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, 2000
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, 2000, 1,013,207 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
June 30, 2000
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 21
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
VALLEY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
June 30 December 31
2000 1999
--------- ---------
<S> <C> <C>
Assets
Cash and due from banks $ 5,147 $ 4,027
Money market investments:
Federal funds sold 1,309 6,034
Interest-bearing deposits in other banks 75 71
--------- ---------
Total money market investments 1,384 6,105
Securities available for sale 34,910 31,964
Loans:
Commercial loans 27,771 24,651
Commercial real estate loans 37,673 33,485
Residential real estate loans 26,000 19,773
Loans to individuals 15,490 13,481
--------- ---------
Total loans 106,934 91,390
Less unearned income (33) (32)
Less allowance for loan losses (1,073) (910)
--------- ---------
Net loans 105,828 90,448
Premises and equipment 2,559 2,629
Accrued interest receivable 1,135 989
Other assets 990 994
--------- ---------
Total assets $ 151,953 $ 137,156
========= =========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand deposits $ 19,382 $ 14,328
Interest bearing demand deposits 7,448 9,423
Money market deposits 21,698 22,178
Other savings deposits 1,543 1,357
Certificates of deposits >100,000 14,157 12,974
Other time deposits 57,279 55,217
--------- ---------
Total deposits 121,507 115,477
--------- ---------
Short-term borrowings 3,000 -
Securities sold under agreements to repurchase 4,167 992
Accrued interest payable 1,034 1,034
Other liabilities 211 598
Subordinated capital note 2,300 -
Federal Home Loan Bank advances 10,000 10,000
--------- ---------
Total liabilities 142,219 128,101
--------- ---------
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 1,013,207 at
June 30, 2000 and 1,013,207 at December
31,1999 9,099 9,099
Accumulated retained earnings 1,618 934
Accumulated other comprehensive loss (983) (978)
--------- ---------
Total shareholders' equity 9,734 9,055
--------- ---------
Total liabilities and shareholders' equity $ 151,953 $ 137,156
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the Period For the Period
January 1, 2000 January 1, 1999
Through Through
June 30, 2000 June 30, 1999
------------- --------------
<S> <C> <C>
Interest Income:
Interest and fees on loans $4,378 $3,192
Interest on money market investments 25 34
Interest on securities - taxable 907 643
Interest on securities - nontaxable 195 153
----- -----
Total interest income 5,505 4,022
----- -----
Interest Expense:
Interest on certificates of deposit > 100,000 363 243
Interest on other deposits 2,034 1,605
Interest on Federal Home Loan Bank advances 265 157
Interest on repurchase agreements 64 -
Interest on borrowed funds 84 17
----- -----
Total interest expense 2,810 2,022
----- -----
Net interest income 2,695 2,000
Provision for loan losses 163 127
----- -----
Net interest income after provision for loan losses 2,532 1,873
----- -----
Noninterest income:
Service charges on deposit accounts 152 101
Other fee income 43 45
Securities gains (losses) - -
----- -----
Total noninterest income 195 146
----- -----
Noninterest expense:
Compensation expense 944 781
Occupancy and equipment expense, net 214 179
Data processing expense 101 81
Marketing and advertising expense 55 73
Office supplies expense 34 52
Other expense 425 292
----- -----
Total noninterest expense 1,773 1,458
----- -----
Net income before taxes 954 561
Provision for income taxes 270 147
Net income $ 684 $ 414
====== ======
Basic earnings per share $ .68 $ .41
====== ======
Diluted earnings per share $ .65 $ .40
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the Period For the Period
April 1, 2000 April 1, 1999
Through Through
June 30, 2000 June 30, 1999
------------- --------------
<S> <C> <C>
Interest Income:
Interest and fees on loans $2,334 $1,652
Interest on money market investments 5 20
Interest on securities - taxable 452 345
Interest on securities - nontaxable 97 80
------ ------
Total interest income 2,888 2,097
------ ------
Interest Expense:
Interest on certificates of deposit > 100,000 194 133
Interest on other deposits 1,057 824
Interest on Federal Home Loan Bank advances 133 95
Interest on repurchase agreements 41 -
Interest on borrowed funds 69 12
------ ------
Total interest expense 1,494 1,064
------ ------
Net interest income 1,394 1,033
Provision for loan losses 99 54
------ ------
Net interest income after provision for loan losses 1,295 979
------ ------
Noninterest income:
Service charges on deposit accounts 88 55
Other fee income 23 17
Securities gains (losses) - -
------ ------
Total noninterest income 111 72
------ ------
Noninterest expense:
Compensation expense 467 404
Occupancy and equipment expense, net 107 102
Data processing expense 50 42
Marketing and advertising expense 41 47
