UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 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 October 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
September 30, 2000
INDEX
<TABLE>
<CAPTION>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
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 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
</TABLE>
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
September 30 December 31
2000 1999
------------ ----------------
Assets
<S> <C> <C>
Cash and due from banks $ 4,263 $ 4,027
Money market investments:
Federal funds sold - 6,034
Interest-bearing deposits in other banks 74 71
--------- ---------
Total money market investments 74 6,105
Securities available for sale 36,214 31,964
Loans:
Commercial and industrial loans 27,383 24,651
Commercial real estate loans 38,139 33,485
Residential real estate loans 26,953 19,773
Loans to individuals 16,316 13,481
--------- ---------
Total loans 108,791 91,390
Less unearned income (31) (32)
Less allowance for loan losses (1,112) (910)
--------- ---------
Net loans 107,648 90,448
Premises and equipment 3,019 2,629
Accrued interest receivable 1,160 989
Other assets 813 994
--------- ---------
Total assets $ 153,191 $ 137,156
========= =========
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand deposits $ 15,202 $ 14,328
Interest bearing demand deposits 7,603 9,423
Money market deposits 18,926 22,178
Other savings deposits 1,747 1,357
Certificates of deposits >100,000 15,329 12,974
Other time deposits 60,114 55,217
--------- ---------
Total deposits 118,921 115,477
--------- ---------
Short-term borrowings 6,258 -
Securities sold under agreements to repurchase 3,959 992
Accrued interest payable 1,070 1,034
Other liabilities 233 598
Subordinated capital note 2,300 -
Federal Home Loan Bank advances 10,000 10,000
--------- ---------
Total liabilities 142,741 128,101
--------- ---------
Commitments and other contingencies
Preferredstock, 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
September 30, 2000 and 1,013,207 at December
31,1999 9,099 9,099
Accumulated retained earnings 1,999 934
Accumulated other comprehensive loss (648) (978)
--------- ---------
Total shareholders' equity 10,450 9,055
--------- ---------
Total liabilities and shareholders' equity $ 153,191 $ 137,156
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
For the Period For the Period
January 1, 2000 January 1, 1999
Through Through
September 30, 2000 September 30, 1999
------------------ -------------------
Interest Income:
<S> <C> <C>
Interest and fees on loans $6,842 $4,965
Interest on money market investments 47 78
Interest on securities - taxable 1,379 1,051
Interest on securities - nontaxable 293 238
------ ------
Total interest income 8,561 6,332
------ ------
Interest Expense:
Interest on certificates of deposit > 100,000 594 389
Interest on other deposits 3,191 2,503
Interest on Federal Home Loan Bank advances 417 284
Interest on repurchase agreements 111 1
Interest on borrowed funds 197 22
------ ------
Total interest expense 4,510 3,199
------ ------
Net interest income 4,051 3,133
Provision for loan losses 203 161
------ ------
Net interest income after provision for loan losses 3,848 2,972
------ ------
Noninterest income:
Service charges on deposit accounts 251 159
Other fee income 81 88
Securities gains (losses) - -
------ ------
Total noninterest income 332 247
------ ------
Noninterest expense:
Compensation expense 1,420 1,191
Occupancy and equipment expense, net 319 287
Data processing expense 150 127
Marketing and advertising expense 78 98
Office supplies expense 48 63
Other expense 650 449
------ ------
Total noninterest expense 2,665 2,215
------ ------
Net income before taxes 1,515 1,004
Provision for income taxes 450 270
------ ------
Net income $1,065 $ 734
====== ======
Basic earnings per share $ 1.05 $ .72
====== ======
Diluted earnings per share $ 1.00 $ .70
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share data)
For the Period For the Period
July 1, 2000 July 1, 1999
Through Through
September 30, 2000 September 30, 1999
------------------ ------------------
Interest Income:
<S> <C> <C>
Interest and fees on loans $2,464 $1,773
Interest on money market investments 22 44
Interest on securities - taxable 472 408
Interest on securities - nontaxable 98 85
------ ------
Total interest income 3,056 2,310
------ ------
Interest Expense:
Interest on certificates of deposit > 100,000 231 146
