UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
Commission File Number: 33-77568
VALLEY FINANCIAL CORPORATION
VIRGINIA 54-1702380
(State of Incorporation) I.R.S. Employer
Identification Number)
36 Church Avenue, S.W.
Roanoke, Virginia 24011
(Address of principal executive offices)
(540) 342-2265
(Issuer's telephone number, including area code)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes _X_ No__
At July 31, 1999, 964,990 shares of the issuer's common stock, no par value,
were outstanding.
Transitional small business disclosure format: Yes __ No _x_.
1
<PAGE>
VALLEY FINANCIAL CORPORATION
FORM 10-QSB
June 30, 1999
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 10
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURES 22
2
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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share data)
June 30 December 31
1999 1998
------- -----------
<S> <C> <C>
Assets
Cash and due from banks $ 3,243 $ 3,462
Money market investments:
Federal funds sold - 1,699
Interest-bearing deposits in other banks 82 44
-------- --------
Total money market investments 82 1,743
Securities available for sale 32,152 26,118
Loans:
Commercial loans 21,419 17,794
Commercial real estate loans 29,523 22,040
Residential real estate loans 19,346 19,140
Loans to individuals 13,396 12,648
-------- --------
Total loans 83,684 71,622
Less unearned income (36) (39)
Less allowance for loan losses (833) (708)
-------- --------
Total net loans 82,815 70,875
Premises and equipment 2,593 1,830
Accrued interest receivable 921 804
Other assets 789 354
-------- --------
Total assets $122,595 $105,186
======== ========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand deposits $ 12,832 $ 10,437
Interest bearing demand deposits 6,772 7,687
Money market deposits 23,572 24,826
Other savings deposits 1,288 1,106
Certificates of deposits>100,000 10,484 8,048
Other time deposits 43,228 37,922
-------- --------
Total deposits 98,176 90,026
-------- --------
Short-term borrowings 4,597 -
Accrued interest payable 652 679
Other liabilities 309 324
Federal Home Loan Bank advances 10,000 5,000
-------- --------
Total liabilities 113,734 96,029
-------- --------
Commitments and other contingencies
Preferred stock, no par value. Authorized 10,000,000
shares; none issued and outstanding.
Common stock, no par value. Authorized 10,000,000
shares; issued and outstanding 964,990 at
June 30, 1999 and 964,590 at December 31,1998 9,099 9,095
Accumulated retained earnings (deficit) 306 (108)
Accumulated other comprehensive income (544) 170
-------- --------
Total shareholders' equity 8,861 9,157
-------- --------
Total liabilities and shareholders' equity $122,595 $105,186
======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
3
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<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
For the Period For the Period
January 1, 1999 January 1, 1998
Through Through
June 30, 1999 June 30, 1998
--------------- ---------------
<S> <C> <C>
Interest Income:
Interest and fees on loans $3,192 $2,239
Interest on money market investments 34 40
Interest on securities - taxable 643 708
Interest on securities - nontaxable 153 55
------ ------
Total interest income 4,022 3,042
------ ------
Interest Expense:
Interest on certificates of deposit>100,000 243 190
Interest on other deposits 1,605 1,273
Interest on Federal Home Loan Bank advances 157 81
Interest on borrowed funds 17 28
------ ------
Total interest expense 2,022 1,572
------ ------
Net interest income 2,000 1,470
Provision for loan losses 127 128
------ ------
Net interest income after provision for
loan losses 1,873 1,342
------ ------
Noninterest Income:
Service charges on deposit accounts 101 73
Other fee income 45 39
Securities gains (losses) - 10
------ ------
Total noninterest income 146 122
------ ------
Noninterest Expense:
Compensation expense 781 579
Occupancy and equipment expense, net 179 147
Data processing expense 81 55
Marketing and advertising expense 73 37
Office supplies expense 52 30
Other expense 292 248
------ ------
Total noninterest expense 1,458 1,096
------ ------
Net income before taxes 561 368
Provision for income taxes 147 108
------ ------
Net income $ 414 $ 260
====== ======
Basic earnings per share $ .43 $ .27
====== ======
Diluted earnings per share $ .42 $ .27
====== ======
See accompanying notes to consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
For the Period For the Period
April 1, 1999 April 1, 1998
Through Through
June 30, 1999 June 30, 1998
--------------- ---------------
<S> <C> <C>
Interest Income:
Interest and fees on loans $1,652 $1,204
Interest on money market investments 20 4
Interest on securities - taxable 345 355
Interest on securities - nontaxable 80 46
------ ------
Total interest income 2,097 1,609
------ ------
Interest Expense:
Interest on certificates of deposit>100,000 133 97
Interest on other deposits 824 655
Interest on Federal Home Loan Bank advances 95 62
Interest on borrowed funds 12 28
------ ------
Total interest expense 1,064 842
------ ------
Net interest income 1,033 767
Provision for loan losses 54 97
------ ------
Net interest income after provision for
loan losses 979 670
------ ------
Noninterest Income:
Service charges on deposit accounts 55 38
Other fee income 17 16
Securities gains (losses) - -
------ ------
Total noninterest income 72 54
------ ------
Noninterest Expense:
Compensation expense 404 293
Occupancy and equipment expense, net 102 75
Data processing expense 42 29
Marketing and advertising expense 47 19
Office supplies expense 22 16
Other expense 146 117
------ ------
Total noninterest expense 763 549
------ ------
Net income before taxes 288 175
Provision for income taxes 75 45
------ ------
Net income $ 213 $ 130
====== ======
Basic earnings per share $ .22 $ .13
====== ======
Diluted earnings per share $ .21 $ .13
====== ======
See accompanying notes to consolidated financial statements.
