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 March 31, 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 April 30, 1999, 964,990 shares of the issuer's common stock, no par value,
were outstanding.
Transitional small business disclosure format: Yes No x .
<PAGE>
VALLEY FINANCIAL CORPORATION
FORM 10-QSB
March 31, 1999
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis 9
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security
Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
2
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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)
March 31 December
1999 1998
-------- --------
<S> <C> <C>
Assets
Cash and due from banks $ 2,705 $ 3,462
Money market investments:
Federal funds sold 10,459 1,699
Interest-bearing deposits in other banks 64 44
-------- --------
Total money market investments 10,523 1,743
Securities available for sale 24,623 26,118
Loans:
Commercial loans 19,093 17,794
Commercial real estate loans 26,186 22,040
Residential real estate loans 19,446 19,140
Loans to individuals 12,924 12,648
-------- --------
Total loans 77,649 71,622
Less unearned income (36) (39)
Less allowance for loan losses (781) (708)
-------- --------
Total net loans 76,832 70,875
Premises and equipment 2,177 1,830
Accrued interest receivable 728 804
Other assets 471 354
-------- --------
Total assets $118,059 $105,186
======== ========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand deposits $ 24,143 $ 10,437
Interest bearing demand deposits 6,126 7,687
Money market deposits 26,159 24,826
Other savings deposits 1,111 1,106
Certificates of deposits >100,000 8,593 8,048
Other time deposits 36,679 37,922
-------- --------
Total deposits 102,811 90,026
-------- --------
Accrued interest payable 698 679
Other liabilities 298 324
Federal Home Loan Bank advances 5,000 5,000
-------- --------
Total liabilities 108,807 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 March 31, 1999 and 964,590 at
December 31,1999 9,099 9,095
Accumulated retained earnings (deficit) 93 (108)
Accumulated other comprehensive income 60 170
-------- --------
Total shareholders' equity 9,252 9,157
-------- --------
Total liabilities and shareholders'
equity $118,059 $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
March 31, 1999 March 31, 1998
--------------- ---------------
<S> <C> <C>
Interest Income:
Interest and fees on loans $1,540 $1,035
Interest on money market investments 14 36
Interest on securities - taxable 298 353
Interest on securities - nontaxable 73 9
------ ------
Total interest income 1,925 1,433
------ ------
Interest Expense:
Interest on certificates of deposit > 100,000 105 92
Interest on other deposits 786 619
Interest on Federal Home Loan
Bank advances 62 19
Interest on borrowed funds 5 -
------ ------
Total interest expense 958 730
------ ------
Net interest income 967 703
Provision for loan losses 73 31
------ ------
Net interest income after provision for
loan losses 894 672
------ ------
Noninterest income:
Service charges on deposit accounts 46 35
Other fee income 28 23
Securities gains (losses) - 10
------ ------
Total noninterest income 74 68
------ ------
Noninterest expense:
Compensation expense 377 286
Occupancy and equipment expense, net 77 72
Data processing expense 39 26
Marketing and advertising expense 26 18
Office supplies expense 30 14
Other expense 146 131
------ ------
Total noninterest expense 695 547
------ ------
Net income before taxes 273 193
Provision for income taxes 72 63
------ ------
Net income $ 201 $ 130
====== ======
Basic earnings per share $ .21 $ .13
====== ======
Diluted earnings per share $ .20 $ .13
====== ======
See accompanying notes to consolidated financial statements.
</TABLE>
4
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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
March 31, 1999 March 31, 1998
--------------- ---------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income $ 201 $ 130
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 73 31
Depreciation and amortization of bank
premises and equipment 40 37
Amortization of organizational expenses 14 14
Gain on sale of securities - (10)
Amortization (accretion) of premiums
and discounts 14 (6)
Decrease in unearned fees (3) (3)
Decrease in accrued interest receivable 76 151
(Increase) decrease in other assets (74) 19
Increase in accrued interest payable 19 56
Decrease in other liabilities (26) (35)
------- -------
Net cash provided by operating activities 334 384
------- -------
Cash Flows From Investing Activities:
(Increase) decrease in money market investments (8,780) 1,333
Purchases of premises and equipment (387) (12)
Purchases of securities available-for-sale (2,124) (13,932)
Proceeds from sales, calls, and maturities of
securities available-for-sale 3,438 6,958
Increase in loans (6,027) (4,777)
------- -------
Net cash used in investing activities (13,880) (10,430)
Cash Flows From Financing Activities:
Increase in time deposits greater than $100,000 545 288
Decrease in other time deposits (1,243) (339)
Increase in other deposits 13,483 4,022
Proceeds from Federal Home Loan Bank advances - 5,000
Proceeds from the issuance of common stock 4 -
------- -------
Net cash provided by financing activities 12,789 8,971
------- -------
Net Decrease in Cash and Due From Banks (757) (1,075)
Cash and Due From Banks at Beginning of Period 3,462 3,324
------- -------
Cash and Due From Banks at End of Period $ 2,705 $ 2,249
======= =======
Supplemental disclosure of cash flows information:
Cash paid during the period for interest $ 939 $ 674
======= =======
Cash paid during the period for taxes $ 115 $ -
======= =======
See accompanying notes to consolidated financial statements.
