UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Common Stock,
No Par Value
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 issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No ___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ X ]
The issuer's revenues for its most recent fiscal year were $4,984,000.
The aggregate market value of the voting stock held by non-affiliates of the
Company (577,459 shares) based on the $15.00 per share last trade price quoted
by the OTC Bulletin Board on March 24, 1998, was $8,361,885. At March 24, 1998,
964,040 shares of the registrant's common stock were issued and outstanding.
Documents incorporated by reference:
The issuer's Proxy Statement dated March 13, 1998 is incorporated by reference
into Form 10-KSB Part III, Items 9, 10, 11 and 12.
Transitional Small Business Disclosure Format (check one): Yes ___ No _X_
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VALLEY FINANCIAL CORPORATION
FORM 10-KSB
December 31, 1997
INDEX
PART I.
Item 1. Description of Business. 3
Item 2. Description of Property. 10
Item 3. Legal Proceedings. 11
Item 4. Submission of Matters to a Vote of
Security Holders. 11
PART. II.
Item 5. Market for Common Equity and Related
Stockholder Matters. 11
Item 6. Management's Discussion and Analysis or Plan
of Operation. 12
Item 7. Financial Statements. 22
Item 8. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure. 49
PART III.
Item 9. Directors, Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a)
of the Exchange Act. 49
Item 10. Executive Compensation. 49
Item 11. Security Ownership of Certain Beneficial
Owners and Management. 49
Item 12. Certain Relationships and Related Transactions 49
Item 13. Exhibits and Reports on Form 8-K. 49
SIGNATURES 52
EXHIBIT INDEX 54
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PART I.
Item 1. Description of Business.
Valley Financial Corporation (the "Company") was incorporated as a Virginia
stock corporation on March 15, 1994, primarily to own and control all of the
capital stock of Valley Bank, N.A. (the "Bank"). The Bank opened for business
on May 15, 1995 at its main office in the City of Roanoke, opened its second
office on September 11, 1995 in the County of Roanoke, and its third office on
January 15, 1997, in the City of Roanoke. In January 1998, the Bank opened a
loan production office in the City of Salem.
The Bank is a national banking association organized under the laws of the
United States, and engages in the business of commercial banking. Its deposits
are insured by the FDIC and it is a member of the Federal Reserve System. The
Company presently engages in no business other than owning and managing the
Bank.
Location and Service Area
The Bank's primary service area consists of the cities of Roanoke and Salem and
Roanoke County, Virginia, where it conducts a general commercial banking
business while emphasizing the needs of small-to-medium sized businesses,
professional concerns and individuals. The Bank operates from its main office
at 36 Church Avenue, SW in the City of Roanoke, its branch offices at 4467
Starkey Road, SW in the County of Roanoke and 2203 Crystal Spring Avenue, SW in
the City of Roanoke, and its loan production office at 302 East Main Street in
the City of Salem.
The Roanoke Metropolitan Statistical Area (MSA) is the regional center for
southwest Virginia, and is located approximately 165 miles west of Richmond,
Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles east of
Charleston, West Virginia and 222 miles southwest of Washington, D.C. Hollins
College and Roanoke College, with student enrollments of approximately 1,100 and
1,700, respectively, are located in the Roanoke MSA. Virginia Polytechnic
Institute & State University, with a student body of some 22,500, is
approximately a 45-minute drive away.
The population in the Roanoke MSA was estimated at 231,100 in 1995 with per
capita income of $22,407. Although the Roanoke MSA's growth typically is slower
than that in the Commonwealth overall and in other key Virginia markets in
particular, the Virginia Employment Commission reported in 1997 that the area,
in the previous three years, enjoyed a 5.5% job growth rate compared with a 4.7%
growth rate for the state as a whole. The Roanoke MSA had an unemployment rate
of 2.8% in January 1998, compared with 5.2% nationally and second only to
Northern Virginia as the lowest in Virginia among major metropolitan areas.
With over 6,000 businesses, Roanoke City, Roanoke County and Salem City combined
ranked fourth in the Commonwealth in terms of the number of businesses and had a
total market payroll of approximately $2.2 billion. The business community in
the Roanoke MSA is well diversified by industry group. The principal components
of the economy are retail trade, services, transportation, manufacturing and
finance, insurance and real estate. The Roanoke MSA's position as a regional
center creates a strong medical, legal and business professional community.
Carilion Health System and Lewis-Gale Hospital are among Roanoke's largest
employers. Other large employers include Norfolk Southern Corporation, General
Electric Co., First Union Corporation, The Kroger Co., Veterans Administration
Hospital and American Electric Power.
Banking Services
The Bank offers a full range of deposit services that are typically available in
most banks and savings and loan associations, including checking accounts,
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NOW accounts, savings accounts and other time deposits of various types,
ranging from daily money market accounts to longer-term certificates of
deposit. The transaction accounts and time certificates are tailored to the
Bank's principal market area at rates competitive to those offered in the
area. In addition, the Bank offers certain retirement account services,
such as Individual Retirement Accounts. All deposit accounts are insured by
the FDIC up to the maximum amount allowed by law (generally, $100,000 per
depositor, subject to aggregation rules). The Bank solicits accounts from
individuals, businesses, associations and organizations and governmental
authorities.
The Bank additionally offers a full range of short to medium term commercial and
personal loans. Commercial loans include both secured and unsecured loans for
working capital (including inventory and receivables), business expansion
(including acquisition of real estate and improvements) and purchase of
equipment and machinery. Consumer loans include secured and unsecured loans for
financing automobiles, home improvements, education and personal investments.
The Bank also originates and holds fixed and variable rate mortgage loans and
real estate construction and acquisition loans.
The Bank's lending activities are subject to a variety of lending limits imposed
by federal laws and regulations. While differing limits apply in certain
circumstances based on the type of loan or the nature of the borrower (including
the borrower's relationship to the Bank), in general the Bank is subject to a
loan-to-one borrower limit of an amount equal to (i) 15% of the Bank's
unimpaired capital and surplus in the case of loans which are not fully secured
by readily marketable collateral, or (ii) 25% of the unimpaired capital and
surplus if the excess over 15% is fully secured by readily marketable
collateral. The Bank may not make any extensions of credit to any director,
executive officer, or principal shareholder of the Bank or the Company, or to
any related interest of such person, unless the extension of credit is approved
by the Board of Directors of the Bank and is made on terms not more favorable to
such person than would be available to an unaffiliated party.
Other Bank services include safe deposit boxes, certain cash management
services, travelers checks, direct deposit of payroll and social security checks
and automatic drafts for various accounts. The Bank is associated with the
Honor, Cirrus and The Exchange shared networks of automated teller machines that
may be used by Bank customers throughout Virginia and other regions. The Bank
also offers VISA and MasterCard credit card services.
The Bank does not plan to exercise trust powers during its initial years of
operation. The Bank may in the future offer a full-service trust department,
but cannot do so without the prior approval of its primary federal regulator,
the Office of the Comptroller of the Currency (the "OCC"). However, the Bank
has entered into an arrangement to refer its customers to an outside vendor for
the provision of trust services, under which arrangement the Bank receives fees
for referring its customers to the vendor.
Competition
The banking business is highly competitive. The Bank competes as a financial
intermediary with other commercial banks, savings and loan associations, credit
unions, mortgage banking firms, consumer finance companies, securities brokerage
firms, insurance companies, money market mutual funds, and other institutions
operating in the Roanoke MSA and elsewhere. In addition, large borrowers
increasingly are obtaining financing directly by issuing commercial paper
without the involvement of banks.
The Bank's market area is a highly concentrated, highly branched banking market.
As of March 15, 1998, there were fifteen commercial banks and savings
associations operating a total of approximately 100 offices in Roanoke City,
Roanoke County and Salem City. The only locally owned and operated commercial
banks are the Bank and Salem Bank & Trust Company. Crestar Bank is a statewide
bank based in Richmond and First Virginia Bank-Southwest is a subsidiary of a
holding company headquartered in Falls Church, Virginia. NationsBank, First
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Union National Bank, Wachovia Bank, First Citizens Bank and BB&T Bank all
are subsidiaries of holding companies headquartered in North Carolina. In
addition, three out-of-town Virginia based community banks, Bank of Floyd,
First National Bank of Rocky Mount and The Bank of Fincastle, each has
opened one branch in the Bank's market area.
Also, numerous credit unions in the aggregate operate additional offices in the
Roanoke MSA. Further, various other financial companies, ranging from local to
national firms, provide financial services to residents of the Bank's market
area.
The Company believes that the Bank will be able to compete effectively in this
market, and that the community will react favorably to the Bank's community bank
focus and emphasis on service to small businesses, individuals and professional
concerns.
Employees
At December 31, 1997, the Bank had twenty-six full-time employees, including its
officers. The Company does not have any regular employees other than its
officers.
SUPERVISION AND REGULATION
The Company and the Bank are subject to state and federal banking laws and
regulations which impose specific requirements or restrictions on and provide
for general regulatory oversight with respect to virtually all aspects of
operations. The following is a brief summary of certain statutes, rules and
regulations affecting the Company and the Bank.
The Company
Because it owns all of the outstanding common stock of the Bank, the Company is
a bank holding company within the meaning of the federal Bank Holding Company
Act of 1956, as amended (the "BHCA"), and Chapter 13 of the Virginia Banking
Act, as amended (the "Virginia Act").
The BHCA. The BHCA is administered by the Board of Governors of the Federal
Reserve System (the "Federal Reserve"), and the Company is required to file with
the Federal Reserve periodic reports and such additional information as the
Federal Reserve may require. The BHCA, with limited exceptions, requires every
bank holding company to obtain the prior approval of the Federal Reserve before,
(i) it or any of its subsidiaries (other than a bank) acquires substantially all
the assets of any bank, (ii) it acquires ownership or control of any voting
shares of any bank if after such acquisition it would own or control, directly
or indirectly, more than 5% of the voting shares of such bank, or (iii) it
merges or consolidates with any other bank holding company.
The BHCA and the Change in Bank Control Act, together with regulations
promulgated by the Federal Reserve, require that, depending on the particular
circumstances, either Federal Reserve Board approval must be obtained or notice
must be furnished to the Federal Reserve and not disapproved prior to any person
or company acquiring "control" of a bank holding company, such as the Company,
subject to certain exemptions for certain transactions. Control is conclusively
presumed to exist if an individual or company acquires 25% or more of any class
of voting securities of the bank holding company. Control is rebuttably
presumed to exist if a person acquires 10% or more but less than 25% of any
class of voting securities and either the company has registered securities
under Section 12 of the Securities Exchange Act of 1934 (the "Exchange Act") or
no other person will own a greater percentage of that class of voting securities
immediately after the transaction.
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Under the BHCA, the Company is generally prohibited from engaging in, or
acquiring direct or indirect control of more that 5% of the voting shares of any
company engaged in nonbanking activities unless the Federal Reserve, by order or
regulation, has found those activities to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto.
The Federal Reserve imposes certain capital requirements on the Company under
the BHCA, including a minimum leverage ratio and a minimum ratio of "qualifying"
capital to risk-weighted assets. Subject to its capital requirements and
certain other restrictions, the Company is able to borrow money to make a
capital contribution to the Bank, and such loans may be repaid from dividends
paid from the Bank to the Company, although the ability of the Bank to pay
dividends is subject to regulatory restrictions. The Company is also able to
raise capital for contributions to the Bank by issuing securities without having
to receive regulatory approval, subject to compliance with federal and state
securities laws.