</TABLE>
5
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<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands, except per share data)
For the Period For the Period
January 1, 1999 January 1, 1998
Through Through
June 30, 1999 June 30, 1998
--------------- ---------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income $ 414 $ 260
Adjustments to reconcile net income
to net cash provided by operating
activities:
Provision for loan losses 127 128
Depreciation and amortization of
premises and equipment 107 52
Amortization of organizational
expenses 14 28
Gain on sale of securities - (10)
Amortization (accretion) of premiums
and discounts 25 (3)
Increase (decrease) in unearned fees (3) 6
Increase in accrued interest receivable (117) (78)
(Increase) decrease in other assets (81) 70
Increase (decrease) in accrued
interest payable (27) 144
Decrease in other liabilities (15) (75)
------- -------
Net cash provided by operating activities 444 522
------- -------
Cash Flows From Investing Activities:
Decrease in money market investments 1,661 1,465
Purchases of premises and equipment (870) (20)
Purchases of securities available-for-sale (14,112) (14,703)
Proceeds from sales, calls and maturities
of securities available-for-sale 6,971 11,297
Increase in loans (12,064) (14,095)
------- -------
Net cash used in investing activities (18,414) (16,056)
------- -------
Cash Flows From Financing Activities:
Increase in time deposits greater than $100,000 2,436 593
Increase in other time deposits 5,306 4,115
Increase in other deposits 408 2,257
Increase in short-term borrowings 4,597 3,479
Proceeds from Federal Home Loan Bank advances 5,000 5,000
Proceeds from the issuance of common stock 4 -
------- -------
Net cash provided by financing activities 17,751 15,444
------- -------
Net Decrease in Cash and Due From Banks (219) (90)
Cash and Due From Banks at Beginning of Period 3,462 3,324
------- -------
Cash and Due From Banks at End of Period $ 3,243 $ 3,234
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 2,049 $ 1,428
======= =======
Cash paid during the period for taxes $ 176 $ -
======= =======
See accompanying notes to consolidated financial statements
</TABLE>
6
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VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
June 30, 1999
(Unaudited)
(In thousands, except share and per share data)
(1) Organization and Summary of Significant Accounting Policies
Valley Financial Corporation (the "Company") was incorporated under
the laws of the Commonwealth of Virginia on March 15, 1994, primarily
to serve as a holding company for Valley Bank, N.A. (the "Bank"),
which opened for business on May 15, 1995. The Company's fiscal year
end is December 31.
The consolidated financial statements of the Company conform to
generally accepted accounting principles and to general banking
industry practices. The interim period consolidated financial
statements are unaudited; however, in the opinion of management, all
adjustments of a normal recurring nature which are necessary for a
fair presentation of the consolidated financial statements herein have
been included. The consolidated financial statements herein should be
read in conjunction with the Company's 1998 Annual Report on Form 10-
KSB.
The Company reports its activities as a single business segment. In
determining the appropriateness of segment definition, the Company
considers components of the business about which financial information
is available and regularly evaluated relative to resource allocation
and performance assessment.
(2) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash and due from banks.
