<PAGE>
Registration No. 333-46758
As filed with the Securities and Exchange Commission on November 16, 2000.
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------------
Post Effective Amendment No. 1 to
Form SB-2
On Form POS AM
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
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VALLEY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
VIRGINIA 6035 54-1702380
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation) Classification Code Number) Identification No.)
<S> <C> <C>
36 Church Avenue, SW 36 Church Avenue, SW
Roanoke, Virginia 24011 Roanoke, Virginia 24011
(540) 342-2265 (540) 342-2265
(Address, including zip code, and (Address of principal place of business or
telephone number, including area intended principal place of business)
code, of principal executive offices)
Copies to:
Ellis L. Gutshall Douglas W. Densmore and Hugh B. Wellons
President Flippin, Densmore, Morse, & Jessee
36 Church Avenue, SW 10 South Jefferson Street, Suite 1800
Roanoke, Virginia 24011 Roanoke, Virginia 24011
(540) 342-2265 (540) 510-3000
(Name, address, including zip code
and telephone number, including
area code, of agent for service)
</TABLE>
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Approximate date of commencement of proposed sale to the public:
As soon as practicable after this Registration Statement becomes effective.
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering.[_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.[_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the securities Act
registration statement number of the earlier effective registration statement
for the same offering.[_]
If delivery of the prospectus is expected to be made pursuant to Rule 434 of the
Securities Act, please check the following box.[_]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.
<PAGE>
175,000 Shares
Valley Financial Corporation
The Holding Company for
[Valley Bank Logo]
Common Stock
Valley Financial Corporation is offering 175,000 shares of common stock. We
own and operate Valley Bank, which is headquartered in Roanoke, Virginia and
operates four branches in the Roanoke Valley, a metropolitan center of
southwest Virginia. Valley Bank provides commercial and consumer banking
services for individuals and small- to medium-sized businesses.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"VYFC." As of November 14, 2000, the last reported sale price of the common
stock on the OTC Bulletin Board was $19.12 per share. Only a limited market
currently exists for our common stock.
Investing in our common stock involves risks. You should read the "Risk
Factors" section beginning on page 5 before investing.
These securities have not been approved or disapproved by the Securities and
Exchange Commission, any state securities commission, any bank regulatory
agency, or any other government agency nor has any such commission or agency
passed upon the accuracy or adequacy of this prospectus. Any representation to
the contrary is a criminal offense.
The shares of common stock offered are not deposit accounts and are not
insured or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency.
----------------
<TABLE>
<CAPTION>
Per Share Total
--------- ----------
<S> <C> <C>
Public offering price..................................... $17.50 $3,062,500
Underwriting discount..................................... 0.87 151,375
Proceeds, before expenses, to Valley Financial............ 16.63 2,911,125
</TABLE>
The underwriting discount is 1% of the public offering price on approximately
60,000 shares being sold to Valley Financial's directors and 7% of the public
offering price on all other shares sold. To the extent that the underwriter
sells more than 175,000 shares of the common stock, the underwriter has the
option to purchase up to an additional 26,250 shares from Valley Financial at
the public offering price less the underwriting discount.
----------------
The underwriter is offering the shares of common stock subject to various
conditions and may reject all or part of any order. The underwriter expects to
deliver the shares to purchasers on or about November 17, 2000.
Davenport & Company LLC
The date of this prospectus is November 14, 2000.
<PAGE>
VALLEY BANK
Branch Locations
[MAP OF ROANOKE/SALEM AREAS]
<PAGE>
SUMMARY
This summary may not contain all of the information that may be important
to you. You should read carefully the entire prospectus, including "Risk
Factors" and the financial statements and related notes included in the
prospectus, before making an investment decision.
Valley Financial and Valley Bank
Valley Financial Corporation is a one-bank holding company headquartered in
Roanoke, Virginia. Our wholly owned subsidiary, Valley Bank, began operating as
a commercial bank in May 1995. Valley Bank operates four full service banking
offices in the greater Roanoke area and has recently acquired the site for its
fifth banking office in the Roanoke area from another bank. As of June 30, 2000
we had assets of $152.0 million, primary regulatory capital of $10.7 million,
and shareholders' equity of $9.7 million, and reported net income of $684,000,
or $0.68 per share, for the first half of 2000. We have grown substantially
since our formation and are continuing to experience rapid growth. For the
quarter ended June 30, 2000, total assets increased by 23.9% and net income
increased by 69.0% over the year-ago period.