The Virginia Act. All Virginia bank holding companies must register with the
Bureau of Financial Institutions of the State Corporation Commission of Virginia
(the "Virginia Commission") under the Virginia Act. A registered bank holding
company must provide the Virginia Commission with information with respect to
the financial condition, operations, management and inter-company relationships
of the holding company and its subsidiaries. The Virginia Commission also may
require such other information as is necessary to keep itself informed about
whether the provisions of Virginia law and the regulations and orders issued
thereunder by the Virginia Commission have been complied with, and may make
examinations of any Virginia holding company and its subsidiaries. Under the
Virginia Act, it is generally unlawful, without the prior approval of the
Virginia Commission, for any Virginia bank holding company to acquire direct or
indirect ownership or control of more than 5% of the voting shares of any
Virginia bank or any other bank holding company.
Glass-Steagall Act. The Company also is restricted in its activities by the
provisions of the Glass-Steagall Act, which prohibit the Company from owning
subsidiaries that are engaged principally in the issue, flotation, underwriting,
public sale or distribution of securities. The interpretation, scope and
application of the provisions of the Glass-Steagall Act currently are being
considered and reviewed by regulators and legislators, and the interpretation
and application of those provisions have been challenged in the federal courts.
The Company does not presently contemplate engaging in securities-related
activities in any material respect.
The Bank
General. The Bank operates as a national banking association organized under
the laws of the United States and is subject to examination by the OCC. The OCC
regulates or monitors all areas of the Bank's operations, including security
devices and procedures, adequacy of capitalization and loss reserves, loans,
investments, borrowings, deposits, mergers, issuances of securities, payment of
dividends, interest rates payable on deposits, interest rates or fees chargeable
on loans, establishment of branches, corporate reorganizations, and maintenance
of books and records. The Bank must maintain certain minimum capital ratios and
is subject to certain limits on aggregate investments in real estate, bank
premises and furniture and fixtures. The Bank is required to prepare quarterly
reports on the Bank's financial condition and to conduct an annual audit of its
financial affairs in compliance with minimum standards and procedures prescribed
by the OCC. The Bank also is required by the OCC to adopt internal control
structures and procedures in order to safeguard assets and monitor and reduce
risk exposure. While considered appropriate for the safety and soundness of
banks, these requirements adversely impact overhead costs.
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The FDIC establishes rates for the payment of premiums by federally-insured
banks for deposit insurance. A Bank Insurance Fund (the "BIF") is maintained
for commercial banks with insurance premiums from the industry used to offset
losses from insurance payouts when banks fail. Due to the high rate of failures
in the late 1980's and early 1990's, the fees that commercial banks paid to the
BIF increased significantly. In 1995, in light of the banking industry's
improved health and recapitalization of the FDIC insurance fund, the FDIC
announced a proposal to lower banks' deposit insurance premiums to a rate of as
low as $.04 per $100 of insured deposits, and the Bank was assessed at that rate
in 1995. For 1996, the Bank was assessed for deposit insurance at a rate of
$.00 per $100 of insured deposits, but was subject to a statutory minimum
payment of $2,000. The statutory minimum has now been eliminated, so the Bank's
deposit insurance premium for 1997 was zero; however, the Bank in 1997 was
assessed approximately $6,000 in connection with interest on the so-called FICO
bonds issued by the federal government to finance the savings and loan industry
bailout. Deposit insurance premiums vary with the financial strength of the
banking industry and there can be no assurance that premiums will remain at
their current low levels.
Transactions with Affiliates. The Federal Reserve Act restricts the amount and
prescribes conditions with respect to loans, investments, asset purchases and
other transactions (collectively, "Covered Transactions") between banks and
their affiliates. In addition to limitations as to amount, each Covered
Transaction must meet specified collateral requirements. Compliance also is
required with certain provisions designed to avoid the taking of low quality
assets. Additionally, transactions, including Covered Transactions and service
contracts entered into between banks and certain affiliates must be on terms and
under circumstances that are substantially the same as those prevailing at the
time for comparable transactions involving nonaffiliated companies. The
foregoing restrictions and conditions apply to certain transactions between the
Company and the Bank.
The Bank is subject to restrictions on extensions of credit to executive
officers, directors, principal shareholders, and their related interests. Such
extensions of credit are limited in their aggregate amount and (i) must be made
on substantially the same terms and conditions, including interest rates and
collateral, as those prevailing at the time for comparable transactions with
unaffiliated parties and (ii) must not involve more than the normal risk of
repayment or present other unfavorable features.
Branching. The Bank may branch without geographic restriction in Virginia. The
Virginia Act permits statewide branching for Virginia state banks and, as a
national bank located in Virginia, these state branch banking laws also apply to
the Bank. On September 29, 1994, the federal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Act") was enacted and became effective
in Virginia on July 1, 1995. The Interstate Act allows bank holding companies
to acquire banks in any state, without regard to state law, except for state
laws relating to the minimum amount of time a bank must be in existence to be
acquired. Under the Virginia Act, a Virginia bank or all the subsidiaries of a
Virginia bank holding company sought to be acquired must have been in continuous
operation for more than two years before the date of such proposed acquisition.
Community Reinvestment Act. The federal Community Reinvestment Act ("CRA")
requires that, in connection with examinations of financial institutions within
their jurisdiction, the federal banking regulators evaluate the record of the
financial institutions in meeting the credit needs of their local communities,
including low and moderate income neighborhoods, consistent with the safe and
sound operation of those institutions. These factors are also considered in
evaluating mergers, acquisitions and applications to open a branch or facility.
Recent legislative and regulatory changes have reduced the paperwork and
regulatory burden of CRA on smaller institutions such as the Bank. The Bank
received a "Satisfactory" CRA rating in 1996 from the OCC pursuant to its first
CRA examination.
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Other Regulations. Interest and certain other charges collected or contracted
for by the Bank are subject to state usury laws and certain federal laws
concerning interest rates. These laws restrict the interest and charges which
the Bank may impose for certain loans and thereby affect the Bank's interest
income. The Bank's loan operations also are subject to certain federal laws
applicable to credit transactions, such as the Truth in Lending Act governing
disclosures of credit terms to consumer borrowers, the Home Mortgage Disclosure
Act requiring financial institutions to provide information to enable the public
and public officials to determine whether a financial institution is fulfilling
its obligation to help meet the housing needs of the community it serves, the
Equal Credit Opportunity Act prohibiting discrimination on the basis of race,
creed or other prohibited factors in extending credit, the Fair Credit Reporting
Act governing the use and provision of information to credit reporting agencies,
and the rules and regulations of the various federal agencies charged with the
responsibility of implementing such federal laws. The deposit operations of the
Bank also are subject to the Truth in Savings Act, which governs disclosure and
advertisement of yields and costs of deposits and deposit accounts, the Right to
Financial Privacy Act, which imposes a duty to maintain confidentiality of
consumer financial records and prescribes procedures for complying with
administrative subpoenas of financial records, the Electronic Funds Transfer Act
and Regulation E issued by the Federal Reserve to implement that Act, which
govern automatic deposits to and withdrawals from deposit accounts and
customers' rights and liabilities arising from the use of automated teller
machines and other electronic banking services, the Expedited Funds Availability
Act and Regulation CC issued by the Federal Reserve to implement that Act, which
govern the availability of funds, return of checks, the settlement of checks,
check endorsement and presentment and notification of nonpayment, and the Bank
Secrecy Act, which requires reporting to the federal government of cash
transactions exceeding $10,000.
Dividends. At present, the Company's revenues consist of interest and dividends
on investments. In the future, it is expected that the principal source of the
Company's revenues will be dividends received from the Bank. The amount of
dividends that may be paid by the Bank to the Company will depend on the Bank's
earnings and capital position and is limited by federal law, regulations and
policies. A national bank may not pay dividends from its capital; all dividends
must be paid out of undivided profits then on hand, after deducting expenses,
including reserves for losses and bad debts. In addition, a national bank is
prohibited from declaring a dividend on its shares of common stock until its
surplus equals its stated capital, unless there has been transferred to surplus
no less than one-tenth of the bank's net profits of (i) the preceding two
consecutive half-year periods (in the case of an annual dividend) or (ii) the
preceding half-year period (in the case of a quarterly or semiannual dividend).
The approval of the OCC is required if the total of all dividends declared by a
national bank in any calendar year exceeds the total of its net profits for that
year combined with its retained net profits for the preceding two years, less
any required transfers to surplus. The Bank may not pay a dividend if, after
giving effect to the dividend, the Bank would be undercapitalized. The Company
does not anticipate paying cash dividends to shareholders in the near term. See
"Capital Regulations" below, "Item 5. Market for Common Equity and Related
Matters" and Note 8 to the Consolidated Financial Statements.
Capital Regulations. The federal bank regulatory authorities impose certain
capital requirements on the Company and the Bank. Under current regulations of
the Federal Reserve, the Company will not be subject to these regulations until
its total assets, on a consolidated basis with the Bank, are $150 million or
more. In addition to minimum capital levels prescribed by regulation, the
Federal Reserve and the OCC have authority to require higher capital levels on a
case-by-case basis as part of their supervisory and enforcement powers. The
federal regulators have stated that banks and bank holding companies
contemplating significant expansion programs should not allow expansion to
diminish their capital ratios and should maintain capital ratios well in excess
of the stated minimums.
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In an effort to achieve a measure of capital adequacy that is more sensitive to
the individual risk profiles of financial institutions, the federal bank
regulatory authorities have adopted risk-based capital adequacy guidelines that
redefine traditional capital ratios to take into account assessments of risks
related to each balance sheet category, as well as off-balance sheet financing
activities. Under the guidelines, banks' and bank holding companies' assets are
given risk weights of 0%, 20%, 50% or 100%, based on assumptions as to the
relative risk inherent in each asset category. Most loans are assigned a 100%
risk weighting, except for first mortgage loans fully secured by residential
property and, under certain circumstances, residential construction loans, both
of which carry a 50% risk weighting. Most investment securities are assigned a
20% risk weighting, except for state and municipal revenue bonds, which carry a
50% risk weighting, and obligations of the United States Treasury or United
States Government agencies, which have a 0% risk weighting.
The risk-weighted asset base is equal to the sum of the aggregate dollar value
of assets and certain off-balance sheet items (such as currency or interest rate
swaps) in each of the four separate risk categories, multiplied by the weight
assigned to each specific asset category. After the items in each category have
been totaled and multiplied by the category's risk factor, category totals are
aggregated to derive the total risk-weighted assets, and the total adjusted
qualifying capital base is divided by the total risk-weighted assets to derive a
ratio.
At least 50% of an institution's qualifying capital must be "Core" or "Tier 1"
capital, and the balance may be "Supplementary" or "Tier 2" capital. Tier 1
capital is essentially equal to common stockholders' equity, retained earnings,
a limited amount of qualifying perpetual preferred stock and minority interests
in equity accounts of consolidated subsidiaries, less goodwill. Banking
institutions may include only noncumulative perpetual preferred stock, and
holding companies may include only limited amounts of cumulative perpetual
preferred stock, in Tier 1 capital, and must exclude certain types of
noncumulative preferred stock on which the dividend is reset periodically based
to some degree on the bank's credit rating. Tier 2 capital includes the excess
of any preferred stock not included in Tier 1 capital, mandatory convertible
securities, hybrid capital instruments, term subordinated debt and intermediate-
term preferred stock and general reserves for loan and lease losses, although
the amount of such reserves included in Tier 2 capital is limited to 1.25% of
risk-weighted assets.
To supplement the risk-based capital guidelines, the federal bank regulatory
agencies also have imposed a leverage ratio, which is Tier 1 capital as a
percentage of average quarterly assets less intangible assets. The principal
objective of the leverage ratio is to place a constraint on the maximum degree
to which a bank or bank holding company may leverage its equity capital base.
Institutions receiving less than the highest composite examination ratings are
required to maintain a leverage ratio of at least 100 basis points above the
regulatory minimum.
At December 31, 1997, the Company and the Bank had the following risk-based
capital and leverage ratios relative to regulatory minimums:
<TABLE>
<CAPTION>
Ratio Company Bank Minimum
----- ------- ---- -------
<S> <C> <C> <C>
Tier 1 15.7% 13.4% 4%
Total 16.5% 14.3% 8%
Leverage 11.5% 9.9% 4%
</TABLE>
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The regulations define five categories of compliance with regulatory capital
requirements, ranging from "well-capitalized" to "critically undercapitalized."