7
<PAGE>
(3) Securities
The carrying values, unrealized gains, unrealized losses and
approximate fair values of investment securities at June 30, 1999 are
shown in the table below. The entire investment portfolio is
classified as available-for-sale in order to provide maximum liquidity
for funding needs. As of June 30, 1999, investments with amortized
costs and fair values of $2,266 and $2,249, respectively, were pledged
as collateral for public deposits, a line of credit available from the
Federal Home Loan Bank and for other purposes as required or permitted
by law.
<TABLE>
<CAPTION>
Carrying Unrealized Unrealized Approximate
Securities available for sale: Values Gains Losses Fair Values
---------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury $ 199 $ 0 $ 0 $ 199
U.S. Government agencies 21,866 1 (630) 21,237
Mortgage-backed securities 2,738 9 (18) 2,729
States and political subdivisions 7,077 1 (186) 6,892
Corporate debt securities 100 0 0 100
Equity securities 997 0 (2) 995
------- --- ----- -------
Total securities available
for sale $32,977 $11 ($836) $32,152
======= === ===== =======
</TABLE>
(4) Allowance for Loan Losses
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Balance at January 1 $708 $459
Provision for loan losses 127 128
Recoveries 0 0
Charged off loans (2) 0
---- ----
Balance at June 30 $833 $587
==== ====
</TABLE>
(5) Earnings Per Share
Basic earnings per share is based upon the weighted average number of
common shares outstanding during the period. The weighted average
shares outstanding for the diluted earnings per share computations
8
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were adjusted to reflect the assumed conversion of shares available
under stock options. The following table summarizes the shares
utilized in the computations:
<TABLE>
<CAPTION>
Weighted Average Shares Outstanding
-----------------------------------
Three months ending June 30: Basic Diluted
----- -------
<S> <C> <C>
1999 964,990 993,912
======= =======
1998 964,040 981,868
======= =======
Six months ending June 30:
1999 964,928 992,325
======= =======
1998 964,040 979,609
======= =======
</TABLE>
(6) Comprehensive Income
On January 1, 1998, The Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income. This
Statement establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general
purpose financial statements. This Statement was issued to address
concerns over the practice of reporting elements of comprehensive
income directly in equity.
The Company is required to classify items of "Other Comprehensive
Income" (such as net unrealized gains (losses) on securities available
for sale) by their nature in a financial statement. It does not
require a specific format for that financial statement but requires
the Company to display an amount representing comprehensive income for
the period in that financial statement. The Company is required to
present 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.
The adoption of Statement 130 on January 1, 1998 did not have any
effect on the consolidated financial position, results of operations
or liquidity of the Company. However, Statement 130 does have an
effect on financial statement displays presented by the Company since
the Company as net unrealized gains (losses) on available-for-sale
securities, an item of other comprehensive income. For the six months
ended June 30, 1999 and 1998, total comprehensive income was $(300)
and $218, respectively. For the three months ended June 30, 1999 and
1998, total comprehensive income was $(391) and $154, respectively.
9
<PAGE>
The information that follows discloses the reclassification
adjustments and the income taxes related to securities available-for-
sale that are included in other comprehensive income, net of income
taxes for the six and three month periods ended June 30, 1999 and
1998.
<TABLE>
<CAPTION>
For the Six Months Ended For the Six Months Ended
June 30, 1999 June 30, 1998
------------------------ ------------------------
<S> <C> <C>
Net unrealized losses on
securities available-for-sale:
Net unrealized holding losses
during the year $ (1,082) $ (47)
Less reclassification
adjustments for gains
included in net income - (17)
Income tax expense 368 22
--------- ---------
Other comprehensive
income, net of income
taxes $ (714) $ (42)
========= =========
For the Three Months Ended For the Three Months Ended
June 30, 1999 June 30, 1998
-------------------------- --------------------------
Net unrealized losses on
securities available-for-sale:
Net unrealized holding losses
during the year $ (915) $ 44
Less reclassification
adjustments for gains
included in net income - (8)
Income tax expense 311 (12)
------- -----
Other comprehensive
income, net of income
taxes $ (604) $ 24
======= =====
</TABLE>
Item 2. Management's Discussion and Analysis (000's omitted, except for share
and per share information).
The following is management's discussion and analysis of the financial condition
and results of operations of the Company as of and for the six months and three
months ended June 30, 1999 and 1998. The discussion should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto.
Overview
The Company was incorporated as a Virginia stock corporation on March 15, 1994,
primarily to own and control all of the capital stock of the Bank. The Bank
opened for business on May 15, 1995.