Office supplies expense 20 22
Other expense 216 146
------ ------
Total noninterest expense 901 763
------ ------
Net income before taxes 505 288
Provision for income taxes 145 75
------ ------
Net income $ 360 $ 213
====== ======
Basic earnings per share $ .36 $ .21
====== ======
Diluted earnings per share $ .34 $ .20
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the Period For the Period
January 1, 2000 January 1, 1999
Through Through
June 30, 2000 June 30, 1999
---------------- ---------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income $ 684 $ 414
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 163 127
Depreciation and amortization of bank
premises and equipment 115 107
Amortization of organizational expenses - 14
Amortization (accretion) of premiums and
discounts 12 25
Increase (decrease) in unearned fees 1 (3)
Increase in accrued interest receivable (146) (117)
(Increase) decrease in other assets 6 (81)
Decrease in accrued interest payable - (27)
Decrease in other liabilities (387) (15)
-------- --------
Net cash provided by operating activities 448 444
-------- --------
Cash Flows From Investing Activities:
Decrease in money market investments 4,721 1,661
Purchases of premises and equipment (45) (870)
Purchases of securities available-for-sale (3,538) (14,112)
Proceeds from sales, calls, and maturities of
securities available-for-sale 573 6,971
Increase in loans (15,544) (12,064)
-------- --------
Net cash used in investing activities (13,833) (18,414)
-------- --------
Cash Flows From Financing Activities:
Increase in time deposits greater than $100,000 1,183 2,436
Increase in other time deposits 2,062 5,306
Increase in other deposits 2,785 408
Increase in short-term borrowings 6,175 4,597
Proceeds from subordinated capital note 2,300 -
Proceeds from Federal Home Loan Bank advances - 5,000
Proceeds from the issuance of common stock - 4
-------- --------
Net cash provided by financing activities 14,505 17,751
-------- --------
Net increase (decrease) in Cash and Due From Banks 1,120 (219)
Cash and Due From Banks at Beginning of Period 4,027 3,462
-------- --------
Cash and Due From Banks at End of Period $ 5,147 $ 3,243
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 2,810 $ 2,049
======== ========
Cash paid during the period for taxes $ 650 $ 176
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE>
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
June 30, 2000
(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
(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 1999 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,
2000 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,
2000, investments with amortized costs and fair values of
$18,779 and $17,961, respectively, were pledged as collateral
for public deposits, a line of credit available from the
Federal Home Loan Bank, customer sweep accounts, 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 $200 $0 ($1) $199
U.S. Government agencies 23,283 6 (1,060) 22,229
Mortgage-backed securities 3,496 0 (67) 3,429
States and political subdivisions 8,154 0 (353) 7,801
Corporate debt securities 100 0 (1) 99
Equity securities 1,168 0 (15) 1,153
----- - ---- -----
Total securities available for sale $36,401 $6 ($1,497) $34,910
=====================================================
======================================================================================================
</TABLE>
(4) Allowance for Loan Losses
Changes in the allowance for loan losses are as follows:
2000 1999
---- ----
Balance at January 1 $910 $708
Provision for loan losses 163 127
Recoveries 0 0
Charged off loans 0 (2)
- ---
Balance at June 30 $1,073 $833
====== ====
(5) Earnings Per Share
Basic earnings per share is based upon the weighted average
number of common shares outstanding during the period. The
weighted average shares outstanding for the diluted earnings
per share computations were adjusted to reflect the assumed
8
<PAGE>
conversion of shares available under stock options. The
following table summarizes the shares utilized in the
computations:
Weighted Average Shares Outstanding
Three months ending June 30: Basic Diluted
----- -------
2000 1,013,207 1,061,838
========= =========
1999 1,013,207 1,043,401
========= =========
Six months ending June 30:
2000 1,013,207 1,060,405
========= =========
1999 1,013,145 1,041,739
========= =========
(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 has net unrealized gains
(losses) on available-for-sale securities, an item of other
comprehensive income. For the six months ended June 30, 2000
and 1999, total comprehensive income (loss) was $679 and
$(300), respectively. For the three months ended June 30, 2000
and 1999, total comprehensive income (loss) was $366 and
$(391), 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 (loss), net of income taxes for the six and three month
periods ended June 30, 2000 and 1999.