Interest on other deposits 1,157 898
Interest on Federal Home Loan Bank advances 152 127
Interest on repurchase agreements 47 1
Interest on borrowed funds 113 5
------ ------
Total interest expense 1,700 1,177
------ ------
Net interest income 1,356 1,133
Provision for loan losses 40 34
------ ------
Net interest income after provision for loan losses 1,316 1,099
------ ------
Noninterest income:
Service charges on deposit accounts 99 58
Other fee income 38 43
Securities gains (losses) - -
------ ------
Total noninterest income 137 101
------ ------
Noninterest expense:
Compensation expense 476 410
Occupancy and equipment expense, net 105 108
Data processing expense 49 46
Marketing and advertising expense 23 25
Office supplies expense 14 11
Other expense 225 157
------ ------
Total noninterest expense 892 757
------ ------
Net income before taxes 561 443
Provision for income taxes 180 123
------ ------
Net income $ 381 $ 320
====== ======
Basic earnings per share $ .38 $ .32
====== ======
Diluted earnings per share $ .36 $ .30
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
<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, 2000 January 1, 1999
Through Through
September 30, 2000 September 30, 1999
------------------ ------------------
Cash Flows From Operating Activities:
<S> <C> <C>
Net income $ 1,065 $ 734
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 203 161
Depreciation and amortization of bank
premises and equipment 170 150
Amortization of organizational expenses - 14
Deferred income taxes - (24)
Amortization (accretion) of premiums and
discounts 19 31
Decrease in unearned fees (1) (6)
Increase in accrued interest receivable (171) (115)
(Increase) decrease in other assets 11 (15)
Increase in accrued interest payable 36 76
Increase (decrease) in other liabilities (365) 69
-------- --------
Net cash provided by operating activities 967 1,075
-------- --------
Cash Flows From Investing Activities:
(Increase) decrease in money market investments 6,031 (2,068)
Purchases of premises and equipment (560) (886)
Purchases of securities available-for-sale (4,594) (15,359)
Proceeds from sales, calls, and maturities of
securities available-for-sale 825 7,530
Increase in loans (17,402) (13,990)
-------- --------
Net cash used in investing activities (15,700) (24,773)
-------- --------
Cash Flows From Financing Activities:
Increase in time deposits greater than $100,000 2,355 3,817
Increase in other time deposits 4,897 11,950
Increase (decrease) in other deposits (3,808) 2,366
Increase in short-term borrowings 9,225 -
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 14,969 23,137
-------- --------
Net increase (decrease) in Cash and Due From Banks 236 (561)
Cash and Due From Banks at Beginning of Period 4,027 3,462
-------- --------
Cash and Due From Banks at End of Period $ 4,263 $ 2,901
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 4,474 $ 3,123
======== ========
Cash paid during the period for taxes $ 837 $ 213
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
September 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
September 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
September 30, 2000, investments with amortized costs and fair
values of $18,778 and $18,224, 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>
Investment Portfolio - Category Distribution
(dollars in thousands)
Amortized Unrealized Unrealized Approximate
Costs Gains Losses Fair Values
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. Treasury $200 $0 ($1) $199
U.S. Government agencies 23,211 6 (722) 22,495
Mortgage-backed securities 3,311 1 (24) 3,288
States and political subdivisions 8,656 8 (242) 8,422
Corporate debt securities 607 0 (1) 606
Equity securities 1,210 0 (6) 1,204
----- - --- -----
Total securities available for sale $37,195 $15 ($996) $36,214
======= === ====== =======
</TABLE>
(4) Allowance for Loan Losses
The following table summarizes the loan loss
experience for the nine-month periods ended September 30, 2000
and 1999.
<TABLE>
<CAPTION>
Allowance for Loan Losses
(dollars in thousands)
2000 1999
---- ----
<S> <C> <C>
Balance at January 1 $910 $708
Provision for loan losses 203 161
Recoveries 0 0
Charged off loans
Credit Cards (1) (11)
Loans to Individuals 0 (2)
- ---
Balance at September 30 $1,112 $856
====== ====
</TABLE>
8
<PAGE>
(5) Earnings Per Share
Basic earnings per share is based upon the weighted
average number of common shares outstanding during the period.