Valley Financial owns and manages Valley Bank and does not engage in any other
business. Valley Bank offers a variety of banking products and services,
including an array of deposit products, consumer loans, commercial loans, and
home mortgages. Valley Bank also offers safe deposit boxes, certain cash
management services, and automatic deposit services.
Our strategic plan is directed towards enhancing profitability and shareholder
value by increasing our market share in the Roanoke Valley market area. We have
historically succeeded in growing our market share by providing a high level of
personal service and targeting small- to medium-sized businesses, professional
firms, and individuals.
Valley Bank's
Roanoke Valley Market Area
Valley Bank operates primarily in the Roanoke Valley area of southwest
Virginia. This area includes the City and County of Roanoke, the City of Salem,
and parts of Montgomery, Bedford, and Botetourt Counties. The Roanoke
Metropolitan Statistical Area, which excludes Montgomery and Bedford counties,
has an estimated population of 231,400 and is the regional and commercial center
of southwest Virginia. Combined FDIC-insured deposits in the Roanoke MSA were
approximately $4.6 billion as of June 30, 1999, the most recent date for which
this data is available, with approximately $3.1 billion residing in the City of
Roanoke. More than 85% of FDIC-insured deposits in the City of Roanoke were held
at larger, out-of-state institutions as of June 30, 1999. We believe this
creates a significant opportunity for a locally owned and managed institution
like us to gain market share. While we have grown our share of the deposits in
our market every year since inception, it is currently less than 3%, which we
believe provides us with a significant opportunity for future growth.
Experienced Management
The President and Chief Executive Officer of Valley Financial and Valley Bank
since June 1996 is Ellis L. Gutshall, who has 26 years' experience in banking.
Mr. Gutshall joined Valley Financial in 1995 as Senior Vice President and Chief
Lending Officer. Immediately prior to that, he was Executive Vice President of
First Virginia Bank - Southwest in Roanoke, Virginia.
A. Wayne Lewis has served Valley Financial and Valley Bank as Senior Vice
President and Chief Operating Officer since operations began in 1995 and as
Executive Vice President since 1996. Mr. Lewis has more than 38 years of
banking experience, including having served as Executive Vice President of
Dominion Bankshares, Inc., a $10.6 billion financial institution that was
acquired by First Union Corporation in 1993.
Reasons for the Offering
We have grown rapidly since our formation and we now need additional equity
capital to support future growth. Since the end of 1997, our assets have more
than doubled to $152.0 million at June 30, 2000. We have strived to enhance
shareholder value by leveraging our existing capital; however, without
additional equity capital our ability to grow will be constrained. Our goal is
to leverage the capital from this offering in a manner that enhances future
earnings per share and shareholder value. We hope to expand operations
throughout the Roanoke Valley through additional branch offices and automated
teller machines. We also intend to make increased use of alternative delivery
systems such as the Internet and telephone. We believe a locally owned and
managed community bank like ours has the ability to take market share away from
our out-of-state competitors.
1
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered by Valley Financial........ 175,000 shares, approximately 60,000 of which we expect our directors to
purchase.
Common stock outstanding after the offering..... 1,188,207 shares (see additional information with respect to this number
following this table).
Use of proceeds................................. We expect to use approximately $2.3 million of the proceeds of the offering to
pay off our subordinated debt (see "Valley Financial's Subordinated Debt" on
page 44) and we will use the remainder of the net proceeds for general corporate
purposes including the future growth and expansion of Valley Bank. See "Use of
Proceeds" on page 7.
Dividends....................................... We have not declared or paid cash dividends since our formation. For the
foreseeable future, we expect that we will retain our earnings to support the
development and growth of our business and will not pay any cash dividends to
shareholders. On January 20, 2000, we did declare a 1.05 for 1.00 stock split
effected in the form of a stock dividend, paid on February 15, 2000 to
shareholders of record as of January 31, 2000.
Trading market and symbol....................... Our common stock is traded on the OTC Bulletin Board under the symbol "VYFC."
Risk factors.................................... You should read the "Risk Factors" section beginning on page 5 before deciding
to purchase any of the shares offered.
</TABLE>
The number of shares of our common stock outstanding after this offering is
based on the number of shares outstanding on June 30, 2000, and excludes the
underwriter's over-allotment option. If the over-allotment option is exercised
in full, 201,250 shares will be offered and 1,214,457 shares will be outstanding
immediately after the offering. The number of shares outstanding after the
offering excludes 103,950 shares that are reserved for issuance under Valley
Financial's Incentive Stock Plan, of which options to purchase 59,063 shares are
outstanding at a weighted average exercise price of $13.06, and 60,732 shares
that are reserved for options granted under the employment agreements of Messrs.