<TABLE>
<CAPTION>
For the Six Months Ended For the Six Months Ended
June 30, 2000 June 30, 1999
------------- -------------
<S> <C> <C>
Net unrealized losses on securities available-for-sale:
Net unrealized holding losses during the year $ (7) $(1,082)
Less reclassification adjustments for gains included
in net income - -
Income tax benefit 2 368
------- -------
Other comprehensive loss, net of income taxes $ (5) $ (714)
======= =======
For the Three Months Ended For the Three Months Ended
June 30, 2000 June 30, 1999
------------- -------------
Net unrealized losses on securities available-for-sale:
Net unrealized holding gains (losses) during the quarter $ 9 $ (915)
Less reclassification adjustments for gains included
in net income - -
Income tax benefit (expense) (3) 311
------- -------
Other comprehensive income (loss), net of income taxes $ 6 $ (604)
======= =======
</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, 2000 and 1999. 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, 2000 were $151,953, up 11% from $137,156 at December
31, 1999. The principal components of the Company's assets at the end of the
period were $34,910 in securities available-for-sale and $106,934 in gross
loans. Total liabilities at June 30, 2000 were $142,219, up 11% from $128,101 at
December 31, 1999 with the increase represented by a $6,030 growth in deposits,
a $3,000 increase in short-term borrowings, a $3,175 growth in securities sold
under agreements to repurchase, and a $2,300 subordinated capital note finalized
during the second quarter.
10
<PAGE>
Total shareholders' equity at June 30, 2000 was $9,734 consisting of $9,099 in
net proceeds from the issuance of common stock, increased by accumulated
retained earnings of $1,618 and decreased by $983 of unrealized losses on
securities available-for-sale, net of related deferred tax liability. At
December 31, 1999 total shareholders' equity was $9,055. Exclusive of unrealized
gains (losses) on investment securities, shareholders' equity was $10,717 at
June 30, 2000 and $10,033 at December 31, 1999.
The Company had net income of $684 for the six months ended June 30, 2000
compared with $414 recorded for the six months ended June 30, 1999, a 65%
increase. Net income for the three months ended June 30, 2000 was $360, a 69%
increase over the $213 recorded for the second quarter of 1999. 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
.97% for the six months ended June 30, 2000 compared to .74% for the same period
in 1999. ROA for the second quarter of 2000 was 1.00% versus .73% in the second
quarter of 1999. Return on average equity ("ROE") was 13.22% for the six months
ended June 30, 2000 compared to 9.07% for the same period in 1999. ROE for the
second quarter of the year was 13.71% in 2000 and 9.18% in 1999. 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 $2,695 for the six months ended June 30, 2000 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 2000 increased 35% from $2,000 for the same period in 1999. The net
interest margin on a fully taxable equivalent ("FTE ") basis was 4.14% for the
first six months of 2000, an increase of 20 basis points from the 3.94% reported
for the same period in 1999. The Company has been successful in increasing the
net interest margin despite Federal Reserve rate increases and fierce
competition for deposits by offsetting cost of funds increases with higher
yields on earning assets.
For the three months ended June 30, 2000 net interest income was $1,394 and the
FTE net interest margin was 4.16%. Net interest income was $1,033 and the net
interest margin was 3.88% for the second quarter of 1999.