The weighted average shares outstanding for the diluted
earnings per share computations were adjusted to reflect the
assumed conversion of shares available under stock options.
The following table summarizes the shares utilized in the
computations:
<TABLE>
<CAPTION>
Weighted Average Shares Outstanding
-----------------------------------
Three months ending September 30: Basic Diluted
----- -------
<S> <C> <C>
2000 1,013,207 1,060,870
========= =========
1999 1,013,207 1,050,050
========= =========
Nine months ending September 30:
2000 1,013,207 1,060,560
========= =========
1999 1,013,166 1,044,587
========= =========
</TABLE>
(6) Comprehensive Income
On January 1, 1998, The Company adopted Statement of
Financial Accounting Standards No. 130, Reporting
Comprehensive Income. This Statement establishes standards for
reporting and presentation of comprehensive income and its
components in a full set of general purpose financial
statements. This Statement was issued to address concerns over
the practice of reporting elements of comprehensive income
directly in equity.
The Company is required to classify items of "Other
Comprehensive Income" (such as net unrealized gains (losses)
on securities available for sale) by their nature in a
financial statement. It does not require a specific format for
that financial statement but requires the Company to display
an amount representing comprehensive income for the period in
that financial statement. The Company is required to present
the accumulated balance of other comprehensive income
separately from retained earnings and additional
paid-in-capital in the equity section of a statement of
financial position. It does not require per share amounts of
comprehensive income to be disclosed.
The adoption of Statement 130 on January 1, 1998 did
not have any effect on the consolidated financial position,
results of operations or liquidity of the Company. However,
Statement 130 does have an effect on financial statement
displays presented by the Company since the Company has net
unrealized gains (losses) on available-for-sale securities, an
item of other comprehensive income (loss). For the nine months
ended September 30, 2000 and 1999, total
9
<PAGE>
comprehensive income (loss) was $1,395 and $(12),
respectively. For the three months ended September 30, 2000
and 1999, total comprehensive income was $716 and $288,
respectively.
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 nine
and three month periods ended September 30, 2000 and 1999.
<TABLE>
<CAPTION>
For the Nine Months Ended For the Nine Months Ended
September 30, 2000 September 30, 1999
------------------ ------------------
<S> <C> <C>
Net unrealized gains (losses) on securities available-for-sale:
Net unrealized holding gains (losses) during the year $ 500 $(1,131)
Less reclassification adjustments for gains included
in net income - -
Income tax benefit (expense) (170) 385
------- -------
Other comprehensive income (loss), net of income taxes $ 330 $ (746)
======= =======
</TABLE>
<TABLE>
<CAPTION>
For the Three Months Ended For the Three Months Ended
September 30, 2000 September 30, 1999
------------------ ------------------
Net unrealized gains (losses) on securities available-for-sale:
<S> <C> <C>
Net unrealized holding gains (losses) during the quarter $ 507 $(49)
Less reclassification adjustments for gains included
in net income - -
Income tax benefit (expense) (172) 17
----- -----
Other comprehensive income (loss), net of income taxes $ 335 $ (32)
===== =====
</TABLE>
Item 2. Management's Discussion and Analysis.
The following is management's discussion and analysis of the financial
condition and results of operations of the Company as of and for the nine months
and three months ended September 30, 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 September 30, 2000 were $153.2 million, up 11.7% from
$137.2 million at December 31, 1999. The principal components of the Company's
assets at the end of the period were $36.2 million in securities
available-for-sale and $108.8 million in gross loans. Total liabilities at
September 30, 2000 were $142.7 million, up 11.4% from $128.1 million at December
31, 1999 with the increase represented by a $3.4 million growth in deposits, a
$6.3 million increase in short-term borrowings, a $3.0 million growth in
securities sold under agreements to repurchase, and a $2.3 million subordinated
capital note finalized during the second quarter.
10
<PAGE>
Total shareholders' equity at September 30, 2000 was $10.5 million
consisting of $9.1 million in net proceeds from the issuance of common stock,
increased by accumulated retained earnings of $2.0 million and decreased by
$648,000 of unrealized losses on securities available-for-sale, net of related
deferred tax liability. At December 31, 1999 total shareholders' equity was $9.1
million. Exclusive of unrealized gains (losses) on investment securities,
shareholders' equity was $11.1 million at September 30, 2000 and $10.0 million
at December 31, 1999.