Gutshall and Lewis at an exercise price of $9.52.
_______________
We were founded as a Virginia corporation in 1994. Our principal executive
offices are located at 36 Church Avenue, SW, Roanoke, Virginia 24011. Our
telephone number is (540) 342-2265.
2
<PAGE>
RECENT DEVELOPMENTS
For the quarter ended September 30, 2000, total assets increased to $153.2
million, compared to $152.0 million at June 30, 2000, and $128.5 million at
September 30, 1999. Total loans were $108.8 million at September 30, 2000
compared to $106.9 million and $85.6 million at June 30, 2000 and September 30,
1999, respectively. Total deposits were $118.9 million at September 30, 2000
compared to $121.5 million and $107.7 million at June 30, 2000 and September 30,
1999, respectively. Net income for the third quarter increased to $381,000 or
basic earnings per share of $.38 versus $320,000 or $.32 per share reported for
the third quarter of 1999, a 19.1% increase. The increase in earnings was due
primarily to the continued growth in earning assets, partially offset by an
increase in funding costs.
For the first nine months of 2000, loans have increased 19.0% while our
primary core customer funding sources, deposits and securities sold under
agreement to repurchase, have grown only 5.5%. This has required us to rely
increasingly on borrowed funds and higher cost certificates of deposit to fund
loan growth, especially in the most recent quarter. Current interest rate
levels, significant competition for deposits and the issuance at mid-year of a
$2.3 million subordinated capital note caused an increase in our cost of funds
to 4.82% for the third quarter of 2000, as compared with 4.02% in the comparable
period in 1999. The net interest margin for the September 30, 2000 quarter was
3.84%, down slightly from 3.89% in the year ago period, but down noticeably from
4.16% in the second quarter of this year, due to the higher cost of funds as
explained above.
Return on average total assets was 1.00% in 2000's third quarter, identical
to the comparable period in 1999, and return on average total equity was 13.77%
in the third quarter of 2000 versus 13.21% in the prior year period.
Nonperforming loans, including restructured loans, as a percent of total loans
were 0.51% as of September 30, 2000 down significantly from 1.10% at June 30,
2000 due primarily to the full repayment of several nonperforming loans and the
return to performing status of two commercial loan relationships.
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data for
Valley Financial Corporation and subsidiary. The selected unaudited financial
data presented below for, and as of the end of, the six-month periods ended June
30, 2000 and 1999 are derived from the unaudited consolidated financial
statements of Valley Financial Corporation and subsidiary. The unaudited
consolidated financial statements as of June 30, 2000 and 1999, and for the six-
month periods then ended include, in the opinion of management, all material
adjustments considered necessary for a fair presentation. Operating results for
the six months ended June 30, 2000 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2000. The unaudited
consolidated financial statements as of June 30, 2000 and for the six-month
period ended June 30, 2000 and 1999, are included elsewhere in this prospectus.
The selected consolidated financial data presented below for, and as of the end
of, the year ended December 31, 1999, are derived from the consolidated
financial statements of Valley Financial Corporation and subsidiary, which
financial statements have been audited by Larrowe & Company, P.L.C., independent
public accountants. The consolidated financial statements as of December 31,
1999 and for the year then ended, and the report thereon, are included elsewhere
in this prospectus. The selected consolidated financial data presented below
for, and as of the end of, each of the years in the four-year period ended
December 31, 1998, are derived from the consolidated financial statements of
Valley Financial Corporation and subsidiary, which financial statements have
been audited by KPMG LLP, independent public accountants. The consolidated
financial statements as of December 31, 1998 and for the year then ended, and
the report thereon are included elsewhere in this prospectus. The selected
financial data should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," our financial
statements and note thereto and other financial data included elsewhere in this
prospectus.