To qualify as a "well-capitalized" institution, a bank must have a leverage
ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a
total risk-based ratio of no less than 10%, and the bank must not be under any
order or directive from the appropriate regulatory agency to meet and maintain a
specific capital level. As of December 31, 1997, both the Company and the Bank
qualified as "well-capitalized" institutions (see Note 8 to the Consolidated
Financial Statements).
The applicable federal bank regulatory agency can treat an institution as if it
were in the next lower category if the agency determines (after notice and an
opportunity for hearing) that the institution is in an unsafe or unsound
condition or is engaging in an unsafe or unsound practice. The degree of
regulatory scrutiny of a financial institution will increase, and the
permissible activities of the institution will decrease, as it moves downward
through the capital categories. Institutions that fall into one of the three
undercapitalized categories may be required to submit a capital restoration
plan, raise additional capital, restrict their growth, deposit interest rates
and other activities, improve their management, eliminate management fees to
parent holding companies, and even divest themselves of all or a part of their
operations. Bank holding companies can be called upon to boost their subsidiary
banks' capital and to partially guarantee the institutions' performance under
their capital restoration plans. If this occurs, capital which otherwise would
be available for holding company purposes, including possible distribution to
shareholders, would be required to be downstreamed to one or more subsidiary
banks.
Effect of Governmental Monetary Policies
The earnings of the Bank are affected by domestic economic conditions and the
monetary and fiscal policies of the United States government and its agencies.
The Federal Reserve's monetary policies have had, and will likely continue to
have, an important impact on the operating results of commercial banks through
its power to implement national monetary policy in order, among other things, to
curb inflation or combat a recession. The monetary policies of the Federal
Reserve have major effects upon the levels of bank loans, investments, deposits,
interest income and interest expense through its open market operations in
United States government securities and through its regulation of interest rates
and the reserve requirements against member bank deposits. It is not possible
to predict the nature or impact of future changes in monetary and fiscal
policies.
Item 2. Description of Property.
The Bank's main office is located in a seven-story office building at 36 Church
Avenue, SW, in downtown Roanoke, Virginia 24011. The Bank leases approximately
8,148 square feet of newly-renovated office space on the first floor of this
facility. The lease commenced April 1, 1995, and has an initial base term
expiring December 31, 1999, renewable for two five-year terms at the Bank's
option. Annual base rent on the leased space is $82,370, payable in equal
monthly installments of $6,864. The Bank also is responsible for paying a pro
rata share of certain operating costs associated with the leased space. Under
the lease, the Bank is granted a right of first refusal to lease approximately
2,900 square feet of space on the mezzanine level. The cost of leasehold
improvements to the leased premises, net of accumulated amortization, was
$220,606 at December 31, 1997.
The Bank's Starkey Road office is a newly-constructed 2,700 square foot building
located on a one-acre site at 4467 Starkey Road in southwest Roanoke County
(Tanglewood Mall area). The Company acquired the site for cash in the amount of
$272,250, and total cost of the facility constructed thereon, net of accumulated
depreciation, was $440,267 at December 31, 1997.
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The Bank's South Roanoke Office is a newly-renovated 914 square foot facility
that the Bank leases at a 1998 annual rate of $10,620, payable in equal monthly
installments of $885. The Bank is also responsible for utilities. The lease
commenced January 1, 1997, and has an initial term of twelve years with one
five-year renewal option. The cost of leasehold improvements to the leased
premises, net of accumulated amortization, was $9,603 at December 31, 1997.
The Salem loan production office is in a downtown building converted to office
suites. The Bank leases approximately 200 square feet for $100 per month on a
month-to-month lease.
In the opinion of management of the Company, its properties are adequate for its
current operations and adequately covered by insurance.
Item 3. Legal Proceedings.
Neither the Company nor the Bank is a party to, nor is any of their property the
subject of, any pending legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this report.
PART II.
Item 5. Market for Common Equity and Related Stockholder Matters.
Market Information. The Company's Articles of Incorporation authorize it to
issue up to 10,000,000 shares of Common Stock, no par value, of which 964,040
shares were issued and outstanding at March 24, 1998.
The Common Stock is quoted under the symbol VYFC on the OTC Bulletin Board, an
electronic quotation and trade reporting service of the National Association of
Securities Dealers. According to information obtained by Company management and
believed to be reliable, the quarterly range of closing prices per share for the
Common Stock during the last two fiscal years was as follows:
<TABLE>
<CAPTION>
1997 Quarter Ended High Close Low Close
------------- ---------- ---------
<S> <C> <C> <C>
03/31/97 $11.50 $9.75
06/30/97 $11.25 $10.00
09/30/97 $14.00 $10.00
12/31/97 $13.00 $11.00
1996 Quarter Ended High Close Low Close
------------- ---------- ---------
03/31/96 $11.25 $9.50
06/30/96 $10.625 $7.75
09/30/96 $11.00 $8.75
12/31/96 $11.00 $9.00
</TABLE>
Holders. At March 24, 1998, there were approximately 625 holders of record of
the Company's outstanding Common Stock.
11
<PAGE>
Dividends. The Company has not paid any dividends and does not anticipate
paying any cash dividends to shareholders in the near term. The Bank's and the
Company's earnings will be retained for several years following the Bank's
opening, and perhaps longer, to expand the Bank's capital base and to support
future growth. See "Supervision and Regulation" and Note 8 to the Consolidated
Financial Statements for restrictions on the payment of dividends.
Item 6. 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 years ended December
31, 1997 and 1996. 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. In July 1995, the Company completed its
initial public offering of 964,040 shares of its common stock, no par value, at
a price of $10.00 per share. The Offering resulted in gross proceeds to the
Company of $9,640, reduced by $551 of direct stock issuance costs associated
with the Offering, for net proceeds of $9,089. Of the net proceeds of the
Offering, $7,900 has been invested in the Bank as equity capital and the
remainder retained at the parent company for working capital needs and future
financial flexibility.
Total assets at December 31, 1997 were $74,677, up 44% from $51,743 at December
31, 1996. The principal components of the Company's assets at the end of the
period were $21,144 in securities available-for-sale and $46,647 in gross loans.
Total liabilities at December 31, 1997 were $66,398, up 50% from $44,390 one
year earlier, with the increase almost entirely represented by $21,971 growth in
deposits.
Total shareholders' equity at December 31, 1997 was $8,279, consisting of $9,089
in net proceeds from the Company's initial public offering, reduced by the
accumulated deficit of $866 and including $56 of unrealized gains on securities
available-for-sale, net of related deferred tax expense. At December 31, 1996,
total shareholder's equity was $7,353.
The Company had net income of $883 for the year ended December 31, 1997,
compared with a $714 net loss recorded for the year ended December 31, 1996.
The significant improvement in profitability results from higher net interest
income partially offset by increased noninterest expenses in virtually all
categories except compensation expense, as well as a $397 income tax benefit
associated with the recognition of deferred tax assets, including the Company's
available net operating loss carryforwards. The 1996 net loss would have been
significantly less except for total severance costs of $326 associated with the
termination of employment on June 20, 1996 of the Company's former President and
Chief Executive Officer.
Profitability as measured by the Company's return on average assets ("ROA") was
1.40% in 1997 and return on average equity ("ROE") was 11.79% in 1997. The loss
for 1996 makes comparison to the prior year not meaningful. Excluding the
income tax benefit referred to above, ROA in 1997 would have been .77% and ROE
would have been 6.48%.
12
<PAGE>
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 $2,295 for 1997 and is attributable to interest income
from loans and securities exceeding the cost of interest paid on deposits and
borrowed funds. 1997's net interest income increased 69% from $1,361 in 1996.
Total interest income was $4,806 for 1997, up $2,191 or 84% over $2,615 in 1996.
The increase is a result of the Bank's reinvestment of deposit growth into
loans and securities. The net interest margin was 3.80% for the year ended
December 31, 1997, a decline from the 4.09% reported for 1996. The decline in
the margin from year to year is attributable to higher deposit costs and a
smaller relative share of the Company's total funds being provided by capital
funds as rapid growth has occurred.
The following table presents the major categories of interest-earning assets,
interest-bearing liabilities and shareholders' equity with corresponding average
balances, related interest income or expense and resulting yields and rates for
the periods indicated.
<TABLE>
<CAPTION>
ANALYSIS OF NET INTEREST INCOME
Years Ended December 31,
----------------------------------------------------
1997 1996
------------------------- -------------------------
Average Interest Rate Average Interest Rate
Assets Balance Income Earned Balance Income Earned
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earnings assets:
Loans(2) $41,080 3,558 8.66% 23,703 2,031 8.57%
Investment securities:
Taxable 17,995 1,180 6.56% 8,128 505 6.21%
Money market investments 1,276 68 5.33% 1,410 79 5.60%
- ------------------------------------------- -----------------
Total interest-earning
assets 60,351 4,806 7.96% 33,241 2,615 7.87%
Other assets:
Reserve for loan
losses (400) (234)
Cash and due from
banks 2,437 2,569
Other assets, net 1,168 614
- ---------------------------------- --------
Total assets $63,556 $36,190
- ---------------------------------- --------
13
<PAGE>
Liabilities and Stockholders' Equity
- ------------------------------------------------------------------------------
Interest-bearing liabilities:
Savings and NOW $13,539 485 3.58% 6,453 215 3.33%
Time 36,541 2,017 5.52% 18,875 1,034 5.48%
Other borrowings 154 9 5.84% 94 5 5.72%
- ------------------------------------------- -----------------
Total interest-bearing
liabilities 50,234 2,511 5.00% 25,422 1,254 4.93%
Noninterest-bearing liabilities:
Demand deposits 4,931 2,617
Other liabilities 886 535
- --------------------------------- -------
Total liabilities 56,051 28,574
Stockholders' equity: 7,505 7,616
- --------------------------------- -------
Total liabilities and
stockholders' equity $63,556 $36,190
- --------------------------------- -------
Net interest income $ 2,295 $ 1,361
------- -------
Net interest margin(3) 3.80% 4.09%
----- -----
</TABLE>
- --------------------------
(1) Averages are daily averages.
(2) Loan interest income includes loan fees of $85 and $71 for the years 1997
and 1996, respectively.
(3) The net interest margin is calculated by dividing net interest income by
average total earning assets.
As discussed above, the Company's net interest income is affected by the change
in the amount and mix of interest-earning assets and interest-bearing
liabilities (referred to as "volume change") as well as by changes in yields
earned on interest-earning assets and rates paid on deposits and borrowed funds
(referred to as "rate change"). The following table presents, for the periods
indicated, a summary of changes in interest income and interest expense for the
major categories of interest-earning assets and interest-bearing liabilities and
the amounts of change attributable to variations in volumes and rates. Changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
14
<PAGE>
<TABLE>
<CAPTION>
RATE/VOLUME ANALYSIS(1)
Year Ended December 31,
------------------------------
1997 compared to 1996
Increase (Decrease)
------------------------------
Volume Rate Net
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest earned on interest-earning assets:
Loans $1,506 21 1,527
Investment securities:
Taxable 646 29 675
Money market investments (8) (3) (11)
- ------------------------------------------------------------------------------
Total interest earned on interest-earning
assets 2,144 47 2,191
- ------------------------------------------------------------------------------
Interest paid on interest-bearing liabilities:
Savings and NOW 253 17 270
Time 975 8 983
Other borrowings 3 1 4
- ------------------------------------------------------------------------------
Total interest paid on interest-bearing
liabilities 1,231 26 1,257
- ------------------------------------------------------------------------------
Change in net interest income $ 913 21 934
- ------------------------------------------------------------------------------
</TABLE>
- --------------------------
(1) 1997 and 1996 were the first full years of operations for the Company.