11
<PAGE>
Provision for Loan Losses. A provision for loan losses of $163 was provided
during the six months ended June 30, 2000, an increase of $36 or 28% over the
same period in 1999, 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 $1,073 as of June
30, 2000 and represented approximately 1.01% of net loans outstanding versus
1.01% of net loans at December 31, 1999 (see Note 4 to the Consolidated
Financial Statements). An additional $20 specific reserve, exclusive of the $10
accrued in the first quarter of 1999, was accrued in the second quarter of 2000
on a commercial loan placed on nonaccrual status in April 1999. Exclusive of the
specific reserves accrued in the first quarter of 1999 and the second quarter of
2000, the provision expense was $143 during the six months ended June 30, 2000,
an increase of $26 or 22% over the same period in 1999.
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 $195 in the six months ended June 30,
2000 consisted of service charges and fees on accounts and other miscellaneous
income, and represented an increase of $49 or 34% over the $146 reported for the
same period one year earlier. For the three months ended June 30, 2000
noninterest income was $111 an increase of $39 or 54% over the $72 reported for
the second quarter of 1999. 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 2000 was
$1,773, an increase of $315 or 22% over the same period in 1999. The largest
components of the increase were compensation expense as additional employees
were hired due to growth, occupancy expense due to growth and expansion,
growth-related data processing expense, and increases in various other expense
categories. Noninterest expense for the quarter ended June 30, 2000 was $901, an
increase of $138 or 18% over the second quarter of 1999. Noninterest expenses
are expected to increase in future years as a direct result of business growth
and expansion.
Year 2000. The Company spent a significant amount of time planning, testing, and
upgrading for the changeover of information technology systems to January 1,
2000 and other identified sensitive dates. The planning and preparation was
successful, as January 1 and February 29, 2000 arrived and departed with no
identified problems with any Bank IT system. The Company incurred no expenses in
the first or second quarter 2000 in relation to the Year 2000 changeover.
Income Taxes. To reflect the Company's anticipated federal income tax liability,
an expense of $270 and $147 at an effective tax rate of 28% and 26% was
recognized in the six months ended June 30, 2000 and June 30, 1999,
respectively. The provision for income taxes was $145 and $75 for the second
quarter of 2000 and 1999, respectively. The second quarter expense for 2000 and
1999 equated to an effective tax rate of 29% and 26%, respectively.
12
<PAGE>
Liquidity and Asset/Liability Management
Asset/liability management activities are designed to ensure that adequate
liquidity is available to meet loan demand or deposit outflows and, through the
management of the Company"s interest sensitivity position, to manage the impact
of interest rate fluctuations on net interest income.
Liquidity. Liquidity measures the ability of the Company to meet its maturing
obligations and existing commitments, to withstand fluctuations in deposit
levels, to fund its operations and to provide for customers" credit needs.
Liquidity represents a financial institution"s ability to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds from alternative funding sources.
The Company"s asset liquidity is provided by cash and due from banks, federal
funds sold, investments available for sale, managing investment
maturities/prepayments and loan repayments. The Company"s ratio of liquid assets
to deposits and short-term borrowings was 32% at June 30, 2000 and 36% at
December 31, 1999. The Company sells excess funds as overnight federal funds
sold to provide an immediate source of liquidity. The Company had Federal funds
sold of $1,309 and $6,034 at June 30, 2000 and December 31, 1999, respectively.
Continued loan growth in the second quarter of 2000 in the amount of $8,189 was
funded by deposit and securities sold under agreements to repurchase growth
during the quarter in the amount of $9,113, the excess substantially
contributing to the amount of federal funds sold as of June 30, 2000. The
Company repaid the $3,589 in federal funds purchased as of March 31, 2000 with a
daily rollover adjustable rate advance from the Federal Home Loan Bank of
Atlanta during the second quarter of 2000. As of June 30, 2000 the balance of
$3,000 was still outstanding and reported as short-term borrowings.
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. The
Bank has established 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.