Total assets at June 30, 1999 were $122,595, up 17% from $105,186 at December
31, 1998. The principal components of the Company's assets at the end of the
period were $32,152 in securities available-for-sale and $83,684 in gross loans.
Total liabilities at June 30, 1999 were $113,734, up 18% from $96,029 at
December 31, 1998 with the increase represented by a $8,150 growth in deposits,
a $4,597 increase in federal funds purchased, and a new $5,000 Federal Home Bank
of Atlanta advance during the second quarter.
10
<PAGE>
Total shareholders' equity at June 30, 1999 was $8,861 consisting of $9,099 in
net proceeds from the issuance of common stock, increased by accumulated
retained earnings of $306 and decreased by $544 of unrealized losses on
securities available-for-sale, net of related deferred tax liability. At
December 31, 1998, total shareholders' equity was $9,157. Exclusive of
unrealized gains(losses) on investment securities, shareholders' equity was
$9,405 at June 30, 1999 and $8,987 at December 31, 1998.
The Company had net income of $414 for the six months ended June 30, 1999
compared with $260 recorded for the six months ended June 30, 1998, a 59%
increase. Net income for the three months ended June 30, 1999 was $213, a 64%
increase over the $130 recorded for the second quarter of 1998. The significant
improvement in profitability in both the six and three month periods results
from higher net interest income partially offset by increased noninterest
expenses in virtually all categories.
Profitability as measured by the Company's return on average assets ("ROA") was
.74% for the six months ended June 30, 1999 compared to .64% for the same period
in 1998. ROA for the second quarter of 1999 was .73% versus .60% in the second
quarter of 1998. Return on average equity ("ROE") was 9.07% for the six months
ended June 30, 1999 compared to 6.26% for the same period in 1998. ROE for the
second quarter of the year was 9.18% in 1999 and 6.16% in 1998. The calculation
of ROE excludes the effect of any unrealized gains or losses on investment
securities.
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 $2,000 for the six months ended June 30, 1999 and is
attributable to interest income from loans and securities exceeding the cost of
interest paid on deposits and borrowed funds. Net interest income for the
first half of 1999 increased 36% from $1,470 for the same period in 1998.
The net interest margin on a fully taxable equivalent ("FTE") basis was 3.94%
for the first six months of 1999, an increase of 3 basis points from the
3.91% reported for the same period in 1998. The increase in the margin from
year to year is attributable to lower yields on earning assets being more
than offset by a lower cost of funds.
For the three months ended June 30, 1999 net interest income was $1,033 and the
FTE net interest margin was 3.88%. Net interest income was $767 and the net
interest margin was 3.86% for the second quarter of 1998.
11
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Provision for Loan Losses. A provision for loan losses of $127 was provided
during the six months ended June 30, 1999, a decrease of $1 or 1% over the same
period in 1998, in recognition of management's estimate of inherent risks
associated with lending activities. Due to the Bank's limited operating
history, this estimate is primarily based on industry practices and
consideration of local economic factors. The amount of the provision for loan
losses is a charge against current earnings, and actual loan losses are charged
against the allowance for loan losses. The allowance for loan losses was $833 as
of June 30, 1999 and represented approximately 1.01% of net loans outstanding
versus 1.00% of net loans at December 31, 1998 (see Note 4 to the Consolidated
Financial Statements). Despite the $12,062 growth or 17% increase in gross
loans from December 31, 1998 to June 30, 1999, the provision expense did not
surpass the amount recorded for the six-month period ended June 30, 1998 due to
the substantial 30% growth in loans between December 31, 1997 and June 30, 1998.
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 $146 in the six months ended June 30,
1999 consisted of service charges and fees on accounts and other miscellaneous
income, and represented an increase of $24 or 20% over the $122 reported for the
same period one year earlier. For the three months ended June 30, 1999
noninterest income was $72, an increase of $18 or 33% over the $54 reported for
the second quarter of 1998. Future levels of noninterest income are expected to
increase as a direct result of business growth and expansion.
Noninterest Expense. Noninterest expense for the first six months of 1999 was
$1,458, an increase of $362 or 33% over the same period in 1998. The largest
components of the increase were compensation expense as additional employees
were hired due to growth, growth-related data processing expense, marketing
expense due to the opening of our newest branch in Salem, office supplies due to
the opening of the above-referenced branch, and increases in various other
expense categories, partially offset by a decrease in loan closing costs
incurred in a home equity line of credit promotion in 1998. Noninterest expense
for the quarter ended June 30, 1999 was $763, an increase of $214 or 39% over
the second quarter of 1998. Noninterest expenses are expected to increase in
future years as a direct result of business growth and expansion.