Provision for Loan Losses. A provision for loan losses of $131 was provided
during 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 charges against the
allowance for loan losses. The allowance for loan losses was $459 as of
December 31, 1997 and represents approximately .99% of net loans outstanding
(see Note 4 to the Consolidated Financial Statements). Provision expense was
$191 for 1996, and the allowance stood at .99% of net loans at December 31,
1996. The decline in provision expense is due to a slowing in 1997 of the sharp
loan growth rate experienced in 1996, the first full year of the Bank's
operations.
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 $178 in 1997 consisted of service
charges and fees on accounts and other miscellaneous income, and represented an
increase of $89 or 100% over the 1996 level. Future levels of noninterest
income are expected to increase as a direct result of business growth and
expansion.
Noninterest Expense. Noninterest expense for 1997 was $1,856, a decrease of
$117 or 6% over 1996. As previously mentioned, the decrease in noninterest
expense is almost entirely attributable to the recognition in 1996 of $326 in
compensation expense to reflect the Company's severance obligation to its former
President. Noninterest expenses are expected to increase in future years as a
direct result of business growth and expansion.
15
<PAGE>
Year 2000. Many banks and other companies are encountering various degrees of
difficulty and expense in modifying or replacing computer software and hardware
to adapt to the coming date changeover from 1999 to 2000. The Company, being
relatively new, enjoys an advantage with respect to Year 2000 issues in that its
hardware and software are newer versions better able to cope with the century
change. Additionally, the Company's major software applications are either
operated or maintained for it by outside vendors whose responsibility it is to
ensure Year 2000 compliance. The Company is continuing to review its operating
systems and obtain compliance representations from vendors, and does not expect
Year 2000 expenses to be material. However, should one or more of the Company's
major software vendors fail to make good on its representation to be Year 2000
compliant, there could be significant adverse consequences to the Company's
operations. The Company is also 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 the Year 2000 impact on its systems, its
operations could be jeopardized and its ability to repay outstanding loans
threatened.
Income Taxes. The Company recorded no expense in 1996 for federal or state
income taxes, due to the availability of net operating loss carryforwards. In
1997, the Company recognized an income tax benefit of $397 associated with
recognition of deferred tax assets, primarily relating to its available net
operating loss carryforwards. The Company anticipates utilizing the available
loss carryforwards in 1998 and incurring income tax expense in 1998.
Asset/Liability Management and Liquidity
Asset/liability management activities are designed to ensure that adequate
liquidity is 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 institution's 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 40% at December 31, 1997 and
38% at December 31, 1996. The Company sells excess funds as overnight federal
funds sold to provide an immediate source of liquidity. Federal funds sold at
December 31, 1997 was $1,440 compared to $2,762 at December 31, 1996.
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.
16
<PAGE>
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).
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 Bank's "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. Utilizing
this methodology and assuming a 200 basis point increase in prime, the Bank at
December 31, 1997 had a negative one-year gap of ($5,127) or 6.99% of total
assets. At that same date and assuming a 200 basis point decrease in prime, the
Bank had a positive one-year gap of $3,402 or 4.64% of total assets. The one-
year gaps under both interest rate scenarios are well within Company policy
parameters.
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.
17
<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 December 31, 1997 were $21,144, an increase of $9,560
or 83% from their level of $11,584 on December 31, 1996. The increase was due
to funds available from deposit growth exceeding loan growth.
<TABLE>
<CAPTION>
INVESTMENT PORTFOLIO - MATURITY DISTRIBUTION
December 31, 1997
------------------------------
Amortized Fair
Available-for-Sale Costs Values Yield
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. Government corporations:
Within one year $ 749 749 5.96%
After one but within five years 9,505 9,549 6.60%
After five years through ten years 5,545 5,545 7.01%
After ten years 2,888 2,912 7.15%
Obligations of states and subdivisions:
Within one year 544 545 5.89%
After one but within five years 768 773 6.42%
After five years through ten years 300 304 6.65%
After ten years -- -- --
Corporate securities:
After one but within five years 99 101 7.05%
Other securities(1) 661 666 6.60%
- -------------------------------------------------------------------
Total available-for-sale $21,059 21,144
- -------------------------------------------------------------------
</TABLE>
- ------------------------
(1) Assumed maturity after 10 years as amounts represent equity securities.
For more information on the investment portfolio, see Note 3 to the Consolidated
Financial Statements.
Loan Portfolio
The Company's total loans were $46,647 at December 31, 1997, an increase of
$13,165 or 39% from the $33,482 reported one year earlier. The Company's ratio
of net loans to total deposits stood at 70.4% at December 31, 1997 and 75.9% at
December 31, 1996. Management seeks to maintain the ratio of loans to deposits
in a range of 70% to 85%.
18
<PAGE>
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 28% of the loan
portfolio as of December 31, 1997, and stood at $12,997 versus $10,591 one year
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 23% of total
loans at December 31, 1997. Outstanding loans in this category equaled $10,812
and $8,182 at December 31, 1997 and 1996, 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
$13,502 in loans (29% of total loans) at December 31, 1997 and $10,101 in such
loans at December 31, 1996. 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 $9,336 (20% of total loans) at December 31, 1997 compared to
$4,608 one year earlier.
Loan Maturity and Interest Rate Sensitivity. The following table presents loan
portfolio information related to the maturity distribution of commercial loans
and real estate construction loans based on scheduled repayments at December 31,
1997.
<TABLE>
<CAPTION>
LOAN MATURITY
Due Within Due One to Due After
One Year Five Years Five Years Total
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Commercial and industrial
loans $6,484 4,435 2,078 12,997
Real estate-construction 189 67 -- 256
</TABLE>
19
<PAGE>
The following table presents the interest rate sensitivity of commercial loans
and real estate construction loans maturing after one year as of December 31,
1997.
INTEREST RATE SENSITIVITY
Fixed interest rates $4,702
Variable interest rates 1,878
- -----------------------------------------------------------------------
Total maturing after one year $6,580
- -----------------------------------------------------------------------
Nonperforming Assets. The Company had no nonperforming assets at December 31,
1997.
Allowance for Loan Losses. The allowance for loan losses was $459 as of
December 31, 1997 and represents approximately .99% of net loans outstanding.
The Bank had no nonperforming assets at December 31, 1997, and no loans still
accruing that were past due more than ninety days. Management believes the
allowance is adequate to provide for any inherent losses in the portfolio as of
December 31, 1997 and periodically evaluates the adequacy of the allowance
considering the specific nature of the portfolio, historical operating trends as
available and other economic and industry factors. See Note 4 to the
Consolidated Financial Statements.
Deposits
As of December 31, 1997, total deposits were $65,588, an increase of $21,971 or
50% from their level of $43,617 one year earlier. Average deposits were $55,165
for 1997, an increase of $27,126 or 97% over 1996's average deposits of $28,039.
The increase in average deposits during 1997 was primarily due to increases in
previously-existing accounts as well as new accounts opened during the year.
For the year ended December 31, 1997, average noninterest-bearing demand
deposits were $4,931 or 9% of average total deposits. For the prior year,
average noninterest-bearing demand deposits were $2,617, also 9% of average
total deposits. Nonmaturity deposits (noninterest-bearing demand deposits,
interest-bearing demand deposits, money market accounts and savings accounts)
averaged $18,470 or 34% of average total deposits in 1997, up from $9,070 or 32%
of average total deposits in 1996. Total interest-bearing deposits averaged
$50,080 for the year ended December 31, 1997, an increase of $24,752 or 98% over
their level of $25,328 for the year ended December 31, 1996.
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. Through these pricing and
marketing strategies, management in 1997 was successful in reducing the ratio of
certificates of deposit to total deposits from 71% at December 31, 1996 to 59%
at December 31, 1997.
The following table presents the maturity schedule of certificates of deposit of
$100,000 or more as of December 31, 1997.
CERTIFICATES OF DEPOSIT OVER $100,000
Three months or less $1,468
Over three through six months 1,135
Over six through 12 months 2,367
Over 12 months 1,511
- ----------------------------------------------------------------------
Total $6,481
- ----------------------------------------------------------------------
20
<PAGE>
Financial Ratios
The following table presents certain financial ratios for the periods indicated.
<TABLE>
<CAPTION>
RETURN ON EQUITY AND ASSETS
Years Ended
December 31,
---------------------------
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Return on average assets 1.40% (1)
Return on average equity 11.79% (1)
Average equity to average assets 11.84% 21.15%
</TABLE>
- --------------------------
(1) Not meaningful due to net loss in 1996.
Capital Resources
The Company's financial position at December 31, 1997 reflects liquidity and
capital levels currently adequate to fund anticipated future 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. See "Supervision and Regulation - Capital
Regulations" and Note 8 to the Consolidated Financial Statements.
Total shareholders' equity was $8,279 at December 31, 1997 compared with $7,353
at December 31, 1996, an increase of $926 or 13%. The increase is attributable
to 1997's net income of $883 and a $43 increase in unrealized gains on
available-for-sale investment securities over their level at December 31, 1996.
Future Accounting Considerations
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income, and No. 131, Disclosures about Segments of an Enterprise
and Related Information. Statement 130 establishes standards for reporting and
display of comprehensive income and was issued to address concerns over the
practice of reporting elements of income directly in equity. Statement 131
requires disclosures about operating segments, products, services, geographic
areas and major customers. Both statements are effective for fiscal years
beginning after December 15, 1997 and are not expected to have a material effect
on consolidated financial position or results of operations; however, Statement
130 will result in a modification of the Company's future financial statement
displays.
21
<PAGE>
Item 7. Financial Statements and Supplementary Data.