13
<PAGE>
Interest Rate Risk
Interest rate risk is the risk to earnings or capital generated by movement of
interest rates. It can come from differences between the timing of rate changes
and the timing of cash flows (repricing risk); from changing rate relationships
among yield curves that affect bank activities (basis risk); from changing rate
relationships across the spectrum of maturities (yield curve risk); and from
interest rate related options imbedded in bank products (option risk).
While no single measure can completely identify the impact of changes in
interest rates on net interest income, a commonly-used technique within the
industry is to assess the differences in the amounts of rate-sensitive assets
and rate-sensitive liabilities. These differences or "gaps" provide an
indication of the extent to which net interest income may be affected by future
changes in interest rates. A "positive gap" exists when rate-sensitive assets
exceed rate-sensitive liabilities and indicates that a greater volume of assets
than liabilities will reprice during a given period. A positive gap may enhance
earnings in a rising interest rate environment and may inhibit earnings in a
declining interest rate environment. Conversely, when rate-sensitive liabilities
exceed rate-sensitive assets (a "negative gap"), a greater volume of liabilities
than assets will reprice within the period. In such a case, a rising interest
rate environment may inhibit earnings and a declining interest rate environment
may enhance earnings.
Some financial institutions evaluate their "gaps" strictly from a balance sheet
perspective, calculating the absolute difference between the volumes of assets
and liabilities that have the contractual ability to reprice within a given
period in response to changes in interest rates. Company management believes
this "balance sheet gap" methodology does not adequately take into consideration
the differences in the way various balance sheet items react to changing
interest rates. For example, the rate on savings accounts does not move in
direct tandem with changes in the prime rate, but typically increases or
decreases to a much lesser extent. On the other hand, home equity lines and many
commercial loans are tied directly to prime and immediately reprice to the full
extent of any changes in the prime rate. Accordingly, the Company utilizes an
"income statement gap" methodology that analyzes the various asset and liability
categories and assigns them a "change ratio" that estimates their relative
change in response to a change in the prime rate, based on industry trends and
the Company"s own experience. At least quarterly, the Company calculates the
Bank"s "income statement gap" to estimate how many assets and liabilities would
reprice and to what extent within a one year period in response to changes in
the prime rate, 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
14
<PAGE>
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, 2000 were $34,910, an increase of $2,946 or 9%
from their level of $31,964 on December 31, 1999. The securities increase in the
amount of $2,946 originated in the first quarter of 2000 as new purchases were
funded from excess cash reserves held at December 31, 1999 in anticipation of
the century change. Securities actually decreased $227 in the second quarter of
2000, primarily due to principal repayments. For more information on the
investment portfolio, see Note 3 to the Consolidated Financial Statements.
Loan Portfolio
The Company"s total loans were $106,934 at June 30, 2000, an increase of $15,544
or 17% from the $91,390 reported at December 31, 1999. The Company"s ratio of
net loans to total deposits stood at 87% at June 30, 2000 and 78% at December
31, 1999. 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.
15
<PAGE>
Commercial Loans. Commercial and industrial loans accounted for 26% of the loan
portfolio as of June 30, 2000 and stood at $27,771 versus $24,651 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, 2000. Outstanding loans in this category equaled $37,673 and $33,485 at June
30, 2000 and December 31, 1999, 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
$26,000 in loans (24% of total loans) at June 30, 2000 and $19,773 in such loans
at December 31, 1999. 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 $15,490 (15% of total loans) at June 30, 2000
compared to $13,481 at December 31, 1999.
Nonperforming Assets. Nonperforming assets include nonaccrual loans, loans past
due 90 days or more and foreclosed/repossessed property. 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 despite its past due status.
A restructured loan is a loan in which the original contract terms have been
modified due to a borrower's financial condition or there has been a transfer of
assets in full or partial satisfaction of the loan. A modification of original
contractual terms is generally a concession to a borrower that a lending
institution would not normally consider. Since the Bank opened in May of 1995,
restructured loans have never been a component of the loan portfolio. The entire
balance of restructured loans as disclosed below is comprised of two loan
customers. Due to proper collateralization of the loans, a timely and proper
review of credit quality and restructuring of the
16
<PAGE>
loans as deemed necessary, the Company believes at the present time that all
amounts of principal and interest as detailed in the contractual terms will be
collected. However, the Company cannot give assurance that unforeseen economic
conditions or other circumstances will not result in impairment.