The Company had net income of $1.1 million for the nine months ended
September 30, 2000 compared with $734,000 recorded for the nine months ended
September 30, 1999, a 45.1% increase. Net income for the three months ended
September 30, 2000 was $381,000, a 19.1% increase over the $320,000 recorded for
the third quarter of 1999. The significant improvement in profitability in both
the nine and three month periods results from higher net interest income and
noninterest income, partially offset by increased noninterest expenses in
virtually all categories.
Profitability as measured by the Company's return on average assets
("ROA") was .98% for the nine months ended September 30, 2000 compared to .84%
for the same period in 1999. ROA for the third quarter of 2000 was 1.00% versus
1.00% in the third quarter of 1999. Return on average equity ("ROE") was 13.41%
for the nine months ended September 30, 2000 compared to 10.50% for the same
period in 1999. ROE for the third quarter of the year was 13.77% in 2000 and
13.21% in 1999. The calculation of ROE excludes the effect of any unrealized
gains or losses on investment securities.
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 $4.1 million for the nine months ended
September 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 nine months of 2000 increased 32.3% from $3.1
million for the same period in 1999. The net interest margin on a fully taxable
equivalent ("FTE ") basis was 4.03% for the first nine months of 2000, an
increase of 11 basis points from the 3.92% 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 September 30, 2000 net interest income was
$1.4 million and the FTE net interest margin was 3.84%. Net interest income was
$1.1 million and the net interest margin was 3.89% for the third quarter of
1999.
11
<PAGE>
Noninterest Income
Noninterest income of $332,000 in the nine months ended September 30,
2000 consisted of service charges and fees on accounts and other miscellaneous
income, and represented an increase of $85,000 or 34.4% over the $247,000
reported for the same period one year earlier. For the three months ended
September 30, 2000 noninterest income was $137,000 an increase of $36,000 or
35.6% over the $101,000 reported for the third 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 nine months of 2000 was $2.7
million, an increase of $450,000 or 20.3% 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 September
30, 2000 was $892,000, an increase of $135,000 or 17.8% over the third quarter
of 1999. Noninterest expenses are expected to increase in future years as a
direct result of business growth and expansion.
Income Taxes
To reflect the Company's anticipated federal income tax liability, an
expense of $450,000 and $270,000 at an effective tax rate of 29.7% and 26.9% was
recognized in the nine months ended September 30, 2000 and September 30, 1999,
respectively. The provision for income taxes was $180,000 and $123,000 for the
third quarter of 2000 and 1999, respectively. The third quarter expense for 2000
and 1999 equated to an effective tax rate of 32.1% and 27.8%, respectively.
Investment Securities
The Company's investment portfolio is used both for investment income
and liquidity purposes. Funds not used for capital expenditures or lending
activities are invested in securities of the U.S. Government and its agencies,
mortgage-backed securities, municipal bonds, corporate bonds and equity
securities. Obligations of the U.S. Government and its agencies include treasury
notes and callable or noncallable agency bonds. Mortgage-backed securities
include pools issued by government agencies. Municipal bonds include taxable and
tax-exempt general obligation and revenue issues. Corporate bonds are investment
grade issue. Equity securities include shares of the Federal Reserve Bank of
Richmond, Federal Home Loan Bank of Atlanta, Community Bankers Bank and
corporate preferred stocks. The Company does not invest in derivatives or other
types of high-risk securities. The entire investment portfolio is classified as
available-for-sale in order to provide maximum liquidity for funding needs.
Investment securities at September 30, 2000 were $36.2 million, an
increase of $4.2 million or 13.1% from their level of $32.0 million on December
31, 1999. Securities approximating $3.4 million were purchased in the first
quarter of 2000, which were funded from excess cash reserves held at December
31, 1999 in anticipation of the century change. Securities of approximately $1.0
million were purchased during the third quarter of 2000 with partial
12
<PAGE>
proceeds of the subordinated capital note finalized at the end of the second
quarter. For more information on the investment portfolio, see Note 3 to the
Consolidated Financial Statements.
