UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
Commission File Number: 33-77568
VALLEY FINANCIAL CORPORATION
VIRGINIA 54-1702380
(State of Incorporation) (I.R.S. Employer
Identification Number)
36 Church Avenue, S.W.
Roanoke, Virginia 24011
(Address of principal executive offices)
(540) 342-2265
(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No ___
At November 10, 1998, 964,165 shares of the issuer's common stock, no par value,
were outstanding.
Transitional small business disclosure format: Yes ___ No _X_.
<PAGE>
VALLEY FINANCIAL CORPORATION
FORM 10-QSB
September 30, 1998
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 10
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of
Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30 December 31
1998 1997
------------ -----------
(in thousands, except share data)
<S> <C> <C>
Assets
Cash and due from banks (note 2) $ 3,240 $ 3,324
Money market investments:
Federal funds sold 0 1,440
Interest-bearing deposits 21 33
------- -------
Total money market investments 21 1,473
Securities available for sale (note 3) 28,038 21,144
Loans:
Commercial loans 16,285 12,997
Commercial real estate loans 23,189 10,812
Residential real estate loans 14,203 13,502
Loans to individuals 12,791 9,336
------- -------
Total loans 66,468 46,647
Less unearned income (41) (38)
Less allowance for loan losses (note 4) (653) (459)
------- -------
Total net loans 65,774 46,150
Premises and equipment 1,635 1,315
Organizational costs 90 134
Other assets 1,042 1,137
------- -------
Total assets $99,840 $74,677
======= =======
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand deposits 9,304 7,956
Interest bearing demand deposits 25,085 18,395
Savings deposits 912 653
Certificates of deposits > $100,000 7,899 6,481
Other time deposits 38,749 32,103
------- -------
Total deposits 81,949 65,588
Federal funds purchased 2,891 0
Federal Home Loan Bank advances 5,000 0
Other liabilities 994 810
------- -------
Total liabilities 90,834 66,398
------- -------
Preferred stock, no par value. Authorized
10,000,000 shares; none issued and
outstanding
Common stock, no par value. Authorized
10,000,000 shares; issued and
outstanding 964,165 at September 30, 1998
and 964,040 at December 31, 1996 (note 5) 9,091 9,089
Accumulated deficit (386) (866)
Accumulated other comprehensive income (note 6) 301 56
------- -------
Total shareholders' equity 9,006 8,279
Total liabilities and shareholders'
equity $99,840 $74,677
======= =======
See accompanying notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the Period For the Period
January 1, 1998 January 1, 1997
Through Through
September 30, 1998 September 30, 1997
------------------ ------------------
(in thousands, except per share data)
<S> <C> <C>
Interest Income:
Interest and fees on loans $3,580 $2,565
Interest on money market investments 116 58
Interest on securities available
for sale 1,202 824
------ ------
Total interest income 4,898 3,447
Interest Expense:
Interest on certificates of deposit
> $100,000 292 218
Interest on other deposits 2,082 1,587
Interest on borrowed funds 185 6
------ ------
Total interest expense 2,559 1,811
------ ------
Net interest income 2,339 1,636
Provision for loan losses (note 4) 194 119
------ ------
Net interest income after provision for
loan losses 2,145 1,517
------ ------
Noninterest Income:
Service charges on deposit accounts 118 84
Other fee income 58 42
Securities gains 10 2
------ ------
Total noninterest income 186 128
------ ------
Noninterest Expense:
Compensation expense 877 667
Occupancy and equipment expense, net 224 213
Data processing expense 83 64
Marketing and advertising expense 60 80
Office supply expense 43 35
Other expense 325 248
Amortization of organizational expense 44 44
------ ------
Total noninterest expense 1,656 1,351
------ ------
Net income before taxes $ 675 $ 294
Provision for income taxes $ 195 $ 0
------ ------
Net income $ 480 $ 294
====== ======
Basic earnings per share (note 5) $0.50 $0.30
====== ======
Diluted earnings per share (note 5) $0.49 $0.30
====== ======
See accompanying notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the Period For the Period
July 1, 1998 July 1, 1997
Through Through
September 30, 1998 September 30, 1997
------------------ ------------------
(in thousands, except per share data)
<S> <C> <C>
Interest Income:
Interest and fees on loans $1,341 $ 948
Interest on money market investments 76 14
Interest on securities available
for sale 439 320
------ ------
Total interest income 1,856 1,282
Interest Expense:
Interest on certificates of deposit
> $100,000 104 85
Interest on other deposits 807 595
Interest on borrowed funds 76 2
------ ------
Total interest expense 987 682