Year 2000. The Year 2000 issue arises from computer programs being written
using two digits rather than four to abbreviate the year portion of dates.
Computer hardware, software and devices with imbedded technology that are time-
sensitive may not recognize the abbreviation "00" as meaning the year 2000, but
instead read it as the year 1900. This could result in system failures or
miscalculations causing disruption of normal operations including, among other
things, a temporary impairment of the ability to process transactions, calculate
interest payments correctly or engage in routine business activities.
12
<PAGE>
The Company has undertaken various initiatives intended to ensure that its
computer equipment and software will function properly with respect to dates in
the year 2000 and thereafter. Included in the initiatives are information
technology ("IT") systems such as accounting, data processing, financial
transaction processing, ATM and telephone, and non-IT systems such as alarm
systems, fax machines, copiers, heating and air conditioning controls and
elevator controls. Both IT and non-IT systems may contain imbedded technology.
The Company's initiatives include awareness of the problem, assessing the size
and complexity of the effort in the context of the Company's systems, renovation
of non-compliant systems through upgrade or replacement, validation through
testing of Year 2000 compliance and implementation of compliant systems. The
Company also is taking steps to ascertain the Year 2000 compliance status of its
major customers and vendors, and to develop contingency plans in the event of
unexpected failure of one or more of its mission-critical systems.
The Company does not operate its own mainframe computer system and has not
developed/supported software code for its information systems, so remediation
efforts have focused on achieving compliance from outside servicers and vendors,
and on internal testing of hardware and software systems. The Company's banking
operations are highly dependent on one external service bureau for its data
processing and on one vendor for loan/deposit platform software. The Company is
monitoring the Year 2000 compliance status of both these third-party providers,
and will validate their compliance through its own testing efforts. A
comprehensive contingency plan has been developed for dealing with the most
reasonably likely worst case scenario in the event of failure by the Company or
its primary third-party providers to achieve Year 2000 compliance on a timely
basis. The Company intends to continue contingency plan analysis and testing
through December 31, 1999.
The Company also has taken steps to assess the potential impacts of Year 2000
issues on its major commercial borrowers. Should a commercial borrower fail to
deal adequately with Year 2000's impact on its computer systems, its operations
could be jeopardized and its ability to repay its loan threatened. All
commercial borrowers in significant amounts have been sent questionnaires
concerning their Year 2000 preparedness. Completed questionnaires have been
evaluated to identify moderate and high-risk credits. Year 2000 risk factors
are being incorporated into the overall risk ratings for all new and renewed
commercial loans and, where appropriate, more stringent standards imposed in
underwriting criteria, loan covenants and required collateral. As of June 30,
the Company considers virtually all commercial borrowers to be low Year 2000
risk.
As part of its board-approved Year 2000 Action Plan, the Company established a
budget for Year 2000 compliance. For the six months ended June 30, 1999 total
expenditures were $36, with $8 expensed and $28 recorded as capital expenditures
with useful lives of 3-5 years. Actual expenditures were $16 for the year ended
December 31, 1998, recorded as a reduction to net income. Total expenditures,
primarily for testing, software upgrades and consultants, are not expected to
exceed $100. The costs of Year 2000 identification, assessment, remediation and
testing efforts and the dates on which the Company currently believes it will
complete such efforts are based upon management's best estimates, which were
derived using numerous assumptions regarding future events, including the
continued availability of certain resources, third-party remediation plans and
other factors. There can be no assurance that these estimates will prove to be
accurate, and actual results may differ materially from those currently
anticipated. Specific factors that could cause such material differences
13
<PAGE>
include, but are not limited to, the availability and cost of personnel trained
in Year 2000 issues, the ability to identify, assess, remediate and test all
relevant IT systems and imbedded technology, and similar uncertainties.
The failure by the Company or a primary third-party provider to correct a
material Year 2000 problem could result in the interruption in, or failure of,
certain normal business activities or operations. Such failure could have a
material adverse effect on the Company's results of operations, liquidity and
financial condition. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-party providers and customers, the Company presently is unable to provide
assurances that such material adverse impact will not be the case. The Year
2000 project is expected to significantly reduce the Company's level of
uncertainty about the Year 2000 problem and, in particular, about the Year 2000
compliance and readiness of its primary third-party providers. The Company
believes that, with the implementation of remediated IT systems and completion
of the Year 2000 project as scheduled, the possibility of significant
interruptions of normal business operations should be reduced.