Loan Portfolio
The Company's total loans were $108.8 million at September 30, 2000, an
increase of $17.4 million or 19.0% from the $91.4 million reported at December
31, 1999. The Company's ratio of net loans to total deposits stood at 90.5% at
September 30, 2000 and 78.3% 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.
The following table summarizes the loan portfolio by category as of the
nine-month periods ended September 30, 2000 and 1999 and the year ended December
31, 1999.
<TABLE>
<CAPTION>
Loan Portfolio Summary
(dollars in thousands)
September 30, December 31, September 30,
2000 1999 1999
---- ---- ----
<S> <C> <C> <C>
Commercial and industrial $27,383 $24,651 $22,049
Commercial real estate 38,139 33,485 31,505
Residential real estate 26,953 19,773 19,124
Loans to individuals 16,316 13,481 12,921
------ ------ ------
Total loans $108,791 $91,390 $85,599
======== ======= =======
</TABLE>
Loan Category Analysis
Commercial Loans. Commercial and industrial loans accounted for 25.2%
of the loan portfolio as of September 30, 2000 and stood at $27.4 million versus
$24.7 million nine 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 credit worthiness 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,
13
<PAGE>
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 35.0% of total
loans at September 30, 2000. Outstanding loans in this category equaled $38.1
million and $33.5 million at September 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 $27.0 million in loans (24.8% of total loans) at September 30, 2000
and $19.8 million 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 $16.3 million (15.0% of total loans) at September 30, 2000
compared to $13.5 million at December 31, 1999.
Summary of Allowance for Loan Losses
Certain credit risks are inherent in making loans. The Company
prudently assesses these risks and attempts to manage them effectively.
Repayment risks are reduced by adhering to our internal credit policies and
procedures. These policies and procedures include officer and customer limits,
periodic loan documentation review, and follow-up on exceptions to credit
policies.
The allowance for loan losses is maintained at a level adequate to
absorb probable losses. Some of the factors which management considers in
determining the appropriate level of the allowance for loan losses are an
evaluation of the current loan portfolio, identified loan problems, loan volume
outstanding, past loss experience, present and expected industry and economic
conditions and, in particular, how such conditions relate to our market area.
Bank regulators also periodically review the loan portfolio and other assets to
assess their quality. The provision for loan loses is charged to income in an
amount necessary to maintain an allowance for loan losses adequate to provide
for expected losses in the loan portfolio. Loans deemed uncollectible are
charged to the allowance for loan losses and recoveries on loans previously
charged off are added to the allowance for loan losses. The Company believes the
allowance for loan losses is adequate to provide for any losses in the loan
portfolio.
No assurance can be given that unforeseen adverse economic conditions
or other circumstances will not result in increased provisions in the future.
14
<PAGE>
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.
A provision for loan losses of $203,000 was provided during the nine
months ended September 30, 2000, an increase of $42,000 or 26.1% over the same
period in 1999, in recognition of management's estimate of inherent risks
associated with lending activities. The allowance for loan losses was $1.1
million as of September 30, 2000 and represented approximately 1.03% of net
loans outstanding versus 1.01% of net loans at December 31, 1999 (see Note 4 to
the Consolidated Financial Statements). A total of $30,000 in specific reserves,
accrued on one commercial loan customer placed on nonaccrual status in April
1999, is included in the balance of the allowance for loan losses as of
September 30, 2000. Of the $30,000 specific reserve, $20,000 was accrued during
the second quarter of 2000.
Nonperforming Assets and Impaired Loans
Nonperforming Assets. Nonperforming assets include nonaccrual loans,
loans past due 90 days or more, restructured loans 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 one loan
customer. Due to a good loan to value ratio, a timely and proper review of
credit quality and restructuring of the loans, the Company believes at the
present time that all amounts of principal and interest 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 quarter the board of directors 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.
15
<PAGE>
Nonperforming assets at September 30, 2000, December 31, 1999 and
September 30, 1999 are presented in the following table.