</TABLE>
5
<PAGE>
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 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 it 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.
6
<PAGE>
(3) Securities
The carrying values, unrealized gains, unrealized losses and
approximate fair values of investment securities at March 31, 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 March 31, 1999, investments with amortized
costs and fair values of $1,216 and $1,226, respectively, were
pledged as collateral for public deposits, a line of credit available
from 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 $2 $0 $201
U.S. Government agencies 13,875 18 (73) 13,820
Mortgage-backed securities 3,193 9 (6) 3,196
States and political subdivisions 6,230 133 (1) 6,362
Corporate debt securities 100 2 0 102
Equity securities 935 7 0 942
------- ---- --- -------
Total securities available
for sale $24,532 $171 ($80) $24,623
======= ==== === =======
</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 73 31
Recoveries 0 0
Charged off loans 0 0
---- ----
Balance at March 31 $781 $490
==== ====
</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
7
<PAGE>
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 March 31: Basic Diluted
----- -------
<S> <C> <C>
1999 964,866 991,079
======= =======
1998 964,040 977,224
======= =======
</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.
Comprehensive income consists of net income and net unrealized gains
(losses) on securities available for sale. Comprehensive income for
the periods ended March 31, 1999 and 1998, was $91 and $64,
respectively. The adoption of Statement 130 did not have any effect
on the Company's consolidated financial position, results of operation
or liquidity.
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 periods ended March 31, 1999 and 1998.
8
<PAGE>
<TABLE>
<CAPTION>
For the Period Ended For the Period Ended
March 31, 1999 March 31, 1998
-------------------- --------------------
<S> <C> <C>
Net unrealized losses on securities
available-for-sale:
Net unrealized holding losses
during the year $ (167) $ (91)
Less reclassification
adjustments for gains
included in net income - (9)
Income tax expense 57 34
------ -----
Other comprehensive
income, net of
income taxes $ (110) $ (66)
====== =====
</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 three months ended
March 31, 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 March 31, 1999 were $118,059, up 12% from $105,186 at December
31, 1998. The principal components of the Company's assets at the end of the
period were $10,459 in federal funds sold, $24,623 in securities available-for-
sale and $77,649 in gross loans. Total liabilities at March 31, 1999 were
$108,807, up 13% from $96,029 at December 31, 1998 with the increase almost
entirely represented by a $12,785 growth in deposits.
Total shareholders' equity at March 31, 1999 was $9,252 consisting of $9,099 in
net proceeds from the issuance of common stock, increased by accumulated
retained earnings of $93 and increased by $60 of unrealized gains on securities
available-for-sale, net of related deferred tax liability. At December 31,
1998, total shareholder's equity was $9,157.
The Company had net income of $201 for the three months ended March 31, 1999
compared with $130 recorded for the three months ended March 31, 1998, a 55%
increase. The significant improvement in profitability 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
.76% for the three months ended March 31, 1999, compared to .69% for the same
period in 1998. Return on average equity ("ROE") was 8.95% for the three months
ended March 31, 1999 compared to 6.37% for the same period in 1998.
9
<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 $967 for the three months ended March
31, 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 three months of 1999 increased 38% from $703 for the
same period in 1998. The net interest margin on a fully taxable equivalent
("FTE ") basis was 4.01% for the first three months of 1999, an increase of 8
basis points from the 3.93% 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 lower deposit costs.
Provision for Loan Losses. A provision for loan losses of $73 was provided
during the three months ended March 31, 1999, an increase of $42 or 135% 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 $781 as
of March 31, 1999 and represented approximately 1.02% of net loans outstanding
versus 1.00% of net loans at December 31, 1998 (see Note 4 to the Consolidated
Financial Statements). The increase in provision expense is due to growth in
average loans outstanding.