3
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Six Months
Ended June 30, Year Ended December 31,
------------------------ -------------------------------------
2000 1999 1999 1998 1997
---- ---- ---- ---- ----
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Interest income..................................... $ 5,505 $ 4,022 $ 8,759 $ 6,770 $ 4,806
Interest expense.................................... 2,810 2,022 4,432 3,512 2,511
---------- ---------- ---------- ---------- ----------
Net interest income................................. 2,695 2,000 4,327 3,258 2,295
Provision for loan losses........................... 163 127 216 249 131
---------- ---------- ---------- ---------- ----------
Net interest income after provision for loan
losses............................................. 2,532 1,873 4,111 3,009 2,164
Noninterest income.................................. 195 146 354 264 178
Noninterest expense................................. 1,773 1,458 3,029 2,252 1,856
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes................... 954 561 1,436 1,021 486
Income tax expense (benefit)........................ 270 147 394 263 (397)
---------- ---------- ---------- ---------- ----------
Net income (loss)................................... $ 684 $ 414 $ 1,042 $ 758 $ 883
========== ========== ========== ========== ==========
Per Share Data: (1)
Basic earnings...................................... $ 0.68 $ 0.41 $ 1.03 $ 0.75 $ 0.87
Diluted earnings.................................... 0.65 0.40 0.99 0.73 0.87
Book value and tangible book value.................. 9.61 8.75 8.94 9.04 8.18
Cash dividends...................................... -- -- -- -- --
Basic weighted average shares outstanding........... 1,013,207 1,013,145 1,013,176 1,012,323 1,012,242
Diluted weighted average shares outstanding......... 1,060,405 1,041,739 1,050,270 1,033,160 1,013,278
End of period shares outstanding.................... 1,013,207 1,013,239 1,013,207 1,012,819 1,012,242
Balance Sheet Data:
Total assets........................................ $ 151,953 $ 122,595 $ 137,156 $ 105,186 $ 74,677
Investment securities............................... 34,910 32,152 31,964 26,118 21,144
Net loans........................................... 105,828 82,815 90,448 70,875 46,150
Allowance for loan losses........................... 1,073 833 910 708 459
Deposits............................................ 121,507 98,176 115,477 90,026 65,588
Short-term borrowings............................... 3,000 4,597 -- -- --
Securities sold under agreements to repurchase...... 4,167 -- 992 -- --
Federal Home Loan Bank advances..................... 10,000 10,000 10,000 5,000 --
Shareholders' equity................................ 9,734 8,861 9,055 9,157 8,279
Performance Ratios: (2)
Return on average assets............................ 0.97% 0.74% 0.86% 0.83% 1.40%
Return on average equity............................ 13.22 9.07 10.98 8.87 11.79
Net interest margin................................. 4.14 3.94 3.92 3.86 3.80
Efficiency ratio (3)................................ 59.26 65.47 60.83 60.60 72.66
Loans to deposits................................... 87.10 84.35 78.33 78.73 70.36
Asset quality ratios:
Nonperforming assets to total assets (4)............ 0.77% 0.18% 0.06% 0.19% --%
Nonperforming loans to total loans (5).............. 1.10 0.27 0.10 0.28 --
Net charge-offs to average loans.................... -- -- 0.02 -- --
Allowance for loan losses to total loans............ 1.00 1.00 1.00 0.99 0.98
Allowance for loan losses to nonperforming
loans (5).......................................... 91.47 370.22 1,045.98 354.00 nm
Capital Ratios:
Leverage ratio...................................... 7.30% 8.00% 7.60% 8.70% 11.50%
Tier 1 risk-based capital........................... 9.20 10.10 9.80 11.30 15.70
Total risk-based capital............................ 12.10 11.00 10.70 12.20 16.50
Equity to assets.................................... 6.41 7.23 6.60 8.71 11.09
<CAPTION>
Year Ended December 31,
----------------------------
1996 1995
---- ----
<S> <C> <C>
Income Statement Data:
Interest income..................................... $ 2,615 $ 900
Interest expense.................................... 1,254 208
------------ ----------
Net interest income................................. 1,361 692
Provision for loan losses........................... 191 137
------------ ----------
Net interest income after provision for loan
losses............................................. 1,170 555
Noninterest income.................................. 89 12
Noninterest expense................................. 1,973 1,306
------------ ----------
Income (loss) before income taxes................... (714) (739)
Income tax expense (benefit)........................ -- --
------------ ----------
Net income (loss)................................... $ (714) $ (739)
============ ==========
Per Share Data: (1)
Basic earnings...................................... (0.71) $ (0.85)
Diluted earnings.................................... (0.71) (0.85)
Book value and tangible book value.................. 7.26 7.97
Cash dividends...................................... -- --
Basic weighted average shares outstanding........... 1,012,242 866,073
Diluted weighted average shares outstanding......... 1,012,242 866,073
End of period shares outstanding.................... 1,012,242 1,012,242