<TABLE>
<CAPTION>
Nonperforming Assets
(dollars in thousands)
September 30, December 31, September 30,
2000 1999 1999
---- ---- ----
<S> <C> <C> <C>
Nonaccrual loans $102 $87 $88
Loans past due 90 days or more 153 - -
Restructured loans 299 - -
---- --- ---
Total nonperforming loans 554 87 88
---- --- ---
Foreclosed, repossessed and idled properties - - -
---- --- ---
Total nonperforming assets $554 $87 $88
==== === ===
</TABLE>
If the nonaccrual loans disclosed above had performed in accordance
with their original terms, additional interest income in the amount of $8,000,
$4,000, and $2,000, respectively would have been recorded for the nine month
period ended September 30, 2000, the year ended December 31, 1999 and the nine
month period ended September 30, 1999.
The total recorded investment in impaired loans was $554, $103 and $88,
respectively for the nine month period ended September 30, 2000, the year ended
December 31, 1999 and the nine month period ended September 30, 1999. The
related loan loss allowance related to impaired loans was $30, $10 and $10,
respectively for the above-referenced time periods.
Deposits
As of September 30, 2000 total deposits were $118.9 million, an
increase of $3.4 million or 2.9% from their level of $115.5 million at December
31, 1999. The major categories of increases were non-interest bearing demand
deposits and time deposits in the amounts of $874,000 and $7.3 million,
respectively offset by declines in money market deposits and NOW accounts in the
amounts of $3.3 million and $1.8 million, respectively.
At September 30, 2000 noninterest-bearing demand deposits were $15.2
million or 12.8% of total deposits. On December 31, 1999 noninterest bearing
demand deposits were $14.3 million or 12.4% of total deposits. Nonmaturity
deposits (noninterest bearing demand deposits, interest bearing demand deposits,
money market accounts and savings accounts) were $43.5 million or 36.6% of total
deposits at September 30, 2000, compared with $47.3 million or 41.0% of total
deposits at December 31, 1999. Total interest bearing deposits stood at $103.7
million at September 30, 2000, an increase of $2.6 million or 2.6% over their
level of $101.1 million at December 31, 1999.
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>
Short-Term Borrowings
The Company placed in service a commercial sweep account program in
third quarter 1999. The balance in the program grew by $3.0 million from its
level of $992,000 at December 31, 1999 to a total of $4.0 million as of
September 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.
The Company's short-term borrowings in the amount of $6.3 million as of
September 30, 2000 consist of a daily rollover adjustable rate advance from the
Federal Home Loan Bank of Atlanta in the amount of $3.0 million closed during
the second quarter and federal funds purchased in the amount of $3.3 million.
See the Liquidity section of this discussion and analysis for further
information on the preceding borrowings.
Other Debt
The Company has outstanding debt with the Federal Home Loan Bank of
Atlanta in the amount of $10.0 million, represented by two advances in the
amount of $5.0 million each. The older advance was drawn on December 2, 1999
with a maturity date of December 2, 2009. Interest payments at a fixed rate of
5.46% began on March 2, 2000 and will continue quarterly on the second day of
each anniversary month. The Federal Home Loan Bank of Atlanta has the option to
convert in whole this transaction to a three-month LIBOR-based floating rate
advance effective December 4, 2000. The other outstanding advance was drawn on
May 24, 2000 with a maturity date of May 24, 2010. Interest payments at a fixed
rate of 5.46% began on August 24, 2000 and will continue quarterly on the
twenty-fourth day of each anniversary month. The Federal Home Loan Bank of
Atlanta also has the option to convert this transaction in whole to a
three-month LIBOR-based floating rate advance effective May 24, 2001.
On June 30, 2000 the Company issued a $2.3 million subordinated capital
note to a commercial bank. The note bears interest at prime minus 125 basis
points and has a final maturity of 12 years, although it can be repaid at any
time without penalty. The note meets the regulator requirements to qualify as
Tier 2 capital, and is the primary reason for the increase in the Company's
total capital ratio as of September 30, 2000. Of the proceeds of the note, $1.0
million was downstreamed to the Bank as additional common equity, $300,000 was
used to retire inter-company debt and $1.0 million was retained at the parent
company for general corporate purposes and to be available as a source of
additional capital for the Bank.
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
17
<PAGE>
(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.
Capital Adequacy
The Company's financial position at September 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.
