Capital Securities of the Trust will represent valid and,
subject to the qualifications set forth in paragraph 3 below, fully paid and
nonassessable undivided beneficial interests in the assets of the Trust.
3. The Capital Security Holders, as beneficial owners of the
Trust, will be entitled to the same limitation of personal liability extended to
stockholders of private corporations for profit organized under the General
Corporation Law of the State of Delaware. We note that the Capital Security
Holders may be obligated to make payments as set forth in the Declaration.
We consent to the filing of this opinion with the Securities and
Exchange Commission as an exhibit to the Registration Statement. In addition, we
hereby consent to the use of our name under the heading "Validity of Securities"
in the Prospectus. In giving the foregoing consents, we do not thereby admit
that we come within the category of persons whose consent is required under
Section 7 of the Securities Act of 1933, as amended, or the rules and
regulations of the Securities and Exchange Commission thereunder.
Very truly yours,
GCK/wrm
Exhibit 8.1
[WILLIAMS, MULLEN, CLARK & DOBBINS LETTERHEAD]
____________, 2000
McKinnon & Company, Inc.
555 Main Street
Norfolk, VA 23510
Re: Southern Financial Capital Trust I
Ladies and Gentlemen:
We have acted as counsel to Southern Financial Bancorp. Inc. (the
"Corporation") and Southern Financial Capital Trust I, a statutory business
trust formed under the laws of Delaware (the "Trust") in connection with the
preparation and filing with the Securities and Exchange Commission of the
Registration Statement on Form S-1, as amended to the date hereof (the
"Registration Statement"), under the Securities Act of 1933, as amended, and the
Prospectus that is a part thereof (the "Prospectus") with respect to the
issuance by the Trust of up to $12.0 million of its $______ Capital Securities
(the "Capital Securities").
In connection with this opinion, we have examined (i) the Registration
Statement, (ii) the Prospectus, (iii) the Declaration of Trust of the Trust,
dated as of December 28, 1999, between the Corporation and Wilmington Trust
Company, as Trustee, (iv) the Amended and Restated Declaration of Trust, dated
as of _________, 2000, among the Corporation, Wilmington Trust Company, as
Property Trustee and Delaware Trustee, and the Administrative Trustees named
therein and (v) such other corporate records, agreements, documents and other
instruments as we have deemed necessary as a basis for the opinion hereinafter
set forth ((i) (ii), (iii), (iv) and (v) collectively the "Offering Documents").
We assume the correctness of the factual matters contained in such reliance
sources and have made no independent investigation for the purpose of confirming
that such factual matters are correct. We have assumed that the operative
documents described in the Prospectus will be performed in accordance with the
terms described therein.
We have assumed (i) the genuineness of all signatures on the Offering
Documents, (ii) the due authorization, execution, and delivery of all documents
and the validity and binding effect thereof, (iii) the authenticity of all
documents submitted to us as originals, (iv) the
<PAGE>
conformity to the originals of all documents submitted to us as copies and the
authenticity of the originals from which the copies were made, and (v) the legal
capacity of natural persons.
Based on the foregoing, we hereby confirm to you our opinion as set
forth in the Prospectus under the heading "United States Federal Income Tax
Consequences," subject to the limitations set forth therein.
In rendering our opinion, we have considered the applicable provisions
of the Internal Revenue Code, Treasury Regulations promulgated thereunder,
pertinent judicial authorities, interpretive rulings of the Internal Revenue
Service, and other authorities we have considered relevant. Our opinion is
limited to the federal tax law of the United States of America and is expressed
as of the date hereof. We do not assume any obligation to update or supplement
our opinion to reflect any fact or circumstance which hereafter comes to our
attention or any change in law which hereafter occurs. Our opinions are limited
to the matters expressly stated; no opinion is implied or may be inferred beyond
such matters.
This opinion is rendered to you and for your benefit solely in
connection with the transactions described herein. We hereby consent to the
filing of this opinion as an exhibit to the Registration Statement, which has
been filed by the Corporation and the Trust with the Securities and Exchange
Commission and to the reference of our firm under the caption "United States
Federal Income Tax Consequences" in the Prospectus. This opinion may not,
without our prior consent, be filed with any other government agency or quoted
in any other document.
Very truly yours,
WILLIAMS, MULLEN, CLARK &
DOBBINS
By:_________________________________
Exhibit 12.1
CALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Year Ended December 31,
------------ ------------ ------------ ------------ ------------
1999 1998 1997 1996 1995
------------ ------------ ------------ ------------ ------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C>
Net income $ 961 $ 3,353 $ 2,808 $ 1,360 $ 1,881
Provision for income taxes 602 1,442 1,332 680 1,078
Fixed charges including interest on deposits (1) 14,308 14,221 12,626 11,343 10,157
------------ ------------ ------------ ------------ ------------
Total 15,871 19,016 16,766 13,383 13,116
Fixed charges excluding interest on deposits (2) 732 270 334 342 460
Ratio of earnings to fixed charges:
Excluding interest on deposits (3) 3.14 18.76 13.40 6.96 7.43
Including interest on deposits (4) 1.11 1.34 1.33 1.18 1.29
</TABLE>
__________________
(1) Fixed charges including interest on deposits is equal to gross interest
expense.
(2) Fixed charges excluding interest on deposits consist of interest on
advances from the FHLB of Atlanta.
(3) Ratio of earnings to fixed charges excluding interest on deposits is
computed by dividing the total of net income, provision for income taxes,
and fixed charges excluding interest.
(4) Ratio of earnings to fixed charges including interest on deposits is
computed by dividing the total of net income, provision for income taxes,
and fixed charges including interest on deposits by fixed charges including
interest on deposits.
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Southern Financial Bancorp, Inc.
We consent to the use of our report dated February 10, 2000, with respect to the
consolidated balance sheets of Southern Financial Bancorp, Inc. 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, and to the reference
to our firm under the heading "Accountants" in the Prospectus. Our report refers
to our reliance on another auditors' report with respect to amounts related to
The Horizon Bank of Virginia for 1998 and 1997 included in the aforementioned
consolidated financial statements.
/s/ KPMG LLP
Richmond, Virginia
March 16, 2000
Exhibit 23.2
[LETTERHEAD OF THOMPSON, GREENSPON & CO., P.C.]
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors
Southern Financial Bancorp, Inc.
We consent to the inclusion in the Form S-1 of Southern Financial Bancorp, Inc.
of our report dated January 29, 1999 relating to the 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 and to the reference to our firm
under the heading "Experts" in the prospectus.
/s/ Thompson, Greenspon & Co., P.C.
Fairfax, Virginia
March 17, 2000