------ ------
Net interest income 869 600
Provision for loan losses (note 4) 66 37
------ ------
Net interest income after provision for
loan losses 803 563
------ ------
Noninterest Income:
Service charges on deposit accounts 45 31
Other fee income 19 12
Securities gains 0 2
------ ------
Total noninterest income 64 45
------ ------
Noninterest Expense:
Compensation expense 298 221
Occupancy and equipment expense, net 77 72
Data processing expense 28 22
Marketing and advertising expense 23 26
Office supply expense 13 8
Other expense 105 79
Amortization of organizational expense 16 15
------ ------
Total noninterest expense 560 443
------ ------
Net income before taxes $ 307 $ 165
Provision for income taxes $ 87 $ 0
------ ------
Net income $ 220 $ 165
====== ======
Basic earnings per share (note 5) $0.23 $0.17
====== ======
Diluted earnings per share (note 5) $0.22 $0.17
====== ======
See accompanying notes to consolidated financial statements.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
- -------------------------------------------------------------------------------
For the Period For the Period
January 1, 1998 January 1, 1997
Through Through
September 30, 1998 September 30, 1997
- -------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 480 $ 294
Adjustments to reconcile net income
to net cash used in operating
activities:
Provision for loan losses 194 119
Depreciation and amortization of
bank premises/equipment 78 123
Amortization of organizational
expenses 44 43
Amortization/accretion of premiums/
discounts, net (9) 5
Gain on sale of securities (10) (2)
Increase in unearned fees 3 4
(Increase) decrease in other assets 95 (142)
Increase in other liabilities 58 51
- --------------------------------------------------------------------------------
Net cash provided by operating activities 933 495
- --------------------------------------------------------------------------------
Cash Flows From Investing Activities:
Net decrease in money market investments 1,452 2,040
Purchases of premises and equipment (399) (77)
Purchases of securities available-for-
sale (29,602) (15,997)
Proceeds from sales, calls and maturities
of securities 23,099 6,235
Net increase in loans (19,821) (11,263)
- --------------------------------------------------------------------------------
Net cash used in investing activities (25,271) (19,062)
- --------------------------------------------------------------------------------
Cash Flows From Financing Activities
Increase (decrease) in time deposits
greater than $100,000 (582) 2,165
Increase in other time deposits 6,646 7,629
Net increase in other deposits 10,297 8,633
Increase in short-term borrowings 2,891 121
Proceeds from stock options exercised 2 0
Proceeds from Federal Home Loan Bank
advances 5,000 0
- --------------------------------------------------------------------------------
Net cash provided by financing activities 24,254 18,548
- --------------------------------------------------------------------------------
Net Decrease in Cash and Due From Banks (84) (19)
Cash and Due From Banks at Beginning of Period 3,324 2,149
- --------------------------------------------------------------------------------
Cash and Due From Banks at End of Period $ 3,240 $ 2,168
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
</TABLE>
6
<PAGE>
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
(In thousands, except share and per share data)
(1) Organization and Summary of Significant Accounting Policies
Valley Financial Corporation (the "Company") was incorporated under
the laws of the Commonwealth of Virginia on March 15, 1994, primarily
to serve as a holding company for Valley Bank, N.A. (the "Bank"),
which opened for business on May 15, 1995. The Company's fiscal year
end is December 31.
The consolidated financial statements of the Company conform to
generally accepted accounting principles and to general banking
industry practices. The interim period consolidated financial
statements are unaudited; however, in the opinion of management, all
adjustments of a normal recurring nature which are necessary for a
fair presentation of the consolidated financial statements herein have
been included. The consolidated financial statements herein should be
read in conjunction with the Company's 1997 Annual Report on Form 10-
KSB.
(2) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash and due from banks.
7
<PAGE>
(3) Securities
The carrying values, unrealized gains, unrealized losses and
approximate fair values of investment securities at September 30, 1998
are shown in the table below. As of September 30, 1998, investments
with an amortized cost of $199 were pledged as collateral for public
deposits.