An impaired loan as defined in SFAS 114 is a loan when, based on current
information and events, it is likely that a lending institution will be unable
to collect all amounts, including both principal and interest, due according to
the contractual terms of the loan agreement.
Once a month the Officers' Loan Committee will review all loans on the Bank's
watch list to determine proper action and reporting of any loans identified as
substandard by the credit quality review.
Nonperforming assets at June 30, 2000, December 31, 1999 and June 30, 1999 are
detailed as follows:
June 30 December 31 June 30
2000 1999 1999
----- ------- -----
Nonaccrual loans $402 $ 87 $225
Loans past due 90 days or more 1 - -
---- ---- ----
Total nonperforming loans 403 87 225
---- ---- ----
Foreclosed, repossessed and idled
Properties - - -
---- ---- ----
Total nonperforming assets $403 $ 87 $225
==== ==== ====
If the nonaccrual loans disclosed above had performed in accordance with their
original terms, additional interest income in the amount of $5, $4, and $8,
respectively would have been recorded for the six month period ended June 30,
2000, the year ended December 31, 1999 and the six month period ended June 30,
1999.
The Bank had restructured loans in the amounts of $770, $0 and $0, respectively
for the six month period ended June 30, 2000, the year ended December 31, 1999
and the six month period ended June 30, 1999.
The total recorded investment in impaired loans was $1,366, $103 and $225,
respectively for the six month period ended June 30, 2000, the year ended
December 31, 1999 and the six month period ended June 30, 1999. The related loan
loss allowance related to impaired loans was $30, $10 and $10, respectively for
the above-referenced time periods.
17
<PAGE>
Deposits
As of June 30, 2000 total deposits were $121,507, an increase of $6,030 or 5%
from their level of $115,477 at December 31, 1999. The major categories of
increases were non-interest bearing demand deposits and times deposits in the
amounts of $5,054 and 3,245, respectively offset by declines in the other
categories. Of the $5,054 increase in non-interest bearing demand deposits,
$2,254 is attributable to an increase in official checks, which include
internally generated expense checks, cashiers checks, money orders, etc.
At June 30, 2000 noninterest-bearing demand deposits were $19,382 or 16% of
total deposits. On December 31, 1999 noninterest bearing demand deposits were
$14,328 or 12% of total deposits. Nonmaturity deposits (noninterest bearing
demand deposits, interest bearing demand deposits, money market accounts and
savings accounts) were $50,071 or 41% of total deposits at June 30, 2000,
compared with $47,286 or 41% of total deposits at December 31, 1999. Total
interest bearing deposits stood at $102,125 at June 30, 2000, an increase of
$976 or 1% over their level of $101,149 at December 31, 1999.
The Company placed in service a commercial sweep account program in third
quarter 1999. The balance in the program grew by $3,175 from their level of $992
at December 31, 1999 to a total of $4,167 as of June 30, 2000. The program
consists of establishing a demand deposit account in which the Bank invests
available balances daily in securities on an overnight basis subject to
repurchase. On the following business day, the Bank will repurchase from the
customer the securities for an amount equal to the amount of available balances
invested in the securities. Interest is calculated daily at the rate applicable
for each overnight period; however, it is posted to the customer accounts only
once per month. The contractual agreement states that a repurchase agreement is
not a deposit and therefore is not insured by the Federal Deposit Insurance
Corporation. Therefore, these repurchase balances are not reported as deposits
but as short-term borrowings. If the balances in the commercial sweep accounts
had been reported as deposits and not short-term borrowings, total deposits
would have increased by $9,205 vs. the $6,030 increase as reported.
The levels and mix of deposits are influenced by such factors as customer
service, interest rates paid, service charges and the convenience of banking
locations. Competition for deposits is intense from other depository
institutions and money market funds, some of which offer interest rates higher
than those paid by the Company. Management attempts to identify and implement
pricing and marketing strategies designed to control the overall cost of
deposits and to maintain a stable deposit mix.
Capital Resources
The Company's financial position at June 30, 2000 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.