Balance Sheet Data:
Total assets........................................ 51,743 $ 24,355
Investment securities............................... 11,584 5,283
Net loans........................................... 33,121 13,686
Allowance for loan losses........................... 328 137
Deposits............................................ 43,617 16,117
Short-term borrowings............................... -- --
Securities sold under agreements to repurchase...... -- --
Federal Home Loan Bank advances..................... -- --
Shareholders' equity................................ 7,353 8,065
Performance Ratios: (2)
Return on average assets............................ (1.97)% na
Return on average equity............................ (9.38) na
Net interest margin................................. 4.09 na
Efficiency ratio (3)................................ 132.14 na
Loans to deposits................................... 75.94 84.92
Asset quality ratios:
Nonperforming assets to total assets (4)............ 0.01% --%
Nonperforming loans to total loans (5).............. 0.01 --
Net charge-offs to average loans.................... -- --
Allowance for loan losses to total loans............ 0.98 0.99
Allowance for loan losses to nonperforming
loans (5).......................................... 8,200.00 nm
Capital Ratios:
Leverage ratio...................................... 15.00% 38.40%
Tier 1 risk-based capital........................... 19.50 49.30
Total risk-based capital............................ 20.40 50.10
Equity to assets.................................... 14.21 33.11
</TABLE>
__________________________
(1) Adjusted for a 1.05-for-1.00 stock split effected in the form of a stock
dividend declared January 20, 2000 and paid on February 15, 2000.
(2) Interim periods annualized where applicable.
(3) Calculated by dividing total noninterest expenses, excluding intangible
asset amortization, by the sum of net interest income on fully taxable
equivalent basis plus noninterest income.
(4) Nonperforming assets consist of nonaccrual loans, loans past due 90 days or
more, restructured loans, and foreclosed, repossessed, and idled
properties.
(5) Nonperforming loans consist of nonaccrual loans, loans past due 90 days or
more, and restructured loans.
na indicates that the number is not available.
nm indicates that the number is not meaningful.
4
<PAGE>
RISK FACTORS
You should consider carefully the following risk factors before deciding to
buy our common stock. These risk factors may adversely impact our business and
financial condition. Additional risks and uncertainties not presently known to
us, or risks that we currently consider immaterial, may also impair our
business. You should read this section together with the other information in
this prospectus.
<TABLE>
<S> <C>
We are still a young Valley Financial opened for business only five years ago. Although Valley Financial has
company with a grown very rapidly and has earned a profit in each of the last three fiscal years
limited operating (becoming profitable less than two years after opening), we have a relatively short
history operating history. There is no assurance that we will continue to perform as well as we
have in the past, and no assurance that we will continue to earn a profit.
Growth may be more Some of the growth of Valley Financial, and Valley Bank, has been the result of a backlash
difficult in the in the Roanoke Valley against consolidation of the banking industry. In the last few
future years, large out-of-state banks have acquired local banks headquartered in and operating
in the Roanoke Valley. Many local customers feel that they are not receiving the level of
service that they had in the past, which has provided an opportunity for a small,
service-orientated bank like Valley Bank. We have taken full advantage of this in our
marketing. There can be no assurance that this backlash against larger out-of-state banks
will continue or that these larger competitors will not begin to offer increased levels of
personal service. Accordingly, in the future we may have to compete with larger banks on
pricing as well as service. We may have to be more aggressive both in terms of pricing
and promoting our deposits and loans, which could reduce our margins and slow our growth
in assets and in earnings.
Our small size can Virtually all of our competitors operating in the Roanoke Valley are larger and have
be a competitive greater resources. The banking business has become extremely competitive, and we compete
disadvantage with the following types of institutions:
. Other banks
. Savings banks
. Thrifts
. Credit unions
. Consumer finance companies
. Securities brokerage firms
. Mortgage brokers
. Insurance companies
. Mutual funds
. Trust companies
Some of our competitors are not regulated as extensively as we are and have greater
flexibility in competing for business. Many of our competitors have advantages of
established customer bases, higher legal lending limits, extensive branch networks,
numerous automated teller machines in this market and throughout the state and country,
and other advantages. We intend to compete primarily by offering customers personal
service and local decision-making, but we may also need to compete in terms of rates
charged on the products we offer and this could negatively impact profit margins.