<TABLE>
<CAPTION>
Carrying Unrealized Unrealized Approximate
Securities held to maturity: Values Gains Losses Fair Values
- ---------------------------- -----------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury 0 0 0 0
U.S. Government agencies 0 0 0 0
Mortgage-backed securities 0 0 0 0
States and political
subdivisions 0 0 0 0
Corporate debt securities 0 0 0 0
Equity securities 0 0 0 0
- - - -
Total securities held to
maturity 0 0 0 0
- ---------------------------- -----------------------------------------------
Securities available for sale:
U.S. Treasury $ 199 $ 4 $0 $ 203
U.S. Government agencies $16,998 $138 ($1) $17,135
Mortgage-backed securities $ 3,244 $ 21 ($1) $ 3,264
States and political
subdivisions $ 6,105 $290 $0 $ 6,395
Corporate debt securities $ 100 $ 3 $0 $ 103
Equity securities $ 935 $ 3 $0 $ 938
------- ---- -- -------
Total securities available
for sale $27,581 $459 ($2) $28,038
- ---------------------------- -----------------------------------------------
Total securities $27,581 $459 ($2) $28,038
======= ==== == =======
</TABLE>
8
<PAGE>
4) Allowance for Loan Losses
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Balance at January 1 $459 $328
Provision for loan losses 194 119
Recoveries 0 0
Charged off loans 0 0
---- ----
Balance at September 30 $653 $447
==== ====
</TABLE>
(5) Earnings Per Share
Basic earnings per share is based upon the weighted average number of
common shares outstanding during the period. The weighted average
shares outstanding for the diluted earnings per share computations
were adjusted to reflect the assumed conversion of shares available
under stock options. The following table summarizes the shares
utilized in the computations:
<TABLE>
<CAPTION>
Weighted Average Shares Outstanding
-----------------------------------
Three months ending September 30: Basic Diluted
----- -------
<S> <C> <C>
1998 964,165 988,382
======= =======
1997 964,040 973,384
======= =======
Nine months ending September 30:
1998 964,082 982,318
======= =======
1997 964,040 967,114
======= =======
</TABLE>
(6) Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income." Statement 130 establishes standards for
reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of general
purpose financial statements. Statement 130 was issued to address
concerns over the practice of reporting elements of comprehensive
income directly in equity.
9
<PAGE>
This statement requires that all items recognized under accounting
standards as components of comprehensive income be reported in a
financial statement that is displayed in equal prominence with the
other financial statements. It does not require a specific format for
that financial statement but requires that an enterprise display an
amount representing total comprehensive income for the period in that
financial statement. Enterprises are required to classify items of
"other comprehensive income" by their nature in the financial
statement and display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in
capital in the equity section of the balance sheet. It does not
require per share amounts of comprehensive income to be disclosed.
Statement 130 is effective for fiscal years beginning after December
15, 1997. Comparative financial statements provided for earlier
periods are required to be reclassified to reflect the provisions of
this statement. Publicly traded enterprises that issue condensed
financial statements for interim periods are required to report a
total for comprehensive income in those financial statements.
Adoption of Statement 130 on January 1, 1998 did not have any effect
on the consolidated financial position, results of operations or
liquidity of the Company. However, Statement 130 does have an effect
on financial statement displays presented by the Company since the
Company has net unrealized gains (losses) on available-for-sale
securities, an item of other comprehensive income. For the nine
months ended September 30, 1998 and 1997, total comprehensive income
(net income plus other comprehensive income) was $725 and $324,
respectively. For the three months ended September 30, 1998 and 1997,
total comprehensive income was $507 and $210, respectively.
Item 2. Management's Discussion and Analysis (000's omitted, except for share
and per share information).
The following is management's discussion and analysis of the financial condition
and results of operations of the Company as of and for the nine months and three
months ended September 30, 1998 and 1997. The discussion should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto.
Overview
The Company was incorporated as a Virginia stock corporation on March 15, 1994,
primarily to own and control all of the capital stock of the Bank. The Bank
opened for business on May 15, 1995.
Total assets at September 30, 1998 were $99,840, up 34% from $74,677 at December
31, 1997. The principal components of the Company's assets at the end of the
10
<PAGE>
period were $28,038 in securities available-for-sale and $66,468 in gross loans.
Total liabilities at September 30, 1998 were $90,834, up 37% from $66,398 at
December 31, 1997 with the increase almost entirely represented by $16,361
growth in deposits, $2,891 in federal funds purchased and $5,000 in advances
from the Federal Home Loan Bank of Atlanta.