Income Taxes. To reflect the Company's anticipated federal income tax
liability, an expense of $147 and $108 at an effective tax rate of 26% and 29%
was recognized in the six months ended June 30, 1999 and June 30, 1998,
respectively. The provision for income taxes was $75 and $45 for the second
quarter of 1999 and 1998, respectively. The second quarter expense for 1999 and
1998 equated to an effective tax rate of 26%.
Liquidity and Asset/Liability Management
Asset/liability management activities are designed to ensure that adequate
liquidity available to meet loan demand or deposit outflows and, through the
management of the Company's interest sensitivity position, to manage the impact
of interest rate fluctuations on net interest income.
Liquidity. Liquidity measures the ability of the Company to meet its maturing
obligations and existing commitments, to withstand fluctuations in deposit
levels, to fund its operations and to provide for customers' credit needs.
Liquidity represents a financial 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 35% at June 30, 1999 and 35% at
December 31, 1998. The Company sells excess funds as overnight federal funds
sold to provide an immediate source of liquidity. The Company had Federal funds
sold of $0 and $1,699 at June 30, 1999 and December 31, 1998, respectively.
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.
14
<PAGE>
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
of June 30, 1999, the Bank is in the process of establishing a credit line
through the discount window of the Federal Reserve Bank of Richmond as an
additional source of cash flow. As a result of the Company's management of
liquid assets and the ability to generate liquidity through alternative funding
sources, management believes the Company maintains overall liquidity sufficient
to meet its depositors' requirements and satisfy its customers' credit needs.
Interest Rate Risk
Interest rate risk is the risk to earnings or capital generated by movement of
interest rates. It can come from differences between the timing of rate changes
and the timing of cash flows (repricing risk); from changing rate relationships
among yield curves that affect bank activities (basis risk); from changing rate
relationships across the spectrum of maturities (yield curve risk); and from
interest rate related options imbedded in bank products (option risk).
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
15
<PAGE>
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, and compares the results to internal
policy guidelines.
Impact of Inflation
The Consolidated Financial Statements and Notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
requires the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies, nearly
all the assets and liabilities of the Company and the Bank are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of changes in the general rate of inflation and
changes in prices. In addition, interest rates do not necessarily move in the
same direction or in the same magnitude as do the prices of goods and services.
Management seeks to manage the relationship between interest-sensitive assets
and liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
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
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 June 30, 1999 were $32,152, an increase of $6,034 or
23% from their level of $26,118 on December 31, 1998. The increase was
attributable to investment of funds available from deposit growth and the
purchase of investment securities with the proceeds of an additional $5,000
advance from the Federal Home Loan Bank of Atlanta during the second quarter.
For more information on the investment portfolio, see Note 3 to the Consolidated
Financial Statements.
16
<PAGE>
Loan Portfolio
The Company's total loans were $83,684 at June 30, 1999, an increase of $12,062
or 17% from the $71,622 reported at December 31, 1998. The Company's ratio of
net loans to total deposits stood at 84% at June 30, 1999 and 79% at December
31, 1998. Management seeks to maintain the ratio of loans to deposits in a
range of 70% to 85%.
The loan portfolio primarily consists of commercial, real estate (including real
estate term loans, construction loans and other loans secured by real estate)
and loans to individuals for household, family and other consumer purposes. The
Company adjusts its mix of lending and the terms of its loan programs according
to economic and market conditions, asset/liability management considerations and
other factors. Loans typically (in excess of 90%) are made to businesses and
individuals located within the Company's primary market area, most of whom
maintain deposit accounts with the Bank. There is no concentration of loans
exceeding 10% of total loans which is not disclosed in the Consolidated
Financial Statements and the Notes thereto or discussed below. The Company has
not made any loans to any foreign entities, including governments, banks,
businesses or individuals. Commercial and construction loans and home equity
lines of credit in the loan portfolio are primarily variable rate loans and have
little interest rate risk.
Commercial Loans. Commercial and industrial loans accounted for 26% of the loan
portfolio as of June 30, 1999 and stood at $21,419 versus $17,794 six months
earlier. Such loans generally are made to provide operating lines of credit, to
finance the purchase of inventory or equipment, and for other business purposes.