Index to Financial Statements
Independent Auditors' Report 23
Consolidated Balance Sheets as of December 31, 1997
and 1996 24
Consolidated Statements of Income (Loss) for the Years
Ended December 31, 1997 and 1996 25
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1997 and 1996 26
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997 and 1996 27
Notes to Consolidated Financial Statements 28
22
<PAGE>
Independent Auditors' Report
The Board of Directors
Valley Financial Corporation:
We have audited the accompanying consolidated balance sheets of Valley Financial
Corporation and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income (loss), shareholders' equity and cash flows
for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Valley Financial
Corporation and subsidiary as of December 31, 1997 and 1996, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
January 23, 1998
23
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
Consolidated Balance Sheets
December 31, 1997 and 1996
(In thousands, except share data)
- ------------------------------------------------------------------------------
Assets 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks (notes 2 and 12) $ 3,324 2,149
Money market investments (note 12):
Federal funds sold 1,440 2,762
Interest-bearing deposits in other banks 33 29
Securities available-for-sale (notes 3 and 12) 21,144 11,584
Loans (notes 4 and 12):
Commercial loans 12,997 10,591
Commercial real estate loans 10,812 8,182
Residential real estate loans 13,502 10,101
Loans to individuals 9,336 4,608
- ------------------------------------------------------------------------------
Total loans 46,647 33,482
Less unearned fees (38) (33)
Less allowance for loan losses (459) (328)
- ------------------------------------------------------------------------------
Loans, net 46,150 33,121
- ------------------------------------------------------------------------------
Premises and equipment, net (note 5) 1,315 1,397
Accrued interest receivable 636 374
Other assets 501 134
Organizational expenses, net 134 193
- ------------------------------------------------------------------------------
Total assets $74,677 51,743
- ------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
- ------------------------------------------------------------------------------
Noninterest-bearing deposits 7,956 3,514
Interest-bearing demand deposits 18,395 9,063
Savings deposits 653 299
Time deposits greater than $100,000 (note 14) 6,481 4,442
Other time deposits (note 14) 32,103 26,299
- ------------------------------------------------------------------------------
Total deposits (note 12) 65,588 43,617
Accrued interest payable 510 432
Other liabilities (note 13) 300 341
- ------------------------------------------------------------------------------
Total liabilities 66,398 44,390
- ------------------------------------------------------------------------------
Shareholders' equity (notes 3, 7 and 8):
Preferred stock, no par value. Authorized
10,000,000 shares; none issued -- --
Common stock, no par value. Authorized
10,000,000 shares; issued and outstanding
964,040 shares 9,089 9,089
Accumulated deficit (866) (1,749)
Unrealized gains on securities available-for-
sale, net of deferred tax expense of $29 and
$7 for 1997 and 1996, respectively 56 13
- ------------------------------------------------------------------------------
Total shareholders' equity 8,279 7,353
Commitments and other matters (notes 3, 5, 7,
8, 11 and 13)
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity $74,677 51,743
- ------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Income (Loss)
Years Ended December 31, 1997 and 1996
(In thousands, except share and per share data)
- ------------------------------------------------------------------------------
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 3,558 2,031
Interest on securities available-for-sale 1,180 505
Interest on money market investments 68 79
- ------------------------------------------------------------------------------
Total interest income 4,806 2,615
- ------------------------------------------------------------------------------
Interest expense:
Interest on certificates of deposit of $100,000
or more 309 175
Interest on other deposits 2,193 1,074
Interest on other borrowed funds 9 5
- ------------------------------------------------------------------------------
Total interest expense 2,511 1,254
- ------------------------------------------------------------------------------
Net interest income 2,295 1,361
Provision for loan losses (note 4) 131 191
- ------------------------------------------------------------------------------
Net interest income after provision for loan losses 2,164 1,170
Noninterest income:
Service charges on deposit accounts 117 57
Gain on sale of securities 2 1
Other income 59 31
- ------------------------------------------------------------------------------
Total noninterest income 178 89
Noninterest expense:
Personnel (note 13) 917 1,117
Occupancy 166 144
Data processing and equipment expenses 212 187
Advertising and promotion 112 79
Supplies 51 37
Amortization of organizational expenses 59 57
Other expense 339 352
- ------------------------------------------------------------------------------
Total noninterest expense 1,856 1,973
- ------------------------------------------------------------------------------
Income (loss) before income taxes 486 (714)
Income tax benefit (note 6) 397 --
- ------------------------------------------------------------------------------
Net income (loss) $ 883 (714)
- ------------------------------------------------------------------------------
Net income (loss) per share $ .92 (.74)
- ------------------------------------------------------------------------------
Weighted average common shares outstanding 964,040 964,040
- ------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 1997 and 1996
(In thousands, except share data)
- ------------------------------------------------------------------------------
Unrealized
Gains on
Securities Total
Common Common Accumulated Available- Shareholders'
Shares Stock Deficit for-Sale Equity
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at December
31, 1995 964,040 $9,089 (1,035) 11 8,065
Net loss -- -- (714) -- (714)
Unrealized gains
on securities
available-for-sale,
net of deferred tax
expense of $2 -- -- -- 2 2
- ------------------------------------------------------------------------------
Balances at December
31, 1996 964,040 9,089 (1,749) 13 7,353
Net income -- -- 883 -- 883
Unrealized gains
on securities
available-for-sale,
net of deferred tax
expense of $22 -- -- -- 43 43
- ------------------------------------------------------------------------------
Balances at December
31, 1997 964,040 $9,089 (866) 56 8,279
- ------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
Years Ended December 31, 1997 and 1996
(In thousands)
- ------------------------------------------------------------------------------
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 883 (714)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Provision for loan losses 131 191
Depreciation and amortization of premises
and equipment 147 131
Deferred income tax (397) --
Amortization of organizational expenses 59 57
Gain on sale of securities (2) (1)
Amortization (accretion) of premiums/
discounts, net (11) 16
Increase in unearned fees 5 33
Increase in accrued interest receivable (262) (234)
(Increase) decrease in other assets 8 3
Increase in accrued interest payable 78 306
Increase (decrease) in other liabilities (41) 292
- ------------------------------------------------------------------------------
Net cash provided by operating activities 598 80
- ------------------------------------------------------------------------------
Cash flows from investing activities:
Net (increase) decrease in money market investments 1,318 (400)
Purchases of premises and equipment (65) (76)
Purchases of securities available-for-sale (18,011) (9,623)
Proceeds from sales, calls and maturities of
securities available-for-sale 8,529 3,311
Increase in loans, net (13,165) (19,659)
- ------------------------------------------------------------------------------
Net cash used in investing activities (21,394) (26,447)
- ------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in time deposits greater than $100,000 2,039 2,771
Increase in other time deposits 5,804 18,923
Net increase in other deposits 14,128 5,806
- ------------------------------------------------------------------------------
Net cash provided by financing activities 21,971 27,500
- ------------------------------------------------------------------------------
Net increase in cash and due from banks 1,175 1,133
Cash and due from banks at beginning of year 2,149 1,016
- ------------------------------------------------------------------------------
Cash and due from banks at end of year $ 3,324 2,149
- ------------------------------------------------------------------------------
Supplemental disclosure of cash flows information:
Cash paid during the year for interest $ 2,433 948
- ------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
(1) Summary of Significant Accounting Policies
General
The accounting and reporting policies of Valley Financial Corporation ("the
Company") and Valley Bank N.A. ("the Bank") conform to generally accepted
accounting principles and to general banking industry practices. The Bank
provides traditional commercial banking services concentrated primarily in
the Roanoke Valley. The Bank does not currently offer trust services;
however, the Bank does refer customers to a provider of trust services in
exchange for a fee.
The following is a summary of the more significant accounting policies:
Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary, the Bank, collectively referred to
hereinafter as the Corporation. All significant intercompany balances and
transactions have been eliminated.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks.
Securities
Investments are classified in three categories and accounted for as
follows: (1) debt securities that the Corporation has the positive intent
and ability to hold to maturity are classified as "securities held-to-
maturity" and reported at amortized cost; (2) debt and equity securities
that are bought and held principally for the purpose of selling them in the
near term are classified as "trading securities" and reported at fair
value, with unrealized gains and losses included in net income; and (3)
debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as "securities available-
for-sale" and reported at fair value, with unrealized gains and losses
excluded from net income (loss) and reported in a separate component of
shareholders' equity.
The Corporation does not currently maintain a trading securities portfolio
and there were no securities classified as held-to-maturity at December 31,
1997 or 1996. Gains or losses on disposition, if any, are based on the net
proceeds and adjusted carrying values of the securities called or sold,
using the specific identification method. A decline in value of any
available-for-sale or held-to-maturity security below cost deemed other
than temporary is charged directly to net income (loss), resulting in the
establishment of a new cost basis for the security.
28
<PAGE>
Loans, Allowance for Loan Losses, Loan Fees and Costs
Loans are stated at the amount of unpaid principal, reduced by unearned
fees on loans, and an allowance for loan losses. Income is recognized over
the terms of the loans using methods which approximate the level yield
method. The allowance for loan losses is a valuation allowance consisting
of the cumulative effect of the provision for loan losses, plus any amounts
recovered on loans previously charged off, minus loans charged off. The
provision for loan losses charged to operating expenses is the amount
necessary in management's judgment to maintain the allowance for loan
losses at a level it believes sufficient to cover losses in the collection
of its loans. Management determines the adequacy of the allowance based
upon reviews of individual credits, recent loss experience, delinquencies,
current economic conditions, the risk characteristics of the various
categories of loans and other pertinent factors. Loans are charged against
the allowance for loan losses when management believes the collectibility
of the principal is unlikely. While management uses available information
to recognize losses on loans, future additions to the allowance for loan
losses may be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan
losses. Such agencies may require the Bank to recognize additions to the
allowance for loan losses based on their judgments about information
available to them at the time of their examinations.
Interest related to nonaccrual loans is recognized on the cash basis.
Loans are generally placed in nonaccrual status when the collection of
principal and interest is 90 days or more past due, unless the obligation
is both well-secured and in the process of collection.
Impaired loans are presented in the financial statements at the present
value of the expected future cash flows or at the fair value of the loan's
collateral. Homogeneous loans such as real estate mortgage loans,
individual consumer loans, home equity loans and bankcard loans are
evaluated collectively for impairment. Management, considering current
information and events regarding the borrowers ability to repay their
obligations, considers a loan to be impaired when it is probable that the
Bank will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Impairment losses are included in the
allowance for loan losses through a charge to the provision for loan
losses. Cash receipts on impaired loans receivable are applied first to
reduce interest on such loans to the extent of interest contractually due
and any remaining amounts are applied to principal.
Loan origination and commitment fees and certain direct loan origination
costs charged by the Bank are deferred and the net amount amortized as an
adjustment of the related loan's yield over the contractual life of the
related loan or, in the case of demand loans, over the estimated life. Net
fees related to letters of credit are recognized over the commitment
period.
29
<PAGE>
Premises and Equipment
Premises and equipment are stated at cost, net of accumulated depreciation
and amortization. Depreciation on buildings, equipment, furniture and
fixtures, and amortization of leasehold improvements is computed by
straight-line or accelerated methods over the shorter of the estimated
useful lives of the assets or the related lease term. Estimated useful
lives for assets include land improvements and leasehold improvements, 3 to
15 years, buildings, 31.5 years, and furniture, fixtures and equipment, 3
to 10 years. The cost of assets retired and sold and the related
accumulated depreciation and amortization are eliminated from the accounts
and the resulting gains or losses are included in determining net income
(loss). Expenditures for maintenance and repairs are charged to expense as
incurred, and improvements and betterments are capitalized.
Organizational Costs
Organizational costs incurred during the development stage of the
Corporation have been capitalized and are being amortized using the
straight-line method over five years.
Income Taxes
Income taxes are accounted for under the asset and liability method,
whereby deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized
in net income (loss) in the period that includes the enactment date.
Stock Options
The Corporation accounts for its stock option plan in accordance
with the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As
such, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price.
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which
permits entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant. Alternatively, SFAS
No. 123 also allows entities to continue to apply the provisions of APB
Opinion No. 25 and provide pro forma net income (loss) and pro forma
earnings per share disclosures for employee stock option grants made in
30
<PAGE>
1995 and future years as if the fair-value-based method defined in SFAS
No. 123 had been applied. The Company has elected to continue to apply
the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
Net Income (Loss) Per Share
Net income (loss) per share of common stock is computed based on the
weighted average number of common shares outstanding for the year. The
weighted average number of common shares outstanding was 964,040 for 1997
and 1996.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, Earnings per Share. Statement
128 establishes new standards for computing and presenting earnings per
share (EPS) and applies to entities with publicly held common stock or
potential common stock. It replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement for all entities with
complex capital structures and requires a reconciliation of the numerator
and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available to
common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance
of common stock that then shared in the earnings of the entity. Statement
128 was adopted by the Company at December 31, 1997. The Statement
requires restatement of prior years EPS data previously presented.
Adoption of this Statement did not have any effect on current or prior
years' EPS data presented. Diluted EPS is not materially different from
basic EPS.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into off-balance-
sheet financial instruments consisting of commitments to extend credit and
standby letters of credit. Such financial instruments are recorded in the
financial statements when they become payable.
31
<PAGE>
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
The Bank adopted the provisions of Statement No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, on January 1, 1997. This Statement provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on consistent application of a
financial-components approach that focuses on control. Under that
approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has
incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. This Statement provides
consistent standards for distinguishing transfers of financial assets that
are sales from transfers that are secured borrowings. This Statement also
provides implementation guidance for assessing isolation of transferred
assets and for accounting for transfers of partial interests, servicing of
financial assets, securitizations, transfers of sales-type and direct
financing lease receivables, securities lending transactions, repurchase
agreements including "dollar rolls," "wash sales," loan syndications and
participations, risk participations in banker's acceptances, factoring
arrangements, transfers of receivables with recourse, and extinguishments
of liabilities. Statement No. 127, Deferral of the Effective Date of
Certain Provisions of Statement 125, issued in December 1996, deferred
until January 1, 1998 the effective date (a) of paragraph 15 of Statement
125 and (b) for repurchase agreement, dollar-roll, securities lending, and
similar transactions, of paragraphs 9 - 12 and 237(b) of Statement 125.