No assurance can be given that unforeseen adverse economic conditions or other
circumstances will not result in increased provisions in the future.
Additionally, regulatory examiners may require the Company to recognize
additions to the allowance based upon their judgment about the loan portfolio
and other information available to them at the time of their examinations.
Noninterest Income. Noninterest income of $74 in the three months ended March
31, 1999 consisted of service charges and fees on accounts and other
miscellaneous income, and represented an increase of $6 or 9% over the $68
reported for the same period one year earlier. 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 three months of 1999 was
$695, an increase of $148 or 27% 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, legal fees, 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
expenses are expected to increase in future years as a direct result of business
growth and expansion.
10
<PAGE>
Year 2000. The Year 2000 issue arises from computer programs being written
using two digits rather than four to abbreviate the year portion of dates.
Computer hardware, software and devices with imbedded technology that are time-
sensitive may not recognize the abbreviation "00" as meaning the year 2000, but
instead read it as the year 1900. This could result in system failures or
miscalculations causing disruption of normal operations including, among other
things, a temporary impairment of the ability to process transactions, calculate
interest payments correctly or engage in routine business activities.
The Company has undertaken various initiatives intended to ensure that its
computer equipment and software will function properly with respect to dates in
the year 2000 and thereafter. Included in the initiatives are information
technology ("IT") systems such as accounting, data processing, financial
transaction processing, ATM and telephone, and non-IT systems such as alarm
systems, fax machines, copiers, 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 software. The Company is
monitoring the Year 2000 compliance status of both these third-party providers,
and will validate their compliance through its own testing efforts. A
comprehensive contingency plan has not yet been developed for dealing with the
most reasonably likely worst case scenario in the event of failure by the
Company or its primary third-party providers to achieve Year 2000 compliance on
a timely basis, and such scenario has not been clearly identified. The Company
presently intends to complete such analysis and contingency planning by December
31, 1999.
The Company also is taking steps to assess the potential impacts of Year 2000
issues on its major commercial borrowers. Should a commercial borrower fail to
deal adequately with Year 2000's impact on its computer systems, its operations
could be jeopardized and its ability to repay its loan threatened. All
commercial borrowers in significant amounts have been sent questionnaires
concerning their Year 2000 preparedness. Completed questionnaires are being
evaluated to identify moderate and high-risk credits. Year 2000 risk factors
are being incorporated into the overall risk ratings for all new and renewed
commercial loans and, where appropriate, more stringent standards will be
imposed in underwriting criteria, loan covenants and required collateral. As of
March 31, the Company expects that virtually all commercial borrowers will be
considered low Year 2000 risk by the end of the second quarter of 1999.
11
<PAGE>
As part of its board-approved Year 2000 Action Plan, the Company established a
budget for Year 2000 compliance. As of March 31, 1999, actual expenditures have
approximated $3, while actual expenditures approximated $16 for the year ended
December 31, 1998. 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 include, but are not limited to, the
availability and cost of personnel trained in Year 2000 issues, the ability to
identify, assess, remediate and test all relevant IT systems and imbedded
technology, and similar uncertainties.
The failure by the Company or a primary third-party provider to correct a
material Year 2000 problem could result in the interruption in, or failure of,
certain normal business activities or operations. Such failure could have a
material adverse effect on the Company's results of operations, liquidity and
financial condition. Due to the general uncertainty inherent in the Year 2000
problem, resulting in part from the uncertainty of the Year 2000 readiness of
third-party providers and customers, the Company presently is unable to provide
assurances that such material adverse impact will not be the case. The Year
2000 project is expected to significantly reduce the Company's level of
uncertainty about the Year 2000 problem and, in particular, about the Year 2000
compliance and readiness of its primary third-party providers. The Company
believes that, with the implementation of remediated IT systems and completion
of the Year 2000 project as scheduled, the possibility of significant
interruptions of normal business operations should be reduced.
Income Taxes. An expense of $72 was recognized in the three months ended March
31, 1999 to reflect the Company's anticipated federal income tax liability for
the period. This equated to an effective tax rate of 26%. Provision for income
taxes was $63 for the first quarter of 1998, an effective tax rate of 33%.
Liquidity and Asset/Liability Management
Asset/liability management activities are designed to ensure that adequate
liquidity available to meet loan demand or deposit outflows and, through the
management of the Company's interest sensitivity position, to manage the impact
of interest rate fluctuations on net interest income.