Total shareholders' equity at September 30, 1998 was $9,006 consisting of $9,091
in net proceeds from the issuance of common stock, reduced by the accumulated
deficit of $386 and increased by $301 of unrealized gains on securities
available-for-sale, net of related deferred tax liability. At December 31,
1997, total shareholder's equity was $8,279.
The Company had net income of $480 for the nine months ended September 30, 1998
compared with $294 recorded for the nine months ended September 30, 1997, a 63%
increase. The significant improvement in profitability results from higher net
interest income partially offset by increased noninterest expenses in virtually
all categories. Net income for the three months ended September 30, 1998 was
$220, a 33% increase over the $165 recorded for the third quarter of 1997.
Comparability of net income is affected by the income tax provision of $195 and
$87 booked for the nine month and three month periods ended September 30, 1998,
respectively, versus no income tax expense booked in the same periods in 1997.
Profitability as measured by the Company's return on average assets ("ROA") was
.73% for the nine months ended September 30, 1998, compared to .65% for the
same period in 1997. ROA for the third quarter of 1998 was .85% versus .98% in
the third quarter of 1997. Return on average equity ("ROE") was 7.62% for the
nine months ended September 30, 1998 compared to 5.30% for the same period in
1997. ROE for the third quarter of the year was 11.64% in 1998 and 8.71% in
1997. Again, comparability of profitability ratios is affected by the income
tax provision of $195 and $87 booked for the nine month and three month periods
ended September 30, 1998, respectively, versus no income tax expense booked in
the same periods in 1997.
Results of Operations
Net Interest Income. Net interest income is the amount by which interest and
fees generated from loans and investments exceeds the interest expense
associated with funding those assets, and represents the principal source of
earnings for the Company. Changes in the volume and mix of earning assets and
interest-bearing liabilities, as well as their respective yields and rates, have
a significant impact on the level of net interest income. Changes in the
interest rate environment and the Company's cost of funds also affect net
interest income.
Net interest income was $2,339 for the nine months ended September 30, 1998 and
is attributable to interest income from loans and securities exceeding the cost
of interest paid on deposits and borrowed funds. Net interest income for the
nine months of 1998 increased 43% from $1,636 for the same period in 1997. The
net interest margin on a fully taxable equivalent ("FTE") basis was 3.84% for
11
<PAGE>
the first nine months of 1998, an increase of 7 basis points from the 3.77%
reported for the same period in 1997. The increase in the margin from year to
year is attributable to lower yields on earning assets being more than offset by
lower deposit costs.
For the three months ended September 30, 1998 net interest income was $869 and
the FTE net interest margin was 3.73%. Net interest income was $600 and the net
interest margin was 3.70% for the third quarter of 1997.
Provision for Loan Losses. A provision for loan losses of $194 was provided
during the nine months ended September 30, 1998, an increase of $75 or 63% over
the same period in 1997, in recognition of management's estimate of inherent
risks associated with lending activities. Due to the Bank's limited operating
history, this estimate is primarily based on industry practices and
consideration of local economic factors. The amount of the provision for loan
losses is a charge against current earnings, and actual loan losses are charged
against the allowance for loan losses. The allowance for loan losses was $694 as
of September 30, 1998 and represented approximately .98% of net loans
outstanding versus .99% of net loans at December 31, 1997 (see Note 4 to the
Consolidated Financial Statements).
Provision expense was $66 for the three months ended September 30, 1998 compared
to $37 for the same period in 1997, a 78% increase. The increase in provision
expense is due to growth in average loans outstanding.
No assurance can be given that unforeseen adverse economic conditions or other
circumstances will not result in increased provisions in the future.
Additionally, regulatory examiners may require the Company to recognize
additions to the allowance based upon their judgment about the loan portfolio
and other information available to them at the time of their examinations.
Noninterest Income. Noninterest income of $186 in the nine months ended
September 30, 1998 consisted of service charges and fees on accounts, gains on
securities sold and other miscellaneous income, and represented an increase of
$58 or 45% over the $128 reported for the same period one year earlier. For the
three months ended September 30, 1998 noninterest income was $64, an increase of
$19 or 42% over the $45 reported for the third quarter of 1997. Future levels
of noninterest income are expected to increase as a direct result of business
growth and expansion.
Noninterest Expense. Noninterest expense for the first nine months of 1998 was
$1,656, an increase of $305 or 23% over the same period in 1997. The largest
components of the increase were compensation expense as additional employees
were hired due to growth, growth-related data processing expense and loan
closing costs incurred in a successful home equity line of credit promotion.