Statement 125 was required to be adopted on a prospective basis and its
adoption did not have a material impact on the Bank's financial position,
results of operations or liquidity.
Use of Estimates
In preparing the consolidated financial statements, management is required
to make certain estimates, assumptions and loan evaluations that effect its
consolidated financial statements for the period. Actual results could
vary significantly from those estimates.
Changing economic conditions, adverse economic prospects for borrowers, as
well as regulatory agency action as a result of an examination, could cause
the Bank to recognize additions to the allowance for loan losses.
Recent Accounting Developments
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,
32
<PAGE>
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.
This Statement requires all items that are required to be 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 than 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 a statement of financial position. 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. Earlier application is permitted. 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 will not have any effect on
the Bank's consolidated financial position, results of operation or
liquidity. However, Statement 130 will have an effect on future financial
statement displays presented by the Company since the Company has net
unrealized gains (losses) on securities available for sale, an item of
other comprehensive income, which is included in the consolidated
statements of shareholders' equity.
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments
of an Enterprise and Related Information. Statement 131 establishes
standards for the way public business enterprises are to report information
about operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. Statement 131 is effective for financial
statements for periods beginning after December 15, 1997. It is not
anticipated that Statement 131 will have any material effect on current or
prior period disclosures presented by the Company.
(2) Restrictions on Cash
To comply with Federal Reserve regulations, the Bank will be required to
maintain certain average reserve balances. There were no daily reserve
requirements for the weeks including December 31, 1997 and 1996 as the Bank
had not met minimum average deposit levels under the current provisions of
the regulations.
33
<PAGE>
(3) Securities
The amortized costs, gross unrealized gains and losses, and approximate
fair values of securities available-for-sale as of December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997
-------------------------------------------------
Gross Gross Approximate
Amortized Unrealized Unrealized Fair
Costs Gains Losses Values
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury $ 200 -- -- 200
U.S. Government agencies and
corporations 18,487 84 (16) 18,555
States and political
subdivisions 1,612 10 -- 1,622
Corporate obligations 99 2 -- 101
Other securities 661 5 -- 666
- ------------------------------------------------------------------------------
Total securities available-
for-sale $21,059 101 (16) 21,144
- ------------------------------------------------------------------------------
1996
-------------------------------------------------
U.S. Treasury 951 1 -- 952
U.S. Government agencies and
corporations 8,599 37 (21) 8,615
States and political
subdivisions 748 2 (1) 749
Corporate obligations 1,005 2 -- 1,007
Other securities 261 -- -- 261
- ------------------------------------------------------------------------------
Total securities available-
for-sale $11,564 42 (22) 11,584
- ------------------------------------------------------------------------------
</TABLE>
The amortized costs and approximate fair values of available-for-sale
securities as of December 31, 1997, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
Approximate
Amortized Fair
Costs Values
- ------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 1,293 1,294
Due after one year through five years 10,372 10,423
Due after five years through ten years 5,845 5,847
Due after ten years 3,549 3,580
- ------------------------------------------------------------------------------
Total $21,059 21,144
- ------------------------------------------------------------------------------
</TABLE>
Securities with amortized costs of $200 as of December 31, 1997 and 1996,
were pledged as collateral for public deposits and for other purposes as
required or permitted by law.
34
<PAGE>
(4) Loans and Allowance for Loan Losses
In the normal course of business, the Bank has made loans to officers,
directors and/or related interests. At December 31, 1997 and 1996, $3,091
and $3,713, respectively, represented direct loans to officers and
directors and $1,778 and $1,324, respectively, represented loans made to
related interests of officers or directors and/or endorsed by officers or
directors.
The following table will summarize activity and amounts receivable from
officers, directors and/or related interests:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Balances at beginning of year $5,037 3,566
Additions 1,387 2,360
Repayments (1,555) (889)
-------------------------------------------------------------------------
Balances at end of year $4,869 5,037
-------------------------------------------------------------------------
</TABLE>
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Balances at beginning of year $328 137
Provision for loan losses 131 191
-------------------------------------------------------------------------
Balances at end of year $459 328
-------------------------------------------------------------------------
</TABLE>
As of December 31, 1997 and 1996, the Bank had no significant past due
loans greater than 90 days and no loans considered to be impaired. During
1997 and 1996, there were no loan amounts charged off.
(5) Premises and Equipment
Components of premises and equipment and total accumulated depreciation and
amortization as of December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 293 293
Building 477 477
Furniture, fixtures and equipment 585 523
Leasehold improvements 310 298
Construction in progress -- 9
-------------------------------------------------------------------------
1,665 1,600
Less accumulated depreciation and amortization 350 203
-------------------------------------------------------------------------
$1,315 1,397
-------------------------------------------------------------------------
</TABLE>
35
<PAGE>
The Bank currently leases its main office location under a noncancellable
operating lease. The lease for the main office has an original term of
five years with the option of two additional renewal terms of five years
each. In addition, the Bank has entered into a lease for a branch location
which opened in January 1997. The property under lease is owned by a
family member of a director, however, the terms of the agreement are
comparable to current market rates. The original lease term is for twelve
years with an option to renew for one additional five-year term. Rental
expenses under operating leases were approximately $93 and $82 for 1997 and
1996, respectively. Future minimum lease payments under noncancellable
operating leases were as follows at December 31, 1997:
1998 $ 93
1999 93
2000 32
2001 12
2002 12
Subsequent years 84
----------------------------
$326
----------------------------
(6) Income Taxes
Total income tax expense (benefit) for the years ended December 31, 1997
and 1996 are allocated as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Income $(397) --
Stockholders' equity for unrealized gains
on available-for-sale securities recognized
for financial statement purposes 22 2
-------------------------------------------------------------------------
$(375) 2
-------------------------------------------------------------------------
Income tax expense (benefit) consists of:
Current -- --
Deferred 397 --
-------------------------------------------------------------------------
$ 397 --
-------------------------------------------------------------------------
</TABLE>
36
<PAGE>
Total income tax expense (benefit) differed from the "expected" amount
computed by applying the U.S. Federal income tax rate of 34 percent to
income (loss) before income taxes as a result of the following:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Computed "expected" tax expense (benefit) $ 165 (243)
Increase (decrease) in income taxes resulting
from:
Increase (decrease in beginning-of-the-year
balance of the valuation allowance for
deferred tax assets (585) 240
Other 23 3
-------------------------------------------------------------------------
Reported income tax expense (benefit) $(397) --
-------------------------------------------------------------------------
</TABLE>
The significant components of deferred income tax expense (benefit) for the
years ended December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Deferred income tax expense (benefit) (exclusive
of the effects of other components below) $ 57 (240)
Utilization of loss carryforward 131 --
Increase (decrease) in beginning of the year
balance of the valuation allowance for
deferred tax assets (585) 240
-------------------------------------------------------------------------
$(397) --
-------------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $176 307
Loans, principally due to allowance for
loan losses 145 77
Preopening expenses due to capitalization
for tax purposes 89 127
Other 36 95
-------------------------------------------------------------------------
Total gross deferred tax assets 446 606
Less valuation allowance -- 585
-------------------------------------------------------------------------
Net deferred tax assets 446 21
-------------------------------------------------------------------------
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Net unrealized gains on available-for-sale
securities 29 7
Other 20 14
-------------------------------------------------------------------------
Total gross deferred tax liabilities 49 21
-------------------------------------------------------------------------
Net deferred tax assets $397 --
-------------------------------------------------------------------------
</TABLE>
The net change in the total valuation allowance for 1997 and 1996 was a
decrease of $585 and an increase of $240, respectively. In assessing the
realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods
in which those temporary differences become deductible and loss
carryforwards become utilized. Management considers the scheduled reversal
of deferred tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. Based upon projections for
future taxable income over the periods in which the deferred tax assets are
deductible, management is able to conclude it is more likely than not the
Corporation will realize the benefits of these deductible differences and
loss carryforwards and, accordingly, a corresponding valuation allowance
for net deferred tax assets is not considered necessary at December 31,
1997.
At December 31, 1997, the Corporation has net operating loss carryforwards
for income tax purposes of approximately $517 available to offset future
taxable income. If not utilized, these loss carryforwards will expire in
2010 and 2011.
(7) Stock Options
The Company has an Incentive Stock Option Plan (the Plan) pursuant to which
the Company's Board of Directors may grant stock options to officers and
key employees. The Plan authorizes grants of options to purchase up to
99,000 shares of the Company's authorized, but unissued common stock.
Accordingly, 99,000 shares of authorized, but unissued common stock are
reserved for use in the Plan. All stock options have been granted with an
exercise price equal to the stock's fair market value at the date of grant.
38
<PAGE>
Stock options generally have 10-year terms, vest at the rate of 20
percent per year, and become fully exercisable five years from the date
of grant. In addition, certain options for 28,920 shares based on
meeting certain performance criteria were granted to officers during 1997.
The per share weighted average fair value of stock options granted during
1997 and 1996 was $5.20 and $5.24, respectively, on the date of grant
utilizing the Black-Scholes option-pricing model with the following
weighted average assumptions:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Expected dividend yield 0% 0%
Risk-free interest rate 6.5% 6.5%
Expected life of options 7.5 years 7.5 years
Expected volatility of stock price 30% 30%
</TABLE>
As previously mentioned, the Company applies APB Opinion No. 25 in
accounting for its Plan and, accordingly, no compensation cost has been
recognized for its stock options in the consolidated financial statements.
Had the Company determined compensation cost based on the fair value of
its stock options at the grant date under SFAS No. 123, the Company's net
income (loss) and net income (loss) per share would have increased to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
---------------------------------------------------------
<S> <C> <C>
Net income (loss):
As reported $883 (714)
Pro forma 829 (729)
Net income (loss) per share:
As reported $.92 (.74)
Pro forma .86 (.76)
</TABLE>
39
<PAGE>
Stock option activity during the years ended December 31, 1997 and 1996 is
as follows:
<TABLE>
<CAPTION>
Weighted Average
Number of Shares Exercise Price
-------------------------------------------------------------------------
<S> <C> <C>
Balance at December 31, 1995 7,750 $10
Granted 9,000 $9.03
Expired/forfeited (2,000) $10
----------------------------------------------------
Balance at December 31, 1996 14,750 $9.24
Granted 38,920 $10.06
Expired/forfeited (2,000) $10.25
----------------------------------------------------
Balance at December 31, 1997 51,670 $9.83
-------------------------------------------------------------------------
</TABLE>
At December 31, 1997, the range of exercise prices and weighted average
remaining contractual life of outstanding options was $8.75 - $10.25 and
8.6 years, respectively.
At December 31, 1997 and 1996, the number of options exercisable was 37,570
and 4,100, respectively, and the weighted average exercise price of those
options was $9.92 and $9.57, respectively.
(8) Restrictions on Payments of Dividends and Capital Requirements
The Company's principal source of funds for dividend payments is dividends
received from the Bank. Under applicable federal laws, the Comptroller of
the Currency, without prior approval, restricts the total dividend payments
of the Bank in any calendar year to the net profits of that year, as
defined, combined with the retained net profits for the two preceding
years. As of December 31, 1997, the Bank is in a deficit position, and,
accordingly, no amounts are available for dividends without prior approval
of the Comptroller of the Currency.
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could
have a direct material effect on the Corporation's consolidated financial
statements. Under capital adequacy guidelines and the regulatory
40
<PAGE>
framework for prompt corrective action, the Company and the Bank must
meet specific capital guidelines that involve quantitative measures of
their assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Company's and
the Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank 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). Management believes,
as of December 31, 1997, that the Company and the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from Office of the
Comptroller of the Currency categorized the Company and the Bank as well
capitalized under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, the Company and the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage
ratios as set forth in the table below. There are no conditions or events
since that notification that management believes have changed the Company's
or the Bank's category.