The creditworthiness of the borrower is analyzed and re-evaluated on a periodic
basis. Most commercial loans are collateralized with business assets such as
accounts receivable, inventory and equipment. Even with substantial collateral
such as all the assets of the business and personal guarantees, commercial
lending involves considerable risk of loss in the event of a business downturn
or failure of the business.
Commercial Real Estate Loans. Commercial real estate construction and
commercial real estate mortgages represent interim and permanent financing of
commercial properties that are secured by real estate, and were 35% of total
loans at June 30, 1999. Outstanding loans in this category equaled $29,523 and
$22,040 at June 30, 1999 and December 31, 1998, 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
$19,346 in loans (23% of total loans) at June 30, 1999 and $19,140 in such loans
at December 31, 1998. 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.
17
<PAGE>
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 $13,396 (16% of total loans) at June 30, 1999 compared to
$12,648 at December 31, 1998.
Nonperforming Assets. A loan will be placed on nonaccrual status when
collection of all principal or interest is deemed unlikely. A loan will
automatically be placed on nonaccrual status when principal or interest is past
due 90 days or more, unless the loan is both well secured and in the process of
being collected. In this case, the loan will continue to accrue interest in
despite its past due status. Once a month the Officers' Loan Committee will
review all loans on the bank's watch list to verify if any of the loans should
be placed on nonaccrual status.
The Company had nonaccrual loans of $225 and $0 at June 30, 1999 and December
31, 1998, respectively. If the nonaccrual loans had performed in accordance
with their original terms, additional interest income in the amount of $8 would
have been recorded for the six months ended June 30, 1999.
Deposits
As of June 30, 1999 total deposits were $98,176, an increase of $8,150 or 9%
from their level of $90,026 at December 31, 1998. The increase is largely
attributable to the opening on April 12, 1999 of the Bank's new Salem office,
partially offset by declines in certain transaction account and time deposit
categories.
At June 30, 1999 noninterest-bearing demand deposits were $12,832 or 13% of
total deposits. On December 31, 1998 noninterest bearing demand deposits were
$10,437 or 12% of total deposits. Nonmaturity deposits (noninterest bearing
demand deposits, interest bearing demand deposits, money market accounts and
savings accounts) were $44,464 or 45% of total deposits at June 30, 1999,
compared with $44,056 or 49% of total deposits at December 31, 1998. Total
interest bearing deposits stood at $85,344 at June 30, 1999, an increase of
$5,755 or 7% over their level of $79,589 at December 31, 1998.
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.
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<PAGE>
Capital Resources
The Company's financial position at June 30, 1999 reflects liquidity and capital
levels currently adequate to fund anticipated near-term business expansion.
Capital ratios are in excess of required regulatory minimums for a well-
capitalized institution. The adequacy of the Company's capital is reviewed by
management on an ongoing basis. Management seeks to maintain a capital
structure adequate to support anticipated asset growth and serve as a cushion to
absorb potential losses.
Total shareholders' equity was $8,861 at June 30, 1999 compared with $9,157 at
December 31, 1998, a decrease of $296 or 3%. The decrease is attributable to a
$714 decrease in accumulated other comprehensive income offset by net income for
the first six months of $414 and $4 from the issuance of common stock pursuant
to the exercise of stock options. Exclusive of unrealized gains(losses) on
investment securities, shareholders' equity was $9,405 at June 30, 1999 and
$8,987 at December 31, 1998.
For the periods indicated, the Company had the following risk-based capital and
leverage ratios relative to regulatory minimums:
<TABLE>
<CAPTION>
Ratio 6/30/99 12/31/98 6/30/98 Minimum
----- ------- -------- ------- -------
<S> <C> <C> <C> <C>
Tier 1 10.1% 11.3% 12.7% 4%
Total 11.0% 12.2% 13.6% 8%
Leverage 8.0% 8.7% 9.7% 4%
</TABLE>
It is anticipated that the Company's capital adequacy ratios will continue to
decline as long as the rate of asset growth continues to outstrip the rate of
internal capital generation through retention of earnings. If this trend
continues, the Company in the future will have to raise additional capital funds
or curtail its rate of asset growth.
Recent and Future Accounting Considerations
In October 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 134, Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise. SFAS No. 134 amends SFAS No. 65
to conform the subsequent accounting (under SFAS No. 115) for securities
retained after the securitization of mortgage loans by a mortgage banking
enterprise to the accounting applicable to nonmortgage banking enterprises.