Noninterest expense for the quarter ended September 30, 1998 was $560, an
increase of $117 or 26% over the third quarter of 1997. Noninterest expenses
are expected to increase in future years as a direct result of business growth
and expansion.
12
<PAGE>
Year 2000. The Year 2000 issue arises from computer programs being written
using two digits rather than four to abbreviate the year portion of dates.
Computer hardware, software and devices with imbedded technology that are time-
sensitive may not recognize the abbreviation "00" as meaning the year 2000, but
instead read it as the year 1900. This could result in system failures or
miscalculations causing disruption of normal operations including, among other
things, a temporary impairment of the ability to process transactions, calculate
interest payments correctly or engage in routine business activities.
The Company has undertaken various initiatives intended to ensure that its
computer equipment and software will function properly with respect to dates in
the year 2000 and thereafter. Included in the initiatives are information
technology ("IT") systems such as accounting, data processing, financial
transaction processing, ATM and telephone, and non-IT systems such as alarm
systems, fax machines, copiers, HVAC controls and elevator controls. Both IT
and non-IT systems may contain imbedded technology. The company's initiatives
include awareness of the problem, assessing the size and complexity of the
effort in the context of the Company's systems, renovation of non-compliant
systems through upgrade or replacement, validation through testing of Year
2000 compliance and implementation of compliant systems. The Company also is
taking steps to ascertain the Year 2000 compliance status of its major
customers and vendors, and to develop contingency plans in the event of
unexpected failure of one or more of its mission-critical systems. The
awareness and assessment phases of the Year 2000 project are 100% complete.
As of September 30, 1998 the Company estimates it had completed 40% of the
remaining phases and that the other 60% will be completed or substantially
completed by June 30, 1999, including all testing by March 31, 1999.
The Company does not operate its own mainframe computer system and has not
developed/supported software code for its information systems, so remediation
efforts have focused on achieving compliance from outside servicers and vendors,
and on internal testing of hardware and software systems. The Company's banking
operations are highly dependent on one external service bureau for its data
processing and one vendor for loan/deposit software. The Company is monitoring
the Year 2000 compliance status of both these third-party providers, and will
validate their compliance through its own testing efforts. A comprehensive
contingency plan has not yet been developed for dealing with the most reasonably
likely worst case scenario in the event of failure by the Company or its primary
third-party providers to achieve Year 2000 compliance on a timely basis, and
such scenario has not been clearly identified. The Company presently intends to
complete such analysis and contingency planning by December 31, 1999.
The Company also is taking steps to assess the potential impacts of Year 2000
issues on its major commercial borrowers. Should a commercial borrower fail to
deal adequately with Year 2000's impact on its computer systems, its operations
could be jeopardized and its ability to repay its loan threatened. All
commercial borrowers in significant amounts have been sent questionnaires
concerning their Year 2000 preparedness. Completed questionnaires are being
evaluated to identify moderate and high-risk credits. Year 2000 risk factors
are being incorporated into the overall risk ratings for all new and renewed
commercial loans and, where appropriate, more stringent standards will be
imposed in underwriting criteria, loan covenants and required collateral. As of
September 30, the Company expects that virtually all commercial borrowers will
be considered low Year 2000 risk by the end of the first quarter of 1999.
As part of its board-approved Year 2000 Action Plan, the Company established a
budget for Year 2000 compliance. As of September 30, actual expenditures have
approximated $2. Total expenditures, primarily for testing, software upgrades
and consultants, is not expected to exceed $100. The costs of Year 2000
identification, assessment, remediation and testing efforts and the dates on
which the Company currently believes it will complete such efforts are based
upon management's best estimates, which were derived using numerous assumptions
regarding future events, including the continued availability of certain
resources, third-party remediation plans and other factors. There can be no
assurance that these estimates will prove to be accurate, and actual results may
differ materially from those currently anticipated. Specific factors that could
cause such material differences include, but are not limited to, the
availability and cost of personnel trained in Year 2000 issues, the ability to
identify, assess, remediate and test all relevant IT systems and imbedded
technology, and similar uncertainties.