The Company's and the Bank's actual capital amounts and ratios are also
presented in the table below.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Total Capital
(to Risk Weighted Assets):
Consolidated $8,548 16.54% 4,134 8.0% N/A N/A
Valley Bank, N.A. 7,285 14.25% 4,090 8.0% 5,114 10.0%
Tier I Capital
(to Risk Weighted Assets):
Consolidated 8,089 15.65% 2,067 4.0% N/A N/A
Valley Bank, N.A. 6,826 13.35% 2,045 4.0% 3,068 6.0%
Tier I Capital (Leverage)
(to Average Assets):
Consolidated 8,089 11.50% 2,813 4.0% N/A N/A
Valley Bank, N.A. 6,826 9.88% 2,764 4.0% 3,454 5.0%
41
<PAGE>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------
As of December 31, 1996:
Total Capital
(to Risk Weighted Assets):
Consolidated $7,475 20.4% 2,931 8.0% N/A N/A
Valley Bank, N.A. 6,339 17.5% 2,901 8.0% 3,626 10.0%
Tier I Capital
(to Risk Weighted Assets):
Consolidated 7,147 19.5% 1,466 4.0% N/A N/A
Valley Bank, N.A. 6,011 16.6% 1,450 4.0% 2,176 6.0%
Tier I Capital (Leverage)
(to Average Assets):
Consolidated 7,147 15.0% 1,912 4.0% N/A N/A
Valley Bank, N.A. 6,011 13.3% 1,813 4.0% 2,266 5.0%
</TABLE>
(9) Parent Company Financial Information
Condensed financial information of Valley Financial Corporation is
presented below:
<TABLE>
<CAPTION>
Condensed Balance Sheets
December 31, 1997 and 1996
December 31,
--------------------------
Assets 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 134 179
Securities available-for-sale 1,206 1,183
Investment in subsidiary, at equity 6,949 6,183
Other assets 132 70
- ------------------------------------------------------------------------------
Total assets $8,421 7,615
- ------------------------------------------------------------------------------
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------
Liabilities and Shareholders' Equity 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Other liabilities $ 142 262
- ------------------------------------------------------------------------------
Total liabilities 142 262
- ------------------------------------------------------------------------------
Shareholders' equity (notes 3, 7 and 8):
Preferred stock, no par value. Authorized 10,000,000
shares; none issued -- --
Common stock of no par value. Authorized 10,000,000
shares; issued and outstanding 964,040 shares 9,089 9,089
Accumulated deficit (866) (1,749)
Unrealized gains on securities available-for-sale,
net of deferred tax expense of $29 and $7 for 1997
and 1996, respectively 56 13
- ------------------------------------------------------------------------------
Total shareholders' equity 8,279 7,353
Commitments and other matters (notes 3, 5, 7,
8, 11 and 13)
- ------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 8,421 7,615
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Condensed Statements of Income (Loss)
Years Ended December 31, 1997 and 1996
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Income:
Interest income $ 81 85
- ------------------------------------------------------------------------------
Expenses:
Other expenses 45 367
- ------------------------------------------------------------------------------
45 367
- ------------------------------------------------------------------------------
Income (loss) before income taxes and equity in
undistributed net income (loss) of subsidiary 36 (282)
Income tax benefit 81 --
- ------------------------------------------------------------------------------
Income (loss) before equity in undistributed net
income (loss) of subsidiary 117 (282)
Equity in net income (loss) of subsidiary 766 (432)
- ------------------------------------------------------------------------------
Net income (loss) $883 (714)
- ------------------------------------------------------------------------------
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
Condensed Statements of Cash Flows
Years Ended December 31, 1997 and 1996
1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 883 (714)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Equity in net income (loss) of subsidiary (766) 432
Amortization of other assets 10 10
(Increase) decrease in other assets (72) 63
Increase (decrease) in other liabilities (120) 218
- ------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (65) 9
- ------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of securities available-for-sale (630) (522)
Proceeds from sales, maturities and calls
of securities available-for-sale 650 553
- ------------------------------------------------------------------------------
Net cash provided by investing activities 20 31
- ------------------------------------------------------------------------------
Net increase (decrease) in cash (45) 40
Cash at beginning of year 179 139
- ------------------------------------------------------------------------------
Cash at end of year $ 134 179
- ------------------------------------------------------------------------------
</TABLE>
(10) Financial Instruments with Off-Balance-Sheet Risk
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and
standby letters of credit. These instruments may involve, to varying
degrees, credit risk in excess of the amount recognized in the balance
sheets. The contract amounts of these instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments.
Credit risk is defined as the possibility of sustaining a loss because the
other parties to a financial instrument fail to perform in accordance with
the terms of the contract. The Bank's maximum exposure to credit loss
under commitments to extend credit and standby letters of credit is
represented by the contractual amount of these instruments. The Bank uses
the same credit policies in making commitments and conditional obligations
as it does for on-balance-sheet instruments.
44
<PAGE>
The Bank requires collateral to support financial instruments when it is
deemed necessary. The Bank evaluates customers' creditworthiness on a
case-by-case basis. The amount of collateral obtained upon extension of
credit is based on management's credit evaluation of the customer.
Collateral may include deposits held in financial institutions, U.S.
Treasury securities, other marketable securities, real estate, accounts
receivable, inventory, and property, plant and equipment.
Financial instruments whose contract amounts represent credit risk as of
December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------
<S> <C> <C>
Commitments to extend credit $9,248 7,296
-------------------------------------------------------------------------
Standby letters of credit $ 795 482
-------------------------------------------------------------------------
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Commitments may be at fixed or
variable rates and generally expire within one year. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. These guarantees
are primarily issued to support public and private borrowing arrangements,
including bond financing and similar transactions. Unless renewed,
substantially all of the Bank's credit commitments at December 31, 1997
will expire within one year. Management does not anticipate any material
losses as a result of these transactions. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loans to customers.
(11) Concentrations of Credit Risk
The Bank grants commercial, residential and consumer loans to customers
primarily in the Roanoke Valley area. The Bank has a diversified loan
portfolio which is not dependent upon any particular economic or industry
sector. As a whole, the portfolio could be affected by general economic
conditions in the Roanoke Valley region.
45
<PAGE>
A detailed composition of the Bank's loan portfolio is provided in the
consolidated financial statements. The Bank's commercial loan portfolio is
diversified, with no significant concentrations of credit. Commercial real
estate loans are generally collateralized by the related property. The
residential real estate loan portfolio consists principally of loans
collateralized by 1-4 family residential property. The loans to
individuals portfolio consists of consumer loans primarily for home
improvements, automobiles, personal property and other consumer purposes.
These loans are generally collateralized by the related property. Overall,
the Bank's loan portfolio is not concentrated within a single industry or
group of industries, the loss of any one or more of which would generate a
materially adverse impact on the business of the Bank.
The Bank has established operating policies relating to the credit process
and collateral in loan originations. Loans to purchase real and personal
property are generally collateralized by the related property. Credit
approval is principally a function of collateral and the evaluation of the
creditworthiness of the borrower based on available financial information.
(12) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires the Corporation to disclose
estimated fair values of its financial instruments.
The following methods and assumptions were used to estimate the approximate
fair value of each class of financial instrument for which it is
practicable to estimate that value:
Cash and Due from Banks and Money Market Investments
The carrying amounts are a reasonable estimate of fair value.
Securities
The fair value of securities, except certain state and municipal
securities, is estimated based on bid prices published in financial
newspapers or bid quotations received from securities dealers. The fair
value of certain state and municipal securities is not readily available
through market sources other than dealer quotations, so fair value
estimates are based on quoted market prices of similar instruments,
adjusted for differences between the quoted instruments and the instruments
being valued.
46
<PAGE>
Loans
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial,
commercial real estate, residential real estate and loans to individuals.
Each loan category is further segmented into fixed and adjustable rate
interest terms.
The fair value of loans is calculated by discounting scheduled cash flows
through the estimated maturity using estimated market discount rates that
reflect the credit and interest rate risk inherent in the loan as well as
estimates for prepayments. The estimate of maturity is based on the Bank's
industry experience with repayments for each loan classification, modified,
as required, by an estimate of the effect of current economic and lending
conditions.
Deposits
The fair value of noninterest-bearing deposits, interest-bearing deposits
and savings deposits is the amount payable on demand. The fair value of
fixed maturity time deposits and certificates of deposit is estimated using
the rates currently offered for deposits with similar remaining maturities.
Commitments to Extend Credit and Standby Letters of Credit
The only amounts recorded for commitments to extend credit and standby
letters of credit are the deferred fees arising from these unrecognized
financial instruments. These deferred fees are not deemed significant at
December 31, 1997 and 1996, and as such, the related fair values have not
been estimated.
The carrying amounts and approximate fair values of the Corporation's
financial instruments are as follows at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
Carrying Approximate Carrying Approximate
Amounts Fair Values Amounts Fair Values
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 3,324 3,324 2,149 2,149
Money market investments 1,473 1,473 2,791 2,791
Securities available-for-sale 21,144 21,144 11,584 11,584
Loans, net 46,647 46,948 33,482 33,664
- ------------------------------------------------------------------------------
Total financial assets $72,588 72,889 50,006 50,188
- ------------------------------------------------------------------------------
Financial liabilities:
Deposits 65,588 65,977 43,617 43,854
- ------------------------------------------------------------------------------
Total financial liabilities $65,588 65,977 43,617 43,854
- ------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Corporation's entire holdings of a
particular financial instrument. Because no market exists for a
significant portion of the Corporation's financial instruments, fair value
estimates are based on judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments and other factors. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. Significant assets that are not
considered financial assets include deferred tax assets and premises and
equipment. In addition, the tax ramifications related to the realization
of the unrealized gains and losses can have a significant effect on fair
value estimates and have not been considered in the estimates.
(13) Other Matters
In connection with the termination of the former president, the Corporation
recognized severance expense of $326 in 1996 which is to be paid monthly
over 31 months. At December 31, 1997, $137 is recorded in other
liabilities and related to these future payments.
(14) Time Deposits
At December 31, 1997, the scheduled maturities of time deposits are as
follows:
Years Ending December 31,
------------------------------
1998 $26,978
1999 6,272
2000 1,212
2001 1,245
2002 2,877
------------------------------
$38,584
------------------------------
48
<PAGE>
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.
The information required by Item 401 of Regulation S-B is set forth under the
caption, "Information Concerning Directors and Nominees," on pages 3-6 of the
Company's Proxy Statement dated March 13, 1998 and is incorporated herein by
reference.
The information required by Item 405 of Regulation S-B is set forth under the
caption, "Section 16(a) Beneficial Ownership Reporting Compliance," on page 8 of
the Company's Proxy Statement dated March 13, 1998 and is incorporated herein by
reference.
Item 10. Executive Compensation.
The information required by Item 402 of Regulation S-B is set forth under the
caption, "Executive Compensation," on pages 7-10 of the Company's Proxy
Statement dated March 13, 1998 and is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required by item 403 of Regulation S-B is set forth under the
caption, "Security Ownership of Certain Beneficial Owners," on page 3 of the
Company's Proxy Statement dated March 13, 1998 and under the caption,
"Information Concerning Directors and Nominees," on pages 3-6 of the Company's
Proxy Statement dated March 13, 1998 and is incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions.
The information required by Item 404 of Regulation S-B is set forth under the
caption, "Certain Relationships and Related Transactions," on pages 6 and 7 of
the Company's Proxy Statement dated March 13, 1998 and is incorporated herein by
reference.
Item 13. Exhibits and Reports on Form 8-K.
(a) The following documents are filed as part of this Report:
1. Financial Statements:
Independent Auditors' Report.