Liquidity. Liquidity measures the ability of the Company to meet its maturing
obligations and existing commitments, to withstand fluctuations in deposit
levels, to fund its operations and to provide for customers credit needs.
Liquidity represents a financial institutions ability to meet present and future
financial obligations through either the sale or maturity of existing assets or
the acquisition of additional funds from alternative funding sources.
12
<PAGE>
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 37% at March 31, 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 $10,459 and $1,699 at March 31, 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.
In addition to asset liquidity, the Company would have liquidity available to it
through increasing certain categories of liabilities. It could purchase
overnight federal funds, borrow from correspondent banks, sell securities under
a repurchase agreement or obtain advances from the Federal Home Loan Bank. As a
result of the Company's management of liquid assets and the ability to generate
liquidity through alternative funding sources, management believes the Company
maintains overall liquidity sufficient to meet its depositors requirements and
satisfy its customers credit needs.
Interest Rate Risk
Interest rate risk is the risk to earnings or capital generated by movement of
interest rates. It can come from differences between the timing of rate changes
and the timing of cash flows (repricing risk); from changing rate relationships
among yield curves that affect bank activities (basis risk); from changing rate
relationships across the spectrum of maturities (yield curve risk); and from
interest rate related options imbedded in bank products (option risk).
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,
arising 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
13
<PAGE>
and liabilities that have the contractual ability to reprice within a given
period in response to changes in interest rates. Company management believes
this "balance sheet gap" methodology does not adequately take into consideration
the differences in the way various balance sheet items react to changing
interest rates. For example, the rate on savings accounts does not move in
direct tandem with changes in the prime rate, but typically increases or
decreases to a much lesser extent. On the other hand, home equity lines and
many commercial loans are tied directly to prime and immediately reprice to the
full extent of any changes in the prime rate. Accordingly, the Company utilizes
an "income statement gap" methodology that analyzes the various asset and
liability categories and assigns them a "change ratio" that estimates their
relative change in response to a change in the prime rate, based on industry
trends and the Company's own experience. At least quarterly, the Company
calculates the Banks "income statement gap" to estimate how many assets and
liabilities would reprice and to what extent within a one year period in
response to changes in the prime rate, and compares the results to internal
policy guidelines.
Impact of Inflation
The Consolidated Financial Statements and Notes thereto presented herein have
been prepared in accordance with generally accepted accounting principles, which
requires the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. Unlike most industrial companies, nearly
all the assets and liabilities of the Company and the Bank are monetary in
nature. As a result, interest rates have a greater impact on the Company's
performance than do the effects of changes in the general rate of inflation and
changes in prices. In addition, interest rates do not necessarily move in the
same direction or in the same magnitude as do the prices of goods and services.
Management seeks to manage the relationship between interest-sensitive assets
and liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
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.
14
<PAGE>
Investment securities at March 31, 1999 were $24,623, a decrease of $1,495 or 6%
from their level of $26,118 on December 31, 1998. The proceeds from calls of
securities were not entirely reinvested into securities due to short-term
liquidity funding needs during the period ended March 31, 1999.
For more information on the investment portfolio, see Note 3 to the Consolidated
Financial Statements.
Loan Portfolio
The Company's total loans were $77,649 at March 31, 1999, an increase of $6,027
or 8% from the $71,622 reported at December 31, 1998. The Company's ratio of
net loans to total deposits stood at 75% at March 31, 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 25% of the loan
portfolio as of March 31, 1999 and stood at $19,093 versus $17,794 three 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 34% of total
loans at March 31, 1999. Outstanding loans in this category equaled $26,186
and $22,040 at March 31, 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.
15
<PAGE>
Residential Real Estate Loans. Residential real estate loans are secured by
first deeds of trust on 1-4 family residential properties. This category had
$19,446 in loans (25% of total loans) at March 31, 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.
Loans to Individuals. Loans to individuals include installment loans and home
equity lines of credit/loans secured by junior liens on residential real estate.
The loan proceeds typically are used to purchase vehicles, finance home
remodeling or higher education, or for other consumer purposes. Loans to
individuals totaled $12,924 (17% of total loans) at March 31, 1999 compared
to $12,648 at December 31, 1998.
Nonperforming Assets. The Company had no nonperforming assets at March 31, 1999
or December 31, 1998.