The failure by the Company or a primary third-party provider to correct a
material Year 2000 problem could result in the interruption in, or failure of,
certain normal business activities or operations. Such failure could have a
material adverse effect on the Company's results of operations, liquidity and
financial condition. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-party providers and customers, the Company presently is unable to provide
assurances that such material adverse impact will not be the case. The Year
2000 project is expected to significantly reduce the Company's level of
uncertainty about the Year 2000 problem and, in particular, about the Year 2000
compliance and readiness of its primary third-party providers. The Company
believes that, with the implementation of remediated IT systems and completion
of the Year 2000 project as scheduled, the possibility of significant
interruptions of normal business operations should be reduced.
Income Taxes. An expense of $195 was recognized in the nine months ended
September 30, 1998 to reflect the Company's anticipated federal income tax
liability for the period. This equated to an effective tax rate of 29%.
Provision for income taxes was $87 for the third quarter of 1998, an effective
tax rate of 28%. The Company recorded no expense in 1997 for federal or state
income taxes, due to the availability of net operating loss carryforwards.
13
<PAGE>
Liquidity and Asset/Liability Management
Asset/liability management activities are designed to ensure that adequate
liquidity available to meet loan demand or deposit outflows and, through the
management of the Company's interest sensitivity position, to manage the impact
of interest rate fluctuations on net interest income.
Liquidity. Liquidity measures the ability of the Company to meet its maturing
obligations and existing commitments, to withstand fluctuations in deposit
levels, to fund its operations and to provide for customers credit needs.
Liquidity represents a financial institutions ability to meet present and future
financial obligations through either the sale or maturity of existing assets or
the acquisition of additional funds from alternative funding sources.
The Company's asset liquidity is provided by cash and due from banks, federal
funds sold, investments available for sale, managing investment
maturities/prepayments and loan repayments. The Company's ratio of liquid
assets to deposits and short term borrowings was 31% at September 30, 1998 and
40% at December 31, 1997. The Company sells excess funds as overnight federal
funds sold to provide an immediate source of liquidity. The Company had no
Federal funds sold at September 30, 1998 compared to $1,440 at December 31,
1997.
The level of deposits may fluctuate, perhaps significantly so, due to seasonal
cycles of depositing customers and the promotional activities of competitor
financial institutions. Similarly, the level of demand for loans may vary
significantly and at any given time may increase or decrease substantially.
However, unlike the level of deposits, management has more direct control over
lending activities and if necessary can adjust the level of those activities
according to the amounts of available funds.
In addition to asset liquidity, the Company would have liquidity available to it
through increasing certain categories of liabilities. It could purchase
overnight federal funds, borrow from correspondent banks, sell securities under
a repurchase agreement or obtain advances from the Federal Home Loan Bank. As a
result of the Company's management of liquid assets and the ability to generate
liquidity through alternative funding sources, management believes the Company
maintains overall liquidity sufficient to meet its depositors requirements and
satisfy its customers credit needs.
Interest Rate Risk
Interest rate risk is the risk to earnings or capital generated by movement of
interest rates. It can come from differences between the timing of rate changes
and the timing of cash flows (repricing risk); from changing rate relationships
among yield curves that affect bank activities (basis risk); from changing rate
relationships across the spectrum of maturities (yield curve risk); and from
interest rate related options imbedded in bank products (option risk).
14
<PAGE>
While no single measure can completely identify the impact of changes in
interest rates on net interest income, a commonly-used technique within the
industry is to assess the differences in the amounts of rate-sensitive assets
and rate-sensitive liabilities. These differences or "gaps" provide an
indication of the extent to which net interest income may be affected by future
changes in interest rates. A "positive gap" exists when rate-sensitive assets
exceed rate-sensitive liabilities and indicates that a greater volume of assets
than liabilities will reprice during a given period. A positive gap may enhance
earnings in a rising interest rate environment and may inhibit earnings in a
declining interest rate environment. Conversely, when rate-sensitive
liabilities exceed rate-sensitive assets (a "negative gap"), a greater volume of
liabilities than assets will reprice within the period. In such a case, a
rising interest rate environment may inhibit earnings and a declining interest
rate environment may enhance earnings.
Some financial institutions evaluate their "gaps" strictly from a balance sheet
perspective, calculating the absolute difference between the volumes of assets
and liabilities that have the contractual ability to reprice within a given
period in response to changes in interest rates. Company management believes
this "balance sheet gap" methodology does not adequately take into consideration
the differences in the way various balance sheet items react to changing
interest rates. For example, the rate on savings accounts does not move in
direct tandem with changes in the prime rate, but typically increases or
decreases to a much lesser extent. On the other hand, home equity lines and
many commercial loans are tied directly to prime and immediately reprice to the
full extent of any changes in the prime rate. Accordingly, the Company utilizes
an "income statement gap" methodology that analyzes the various asset and
liability categories and assigns them a "change ratio" that estimates their
relative change in response to a change in the prime rate, based on industry
trends and the Company's own experience. At least quarterly, the Company
calculates the Banks "income statement gap" to estimate how many assets and
liabilities would reprice and to what extent within a one year period in
response to changes in the prime rate, and compares the results to internal
policy guidelines.