SFAS No. 134 is effective for the quarter ended March 31, 1999. Also, in June
1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities. SFAS No. 133 provides guidance for accounting for all
derivative instruments, including certain derivative instruments embedded in
19
<PAGE>
other contracts, and for hedging activities. SFAS No. 133 is effective for
fiscal years beginning after June 15, 1999. Neither statement has nor is
expected to have a material effect on the consolidated financial position or
results of operations of the Company.
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its 1999 Annual Meeting of Shareholders on April 29, 1999, at
which meeting five Class B directors were re-elected to new three year terms.
The following table indicates the total votes in favor of, and withheld from
voting on, the re-election of each nominee, and provides certain information
with respect to those directors not standing for re-election whose term of
office continued past the 1999 Annual Meeting of Shareholders:
<TABLE>
<CAPTION>
Term of Affirmative Votes
Director Name Office Votes Withheld
------------- ------- ----------- --------
<S> <C> <C> <C>
Class A Directors
Eddie F. Hearp 1998-2001
Anna L. Lawson 1998-2001
John W. Starr, M.D. 1998-2001
Michael E. Warner 1998-2001
Class B Directors
Abney S. Boxley, III 1999-2002 771,660 800
W. Jackson Burrows 1999-2002 771,560 900
William D. Elliot 1999-2002 770,905 1,555
Barbara B. Lemon 1999-2002 771,560 900
Ward W. Stevens, M.D. 1999-2002 771,660 800
Class C Directors
Ellis L. Gutshall 1997-2000
Mason Haynesworth 1998-2000
A. Wayne Lewis 1997-2000
George W. Logan 1997-2000
Maury L. Strauss 1997-2000
</TABLE>
20
<PAGE>
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The Company filed the following exhibits for the quarter ended June 30,
1999:
27. Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended June 30,
1999. The report, dated April 29, 1999, reported the Company's engagement
of new external auditors for the year ended December 31, 1999.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALLEY FINANCIAL CORPORATION
August 13, 1999 /s/ Ellis L. Gutshall
- --------------- ----------------------
Date Ellis L. Gutshall, President
and Chief Executive Officer
August 13, 1999 /s/ A. Wayne Lewis
- --------------- -------------------
Date A. Wayne Lewis, Executive
Vice President and Chief
Financial Officer
22
<PAGE>
Exhibit 27
Financial Data Schedule
[ARTICLE] 9
[MULTIPLIER] 1,000
[CIK] 0000921590
[NAME] VALLEY FINANCIAL CORP/VA/
[FISCAL-YEAR-END] DEC-31-1999
[PERIOD-START] JAN-01-1999
[PERIOD-END] JUN-30-1999
[PERIOD-TYPE] 6-MOS
[CASH] 3,243
[INT-BEARING-DEPOSITS] 82
[FED-FUNDS-SOLD] 0
[TRADING-ASSETS] 0
[INVESTMENTS-HELD-FOR-SALE] 32,152
[INVESTMENTS-CARRYING] 0
[INVESTMENTS-MARKET] 0
[LOANS] 83,684
[ALLOWANCE] 833
[TOTAL-ASSETS] 122,595
[DEPOSITS] 98,176
[SHORT-TERM] 4,597
[LIABILITIES-OTHER] 961
[LONG-TERM] 10,000
[COMMON] 9,099
23
<PAGE>
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[OTHER-SE] (238)
[TOTAL-LIABILITIES-AND-EQUITY] 122,595
[INTEREST-LOAN] 3,192
[INTEREST-INVEST] 796
[INTEREST-OTHER] 34
[INTEREST-TOTAL] 4,022
[INTEREST-DEPOSIT] 1,848
[INTEREST-EXPENSE] 2,022
[INTEREST-INCOME-NET] 2,000
[LOAN-LOSSES] 127
<SECURITIES-GAIN> 0
[EXPENSE-OTHER] 1,458
[INCOME-PRETAX] 561
[INCOME-PRE-EXTRAORDINARY] 561
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] 414
[EPS-BASIC] 0.43
[EPS-DILUTED] 0.42
[YIELD-ACTUAL] 3.94
[LOANS-NON] 225
[LOANS-PAST] 0
[LOANS-TROUBLED] 0
24
<PAGE>
[LOANS-PROBLEM] 0
[ALLOWANCE-OPEN] 708
[CHARGE-OFFS] 2
[RECOVERIES] 0
[ALLOWANCE-CLOSE] 833
[ALLOWANCE-DOMESTIC] 833
[ALLOWANCE-FOREIGN] 0
[ALLOWANCE-UNALLOCATED] 823
25