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<PAGE>
Total shareholders" equity was $9,734 at June 30, 2000 compared with $9,055 at
December 31, 1999, an increase of $679 or 7%. The increase is attributable to
net income for the first six months of $684, offset by a $5 decrease in
accumulated other comprehensive loss. Exclusive of unrealized gains (losses) on
investment securities, shareholders' equity was $10,717 at June 30, 2000 and
$10,033 at December 31, 1999.
For the periods indicated, the Company had the following risk-based capital and
leverage ratios relative to regulatory minimums:
-----------------------------------------------
Ratio 6/30/00 12/31/99 6/30/99 Minimum
----- ------- -------- ------- -------
Tier 1 9.2% 9.8% 10.1% 4%
-----------------------------------------------
Total 12.1% 10.7% 11.0% 8%
-----------------------------------------------
Leverage 7.3% 7.6% 8.0% 4%
-----------------------------------------------
On June 30, 2000 the Company issued a $2,300 subordinated capital note to a
commercial bank lender. The note bears interest at prime minus 125 basis points
and has a final maturity of twelve years, although it can be repaid at any time
without penalty. The note meets the regulatory requirements to qualify as Tier 2
capital, and is the primary reason for the increase in the Company's total
capital ratio at June 30. Of the proceeds of the note, $1,000 was downstreamed
to the Bank as additional common equity, $300 was used to retire inter-company
debt and $1,000 was retained at the parent company for general corporate
purposes and to be available as a source of additional capital for the Bank.
It is anticipated that the Company"s capital adequacy ratios will 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 June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities. Statement 133 established standards for accounting and
reporting for derivative instruments, including certain instruments embedded in
other contracts and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. Statement 133 was issued
to establish guidelines over the accounting and reporting of derivative
instruments and hedging activities.
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Statement 133 shall be effective for all fiscal quarters of all fiscal years
beginning after June15, 2000. Initial application of this Statement shall be as
of the beginning of an entity's fiscal quarter. Earlier application of all of
the provisions of this Statement is encouraged but is permitted only as of the
beginning of any fiscal quarter that begins after issuance of this Statement.
Earlier application of selected provisions of this Statement is not permitted.
This Statement shall not be applied retroactively to financial statements of
prior periods. Adoption of Statement 133 on January 1, 2000 did not have any
effect on the Bank's consolidated financial position, results of operation or
liquidity.
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<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its 2000 Annual Meeting of Shareholders on April 27, 2000, at
which meeting four Class C 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 2000 Annual Meeting of Shareholders:
---------------------- ------------------ -------------------- ---------------
DIRECTOR NAME TERM OF AFFIRMATIVE VOTES
OFFICE VOTES WITHHELD
---------------------- ------------------ -------------------- ---------------
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
---------------------- ------------------ -------------------- ---------------
William D. Elliot 1999-2002
---------------------- ------------------ -------------------- ---------------
Barbara B. Lemon 1999-2002
---------------------- ------------------ -------------------- ---------------
Ward W. Stevens, M.D. 1999-2002
---------------------- ------------------ -------------------- ---------------
Class C Directors
---------------------- ------------------ -------------------- ---------------
Ellis L. Gutshall 2000-2003 755,346 0
---------------------- ------------------ -------------------- ---------------
Mason Haynesworth 2000-2003 755,346 0
---------------------- ------------------ -------------------- ---------------
A. Wayne Lewis 2000-2003 755,136 210
---------------------- ------------------ -------------------- ---------------
George W. Logan 2000-2003 755,346 0
---------------------- ------------------ -------------------- ---------------
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<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, 2000:
27. Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended June
30, 2000. The report, dated May 3, 2000, reported the Company"s
consolidated financaial results for the quarter ended March 31, 2000.
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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 11, 2000 /s/ Ellis L. Gutshall
------------------ ------------------------------
Date Ellis L. Gutshall, President
and Chief Executive Officer
August 11, 2000 /s/ A. Wayne Lewis
------------------ ---------------------------
Date A. Wayne Lewis, Executive
Vice President and Chief
Financial Officer
23