Impact of Inflation
The Consolidated Financial Statements and Notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
requires the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies, nearly
all the assets and liabilities of the Company and the Bank are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of changes in the general rate of inflation and
changes in prices. In addition, interest rates do not necessarily move in the
same direction or in the same magnitude as do the prices of goods and services.
Management seeks to manage the relationship between interest-sensitive assets
and liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
15
<PAGE>
Investment Portfolio
The Company's investment portfolio is used both for investment income and
liquidity purposes. Funds not used for capital expenditures or lending
activities are invested in securities of the U.S. Government and its agencies,
mortgage-backed securities, municipal bonds, corporate bonds and equity
securities. Obligations of the U.S. Government and its agencies include
treasury notes and callable or noncallable agency bonds. Mortgage-backed
securities include pools issued by government agencies. Municipal bonds include
taxable and tax-exempt general obligation and revenue issues. Corporate bonds
are investment grade issue. Equity securities include shares of the Federal
Reserve Bank of Richmond, Federal Home Loan Bank of Atlanta, Community Bankers
Bank and corporate preferred stocks. The Company does not invest in derivatives
or other types of high-risk securities. The entire investment portfolio is
classified as available-for-sale in order to provide maximum liquidity for
funding needs.
Investment securities at September 30, 1998 were $28,038, an increase of $6,894
or 33% from their level of $21,144 on December 31, 1997. The increase is
attributable to investment of funds available from deposit growth and the
purchase of investment securities with the proceeds of a $5,000 advance from the
Federal Home Loan Bank of Atlanta.
For more information on the investment portfolio, see Note 3 to the Consolidated
Financial Statements.
Loan Portfolio
The Company's total loans were $66,468 at September 30, 1998, an increase of
$19,821 or 43% from the $46,647 reported at December 31, 1997. The Company's
ratio of net loans to total deposits stood at 80% at September 30, 1998 and 70%
at December 31, 1997. Management seeks to maintain the ratio of loans to
deposits in a range of 70% to 85%.
The loan portfolio primarily consists of commercial, real estate (including real
estate term loans, construction loans and other loans secured by real estate)
and loans to individuals for household, family and other consumer purposes. The
Company adjusts its mix of lending and the terms of its loan programs according
to economic and market conditions, asset/liability management considerations and
other factors. Loans typically (in excess of 90%) are made to businesses and
individuals located within the Company's primary market area, most of whom
maintain deposit accounts with the Bank. There is no concentration of loans
exceeding 10% of total loans which is not disclosed in the Consolidated
Financial Statements and the Notes thereto or discussed below. The Company has
not made any loans to any foreign entities, including governments, banks,
businesses or individuals. Commercial and construction loans and home equity
lines of credit in the loan portfolio are primarily variable rate loans and have
little interest rate risk.
Commercial Loans. Commercial and industrial loans accounted for 25% of the loan
portfolio as of September 30, 1998 and stood at $16,285 versus $12,997 nine
16
<PAGE>
months earlier. Such loans generally are made to provide operating lines of
credit, to finance the purchase of inventory or equipment, and for other
business purposes. The creditworthiness of the borrower is analyzed and re-
evaluated on a periodic basis. Most commercial loans are collateralized with
business assets such as accounts receivable, inventory and equipment. Even with
substantial collateral such as all the assets of the business and personal
guarantees, commercial lending involves considerable risk of loss in the event
of a business downturn or failure of the business.
Commercial Real Estate Loans. Commercial real estate construction and
commercial real estate mortgages represent interim and permanent financing of
commercial properties that are secured by real estate, and were 35% of total
loans at September 30, 1998. Outstanding loans in this category equaled
$23,189 and $10,812 at September 30, 1998 and December 31, 1997, respectively.
The Company prefers to make commercial real estate loans secured by owner-
occupied properties. These borrowers are engaged in business activities other
than real estate, and the primary source of repayment is not solely dependent on
conditions in the real estate market.