49
<PAGE>
Consolidated Balance Sheets as of December 31, 1997 and
1996.
Consolidated Statements of Income (Loss) for the Years Ended
December 31, 1997 and 1996.
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1997 and 1996.
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997 and 1996.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules:
All schedules are omitted as the required information is inapplicable
or the information is presented in the Financial Statements or related
notes.
3. Exhibits:
3.1 Articles of Incorporation (incorporated herein by reference to
Exhibit No. 3.1 of Registration Statement No. 33-77568, on Form
S-1, as amended).
3.2 Bylaws (incorporated herein by reference to Exhibit No. 3.2 of
Registration Statement No. 33-77568, on Form S-1, as amended).
*10.2 Employment Agreement dated April 8, 1994, by and
between the Company and A. Wayne Lewis (incorporated
herein by reference to Exhibit No. 10.2 of
Registration Statement No. 33-77568, on Form S-1, as
amended).
*10.3 Severance Agreement dated December 19, 1996, by and
between the Company and Ellis L. Gutshall
(incorporated herein by reference to Exhibit No.
10.3 of Form 10-KSB filed March 27, 1997, File No.
33-77568).
*10.4 Stock Option Agreement dated December 19, 1996, by
and between the Company and Ellis L. Gutshall
(incorporated herein by reference to Exhibit No.
10.4 of Form 10-KSB filed March 27, 1997, File No.
33-77568).
10.5 Office Lease dated February 28, 1994, by and between First
Federal Building, L.C. and Valley Financial Enterprises, L.C.
(incorporated herein by reference to Exhibit No. 10.5 of
Registration Statement No. 33-77568, on Form S-1, as amended).
10.10 First amendment dated August 5, 1994, to the Office Lease dated
February 28, 1994, by and between First Federal Building, L.C.
and Valley Financial Enterprises, L.C. (incorporated herein by
reference to Exhibit No. 10.10 of Form 10-K filed March 30,
1995, File No. 33-77568).
10.12 Second amendment dated December 14, 1994, to the Office Lease
dated February 28, 1994, by and between First Federal Building,
L.C. and Valley Financial Enterprises, L.C. (incorporated herein
by reference to Exhibit No. 10.12 of Form 10-K filed March 30,
1995, File No. 33-77568).
50
<PAGE>
10.13 Lease agreement for office space dated September 20, 1996, by and
between Valley Bank, N.A. and Betty J. Burrows (incorporated
herein by reference to Exhibit No. 10.13 of Form 10-KSB filed
March 27, 1997, File No. 33-77568).
21. Subsidiaries of the Registrant.
24. Power of Attorney.
27. Financial Data Schedule.
- --------------------------
*Management contract or compensatory plan or agreement required to be filed as
an Exhibit to this Form 10-KSB pursuant to Item 13(a).
(b) Reports on Form 8-K filed during the last quarter of the period
covered by this report:
None.
51
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March 27, 1998.
Valley Financial Corporation
By: /s/ Ellis L. Gutshall
------------------------------
Ellis L. Gutshall
President and Chief Executive Officer
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
following persons in the capacities indicated as of March 27, 1998.
Signature Title
--------- -----
/s/ Ellis L. Gutshall
- ------------------------ President, Chief Executive Officer and Director
(Ellis L.Gutshall) (Chief Executive Officer)
/s/ A. Wayne Lewis
- ------------------------ Executive Vice President, Chief Operating
(A. Wayne Lewis) Officer and Director
/s/ A. Wayne Lewis
- ------------------------ Chief Financial Officer (Principal Financial
(A. Wayne Lewis) Officer and Principal Accounting Officer)
/s/ Abney S. Boxley, III * Director
- ------------------------
(Abney S. Boxley, III)
/s/ W. Jackson Burrows * Director
- ------------------------
(W. Jackson Burrows)
/s/ William D. Elliot * Director
- ------------------------
(William D. Elliot)
- ------------------------ Director
(Mason Haynesworth)
52
<PAGE>
Signature Title
--------- -----
/s/ Eddie F. Hearp * Director
- ------------------------
(Eddie F. Hearp)
- ------------------------ Director
(Anna L. Lawson)
/s/ Barbara B. Lemon * Director
- ------------------------
(Barbara B. Lemon)
/s/ George W. Logan * Director
- ------------------------
(George W. Logan)
- ------------------------ Director
(Dr. John W. Starr)
/s/ Ward W. Stevens * Director
- ------------------------
(Dr. Ward W. Stevens)
- ------------------------ Director
(Maury L. Strauss)
/s/ Michael E. Warner * Director
- ------------------------
(Michael E. Warner)
* By /s/ A. Wayne Lewis
------------------------
A. Wayne Lewis
(Attorney in Fact)
53
<PAGE>
INDEX TO EXHIBITS
Exhibit Page
Number Description Number
- ------- ----------- ------
3.1 Articles of Incorporation (incorporated herein by
reference to Exhibit No. 3.1 of Registration Statement
No. 33-77568, on Form S-1, as amended).
3.2 Bylaws (incorporated herein by reference to Exhibit No.
3.2 of Registration Statement No. 33-77568, on Form S-
1, as amended).
10.2 Employment Agreement dated April 8, 1994, by and
between the Company and A. Wayne Lewis (incorporated
herein by reference to Exhibit No. 10.2 of Registration
Statement No. 33-77568, on Form S-1, as amended).
10.3 Severance Agreement dated December 19, 1996, by and
between the Company and Ellis L. Gutshall (incorporated
herein by reference to Exhibit No. 10.3 of Form 10-KSB
filed March 27, 1997, File No. 33-77568).
10.4 Stock Option Agreement dated December 19, 1996, by
and between the Company and Ellis L. Gutshall
(incorporated herein by reference to Exhibit No. 10.4 of
Form 10-KSB filed March 27, 1997, File No. 33-77568).
10.5 Office Lease dated February 28, 1994, by and between
First Federal Building, L.C. and Valley Financial
Enterprises, L.C. (incorporated herein by reference to
Exhibit No. 10.5 of Registration Statement No. 33-
77568, on Form S-1, as amended).
10.10 First amendment dated August 5, 1994, to the Office
Lease dated February 28, 1994, by and between First
Federal Building, L.C. and Valley Financial
Enterprises, L.C. (incorporated herein by reference to
Exhibit No. 10.10 of Form 10-K filed March 30, 1995,
File No. 33-77568).
10.12 Second amendment dated December 14, 1994, to the Office
Lease dated February 28, 1994, by and between First
Federal Building, L.C. and Valley Financial
Enterprises, L.C. (incorporated herein by reference to
Exhibit No. 10.12 of Form 10-K filed March 30, 1995,
File No. 33-77568).
10.13 Lease agreement for office space dated September 20,
1996, by and between Valley Bank, N.A. and Betty J.
Burrows (incorporated herein by reference to Exhibit 10.13
of Form 10-KSB filed March 27, 1997, File No. 33-77568).
21 Subsidiaries of the Registrant. 55
24 Power of Attorney. 56
27 Financial Data Schedule. 57
54
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Valley Bank, N.A. is a subsidiary of the registrant, Valley Financial
Corporation. Valley Financial Corporation owns 100% of the Common Stock of the
Bank.
55
<PAGE>
Exhibit 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers
and/or directors of Valley Financial Corporation, a Virginia corporation
("Valley"), does hereby constitute and appoint Ellis L. Gutshall and A. Wayne
Lewis, and each of them (with full power to each of them to act alone), his true
and lawful Attorneys in Fact and Agents for him and on his behalf and in his
name, place and stead in any and all capacities and particularly as an officer
and/or director of Valley, to sign, execute and affix his seal thereto and file
any of the documents referred to below:
Annual Report for the calendar year ended December 31, 1997,
on Form 10-KSB, and any amendments thereto, together with
all exhibits and any and all documents required to be filed
with respect thereto, with the Securities and Exchange
Commission and all other appropriate regulatory authorities;
granting unto said Attorneys and each of them full power and authority
to do and perform every act and thing requisite and necessary to be
done in and about the premises in order to effectuate the same as
fully, to all intents and purposes, as he himself might or could do if
personally present, hereby ratifying and affirming all that said
Attorneys in Fact and Agents or each of them may lawfully do or cause
to be done by virtue hereof.
WITNESS the signatures and seals of the undersigned this 19th day of
March, 1998.
/s/ George W. Logan /s/ Michael E. Warner
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ Abney S. Boxley, III /S/ Ellis L. Gutshall
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ William D. Elliot /s/ A. Wayne Lewis
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ Barbara B. Lemon
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ W. Jackson Burrows
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ Eddie F. Hearp
- ------------------------ --------------------------
(SEAL) (SEAL)
/s/ Ward W. Stevens
- ------------------------ --------------------------
(SEAL) (SEAL)
COMMONWEALTH OF VIRGINIA )
) to wit:
CITY OF ROANOKE )
I, Mary P. Hundley, a Notary Public in and for the jurisdiction aforesaid,
do hereby certify that Abney S. Boxley, III, W. Jackson Burrows, William D.
Elliot, Ellis L. Gutshall, Eddie F. Hearp, Barbara B. Lemon, A. Wayne Lewis,
George W. Logan, Ward W. Stevens and Michael E. Warner, whose names are signed
to the foregoing writing bearing date the 19th day of March, 1998, this day
personally appeared before me and acknowledged the same in my City and State
aforesaid.
GIVEN under my hand and seal this 19th day of March, 1998.
/s/ Mary P. Hundley
-------------------------------
Notary Public
My commission expires October 31, 2002
(SEAL)
56
<PAGE>
VALLEY FINANCIAL CORPORATION
Financial Data Schedule
[ARTICLE] 12
[LEGEND]
[RESTATED]
[CIK] 0000921590
[NAME] VALLEY FINANCIAL CORP /VA/
[MULTIPLIER] 1,000
[FISCAL-YEAR-END] DEC-31-1997
[PERIOD-START] JAN-01-1997
[PERIOD-END] DEC-31-1997
[PERIOD-TYPE] 12-MOS
[CASH] 3,324
[INT-BEARING-DEPOSITS] 33
[FED-FUNDS-SOLD] 1,440
[TRADING-ASSETS] 0
[INVESTMENTS-HELD-FOR-SALE] 21,144
[INVESTMENTS-CARRYING] 0
[INVESTMENTS-MARKET] 0
[LOANS] 46,647
[ALLOWANCE] 459
[TOTAL-ASSETS] 74,677
[DEPOSITS] 65,588
[SHORT-TERM] 0
[LIABILITIES-OTHER] 810
[LONG-TERM] 0
[COMMON] 9,089
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[OTHER-SE] 0
[TOTAL-LIABILITIES-AND-EQUITY] 74,677
[INTEREST-LOAN] 3,558
[INTEREST-INVEST] 1,248
[INTEREST-OTHER] 0
[INTEREST-TOTAL] 4,806
[INTEREST-DEPOSIT] 2,502
[INTEREST-EXPENSE] 2,511
[INTEREST-INCOME-NET] 2,295
[LOAN-LOSSES] 131
<SECURITIES-GAIN> 2
[EXPENSE-OTHER] 1,856
[INCOME-PRETAX] 486
[INCOME-PRE-EXTRAORDINARY] 883
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] 883
[EPS-PRIMARY] .92
[EPS-DILUTED] .92
[YIELD-ACTUAL] 3.80
[LOANS-NON] 0
[LOANS-PAST] 0
[LOANS-TROUBLED] 0
[LOANS-PROBLEM] 0
57
<PAGE>
[ALLOWANCE-OPEN] 328
[CHARGE-OFFS] 0
[RECOVERIES] 0
[ALLOWANCE-CLOSE] 459
[ALLOWANCE-DOMESTIC] 459
[ALLOWANCE-FOREIGN] 0
[ALLOWANCE-UNALLOCATED] 0
58