Total shareholders' equity was $10.5 million at September 30, 2000
compared with $9.1 million at December 31, 1999, an increase of $1.4 million or
15.4%. The increase is attributable to net income for the first nine months of
$1.1 million and a $330,000 increase in accumulated other comprehensive loss.
Exclusive of unrealized gains (losses) on investment securities, shareholders'
equity was $11.1 million at September 30, 2000 and $10.0 million at December 31,
18
<PAGE>
1999.
For the periods indicated, the Company had the following risk-based
capital and leverage ratios relative to regulatory minimums:
<TABLE>
<CAPTION>
Capital Ratios
Ratio 9/30/00 12/31/99 9/30/99 Minimum
----- ------- -------- ------- -------
<S> <C> <C> <C> <C>
Tier 1 9.3% 9.8% 10.1% 4%
Total 12.2% 10.7% 11.0% 8%
Leverage 7.3% 7.6% 7.6% 4%
</TABLE>
The Company announced in September 2000 plans to sell up to 230,000
additional shares of its common stock through a public offering underwritten by
Davenport & Company LLC. Approximately $2.3 million of the proceeds of this
offering will be used to pay off the subordinated capital note. The remainder of
the proceeds will be used for general corporate purposes including future growth
and expansion of the Bank.
Liquidity
Asset/liability management activities are designed to ensure that
adequate liquidity is available to meet loan demand or deposit outflows and,
through the management of the Company's interest sensitivity position, to manage
the impact of interest rate fluctuations on net interest income.
Liquidity 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, and through management of
investment maturities/prepayments and loan repayments. The Company's ratio of
liquid assets to deposits and short-term borrowings was 31.3% at September 30,
2000 and 36.1% 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 $0 and $6.0 million at September 30, 2000 and December 31,
1999, respectively. Federal funds sold decreased $6.0 million during the first
nine months of 2000 primarily because deposit growth and securities sold under
agreements to repurchase growth in the amounts of $3.4 million and $3.0 million,
respectively have not kept pace with the Company's loan growth in the amount of
$17.4 million over the same period. The
19
<PAGE>
remaining $5.0 million deficit in loan funding was met by obtaining a daily
rollover adjustable rate from the Federal Home Loan Bank of Atlanta during the
second quarter of 2000 in the amount of $3.0 million and by purchasing federal
funds in the amount of $3.3 million as of September 30, 2000.
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.
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. Our efforts were successful, as there
were no identified problems with our data processing system. As a result, we
incurred no expenses in the first nine months of 2000 in relation to the Year
2000 changeover, and none are anticipated in the future. We are aware of no year
2000 problem with a third party provider or customer that will significantly
impact us.
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.
Recent and Future Accounting Considerations
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial
20
<PAGE>
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.
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.
FASB Interpretation No. 44 which clarifies the application of APB
Opinion 25, "Accounting for Stock Issued to Employees" is generally effective
beginning July 1, 2000. The Interpretation applies prospectively at that date
for repricings that occurred after December 15, 1998. The Interpretation defines
the definition of an employee and the FASB granted an exception to the
definition of an employee to include elected outside members of a company's
board of directors. Without this exception, compensation cost for outside
directors' plans would be been calculated in accordance with fair value method
of accounting under FAS 123 and charged directly into income. The Interpretation
did not have any effect on the Company's consolidated financial position,
results of operation or liquidity because no options have been repriced and none
are intended to be repriced in the future.
21
<PAGE>
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
quarter.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The Company filed the following exhibits for the quarter ended
September 30, 2000:
27. Financial Data Schedule
(b) The Company filed one report on Form 8-K during the quarter ended
September 30, 2000. The report, dated August 4, 2000, reported the
Company's consolidated financial results for the quarter ended June 30,
2000.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALLEY FINANCIAL CORPORATION
November 14, 2000 /s/ Ellis L. Gutshall
-------------------------- ---------------------------------------
Date Ellis L. Gutshall, President
and Chief Executive Officer
November 14, 2000 /s/ A. Wayne Lewis
---------------------------- ---------------------------------------
Date A. Wayne Lewis, Executive
Vice President and Chief
Financial Officer
23