Residential Real Estate Loans. Residential real estate loans are secured by
first deeds of trust on 1-4 family residential properties. This category had
$14,203 in loans (21% of total loans) at September 30, 1998 and $13,502 in such
loans at December 31, 1997. To mitigate interest rate risk, the Company usually
limits the final maturity of residential real estate loans held for its own
portfolio to 15-20 years and offers a bi-weekly payment option to encourage
faster repayment. Residential real estate lending involves risk elements when
there is lack of timely payment and/or a decline in the value of the collateral.
Loans to Individuals. Loans to individuals include installment loans and home
equity lines of credit/loans secured by junior liens on residential real estate.
The loan proceeds typically are used to purchase vehicles, finance home
remodeling or higher education, or for other consumer purposes. Loans to
individuals totaled $12,791 (19% of total loans) at September 30, 1998 compared
to $9,336 at December 31, 1997.
Nonperforming Assets. The Company had $2 in nonperforming assets at September
30, 1998 versus $0 at December 31, 1997.
Deposits
As of September 30, 1998 total deposits were $81,949, an increase of $16,361 or
25% from their level of $65,588 at December 31, 1997. The increase in total
deposits was due to increases in previously-existing accounts as well as new
accounts opened.
At September 30, 1998 noninterest bearing demand deposits were $9,304 or 11% of
total deposits. On December 31, 1997 noninterest bearing demand deposits were
$7,956 or 12% of total deposits. Nonmaturity deposits (noninterest bearing
demand deposits, interest bearing demand deposits, money market accounts and
savings accounts) were $35,301 or 43% of total deposits at September 30, 1998,
up from $27,004 or 41% of total deposits at December 31, 1997. Total interest
bearing deposits stood at $72,645 at September 30, 1998, an increase of $15,013
or 26% over their level of $57,632 at December 31, 1997.
17
<PAGE>
The levels and mix of deposits are influenced by such factors as customer
service, interest rates paid, service charges and the convenience of banking
locations. Competition for deposits is intense from other depository
institutions and money market funds, some of which offer interest rates higher
than those paid by the Company. Management attempts to identify and implement
pricing and marketing strategies designed to control the overall cost of
deposits and to maintain a stable deposit mix.
Capital Resources
The Company's financial position at September 30, 1998 reflects liquidity and
capital levels currently adequate to fund anticipated near-term business
expansion. Capital ratios are well in excess of required regulatory minimums
for a well-capitalized institution. The adequacy of the Company's capital is
reviewed by management on an ongoing basis. Management seeks to maintain a
capital structure adequate to support anticipated asset growth and serve as a
cushion to absorb potential losses.
Total shareholders equity was $9,006 at September 30, 1998 compared with $8,279
at December 31, 1997, an increase of $727 or 9%. The increase is attributable
to the first nine months net income of $480, plus $245 in increased accumulated
other comprehensive income and $2 from the issuance of common stock pursuant to
the exercise of stock options.
For the periods indicated, the Company had the following risk-based capital and
leverage ratios relative to regulatory minimums:
<TABLE>
<CAPTION>
Ratio 9/30/98 12/31/97 9/30/97 Minimum
----- ------- -------- ------- -------
<S> <C> <C> <C> <C>
Tier 1 11.8% 15.6% 15.4% 4%
Total 12.7% 16.5% 16.3% 8%
Leverage 8.6% 11.5% 11.2% 4%
</TABLE>
It is anticipated that the Company's capital adequacy ratios will continue to
decline as long as the rate of asset growth continues to outstrip the rate of
internal capital generation through retention of earnings. If this trend
continues, the Company in the future will have to raise additional capital funds
or curtail its rate of asset growth.
18
<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
quarter.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The Company filed the following exhibits for the quarter ended September
30, 1998:
27. Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended September
30, 1998. The report, dated August 6, 1998, reported the Company's
consolidated financial results for the quarter ended June 30, 1998.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALLEY FINANCIAL CORPORATION
November 12,1998 /s/ Ellis L. Gutshall
- --------------------- -----------------------------------
Date Ellis L. Gutshall, President
and Chief Executive Officer
November 12, 1998 /s/ A. Wayne Lewis
- --------------------- -----------------------------------
Date A. Wayne Lewis, Executive
Vice President and Chief
Financial Officer
20
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<CIK> 0000921590
<NAME> VALLEY FINANCIAL CORP/VA/
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
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0
0
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