Deposits
As of March 31, 1999 total deposits were $102,811 an increase of $12,785 or 14%
from their level of $90,026 at December 31, 1998. The increase in total
deposits was due to increases in previously-existing accounts as well as new
accounts opened. Included in the increase of $12,785 is a $12,130 temporary
deposit to a real estate title insurance company account received late in the
first quarter in connection with settlement of a pending transaction. The
temporary deposit was held approximately three business days, and is being
disclosed to provide better comparability between periods.
At March 31, 1999 noninterest bearing demand deposits were $24,143 or 23% 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 $57,539 or 56% of total deposits at March 31, 1999, up
from $44,056 or 49% of total deposits at December 31, 1998. Total interest
bearing deposits stood at $78,668 at March 31, 1999, a decrease of $921 or 1%
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.
16
<PAGE>
Capital Resources
The Company's financial position at March 31, 1999 reflects liquidity and
capital levels currently adequate to fund anticipated near-term business
expansion. Capital ratios are well in excess of required regulatory minimums
for a well-capitalized institution. The adequacy of the Company's capital is
reviewed by management on an ongoing basis. Management seeks to maintain a
capital structure adequate to support anticipated asset growth and serve as a
cushion to absorb potential losses.
Total shareholders equity was $9,252 at March 31, 1999 compared with $9,157 at
December 31, 1998, an increase of $95 or 1%. The increase is attributable to
the first three months net income of $201, minus $110 in decreased accumulated
other comprehensive income and $4 from the issuance of common stock pursuant to
the exercise of stock options.
For the periods indicated, the Company had the following risk-based capital and
leverage ratios relative to regulatory minimums:
<TABLE>
Ratio 3/31/99 12/31/98 3/31/98 Minimum
----- ------- -------- ------- -------
<S> <C> <C> <C> <C>
Tier 1 10.6% 11.3% 14.4% 4%
Total 11.5% 12.2% 15.3% 8%
Leverage 8.5% 8.7% 10.8% 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
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.
17
<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
quarter.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The Company filed the following exhibits for the quarter ended March 31,
1999:
27. Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended March 31,
1999. The report, dated February 5, 1999, reported the Company's
consolidated financial results for the year ended December 31, 1998.
18
<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
May 13, 1999 /s/ Ellis L. Gutshall
- ----------------- ----------------------------
Date Ellis L. Gutshall, President
and Chief Executive Officer
May 13, 1999 /s/ A. Wayne Lewis
- ----------------- ----------------------------
Date A. Wayne Lewis, Executive
Vice President and Chief
Financial Officer
19
<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] MAR-31-1999
[PERIOD-TYPE] 3-MOS
[CASH] 2,705
[INT-BEARING-DEPOSITS] 64
[FED-FUNDS-SOLD] 10,459
[TRADING-ASSETS] 0
[INVESTMENTS-HELD-FOR-SALE] 24,623
[INVESTMENTS-CARRYING] 0
[INVESTMENTS-MARKET] 0
[LOANS] 77,649
[ALLOWANCE] 781
[TOTAL-ASSETS] 118,059
[DEPOSITS] 102,811
[SHORT-TERM] 0
[LIABILITIES-OTHER] 996
[LONG-TERM] 5,000
[COMMON] 9,099
20
<PAGE>
[PREFERRED-MANDATORY] 0
[PREFERRED] 0
[OTHER-SE] 153
[TOTAL-LIABILITIES-AND-EQUITY] 118,059
[INTEREST-LOAN] 1,540
[INTEREST-INVEST] 371
[INTEREST-OTHER] 14
[INTEREST-TOTAL] 1,925
[INTEREST-DEPOSIT] 891
[INTEREST-EXPENSE] 958
[INTEREST-INCOME-NET] 967
[LOAN-LOSSES] 73
<SECURITIES-GAIN> 0
[EXPENSE-OTHER] 695
[INCOME-PRETAX] 273
[INCOME-PRE-EXTRAORDINARY] 273
[EXTRAORDINARY] 0
[CHANGES] 0
[NET-INCOME] 201
[EPS-PRIMARY] 0.21
[EPS-DILUTED] 0.20
[YIELD-ACTUAL] 4.01
[LOANS-NON] 0
[LOANS-PAST] 1
[LOANS-TROUBLED] 0
21
<PAGE>
[LOANS-PROBLEM] 200
[ALLOWANCE-OPEN] 708
[CHARGE-OFFS] 0
[RECOVERIES] 0
[ALLOWANCE-CLOSE] 781
[ALLOWANCE-DOMESTIC] 781
[ALLOWANCE-FOREIGN] 0
[ALLOWANCE-UNALLOCATED] 771
22
<PAGE>