Technology and Technology, including automated teller machines, internet banking, telephone banking, and
regulatory other recent developments, are changing the entire financial services industry.
developments may Similarly, changes in laws and regulations have resulted in banks operating in new
impact our markets, and in non-banks providing financial services. Last year, the U.S. Congress
performance passed the Gramm-Leach-Bliley Financial Services Modernization Act, which allowed
combinations of banking, insurance, and securities companies. This year, the U.S.
Congress is considering other legislation that could further change the way banks operate.
In order to remain competitive in today's fast-changing financial environment, we must
offer new technology-based products and services on a continuing basis. Similarly, we
must rapidly adjust to changes in these laws and regulations. If we fail to react quickly
and appropriately to these developments in technology and law, we may not be able to
compete successfully, which could have a material adverse effect on our business growth
and development.
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
Our focus on We offer a variety of loan products, including residential mortgage, consumer,
commercial loans construction, and commercial loans. Approximately 62% of Valley Bank's loans are
may increase the commercial loans, including those secured by commercial real estate. We expect, as we
risk of substantial grow, that this percentage will remain about the same. Commercial lending is more risky
credit losses than mortgage and consumer lending, because loan balances are greater, and the borrower's
ability to repay is contingent on the success of his or her business. Risk of loan
defaults is unavoidable in the banking industry, and we try to limit exposure to this risk
by monitoring carefully the amount of loans in specific industries and by exercising
prudent lending practices. However, we cannot eliminate the risk, and substantial credit
losses could result in reduced earnings or losses. See "Business" on page 9.
The Roanoke market The Roanoke Valley has enjoyed steady but slow growth, growing more slowly than the other
has slow growth; an metropolitan areas of Virginia. Although we may expand to areas adjacent to the Roanoke
economic downturn Valley, we do not intend to expand outside of this general geographic area in the
would hurt foreseeable future. Any slowdown in growth or a local or broader recession would hamper
performance our ability to grow and could hurt our performance. Although the Roanoke area has a
varied manufacturing and service base, it is small enough that a regional economic
downturn can be caused by problems with only a few larger local employers. See "Business
- Market Area" on page 10.
We depend on Messrs. Ellis L. Gutshall is our President and Chief Executive Officer. A. Wayne Lewis is our
Gutshall and Lewis, Executive Vice President and Chief Operating Officer. Both of these individuals have many
and they would be years of experience in the banking industry and are extremely valuable to us and would be
difficult to replace difficult to replace. The loss of the services of Mr. Gutshall or Mr. Lewis could have a
material adverse effect upon the future prospects of Valley Financial and Valley Bank.
While we do not carry key man life insurance on our senior officers, we have attempted to
reduce our risk through employment agreements and covenants not to compete. See
"Management - Employment Contracts, Termination and Change-in-Control Agreements" on page
42.
Our profitability Our profitability depends in substantial part on our net interest margin, which is the
depends on interest difference between the rates we receive on loans and investments and the rates we pay for
rates generally deposits and other sources of funds. Our net interest margin depends on many factors that
are partly or completely outside of our control, including competition, federal economic,
monetary, and fiscal policies, and economic conditions generally. Recently, net interest
margins for some financial institutions have changed in response to these and other
factors. Changes in interest rates will affect our operating performance and financial
condition. We try to minimize our exposure to interest rate risk, but we are unable to
completely eliminate this risk. Especially because of our relatively small size, more
aggressive competition could make it difficult for us to attract deposits, which are
necessary to fund loans and other investments.
There is no There is a limited public market for our common stock. The public offering price for the
assurance that you shares will be determined by negotiations between the underwriter and us. We and the
will be able to underwriter expect to consider a number of factors including prevailing market conditions,
resell the stock the current market for our stock, market prices and demand for common stock of other
you purchase for similar publicly-traded companies, the history of and prospects for our industry and for
more than the financial institutions generally, an assessment of our management, our present operations,
offering price our historical results of operations, the trend of our revenues and earnings, and our
earnings prospects. Neither we nor the underwriter can assure investors that the common
stock will trade in the public market at or above the public offering price.
Our stock has a Our stock is traded publicly on the OTC Bulletin Board under the symbol "VYFC." Trades
limited trading are infrequent and usually in small lots. We have several market makers in our stock, but
volume that does not assure significant trading volume or liquidity. We hope that this offering
will increase the trading in our stock, but there is no assurance that it will do so. An
active and liquid trading market for our stock may not develop.
</TABLE>
6
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<TABLE>
<S> <C>
Part of the proceeds Much of the proceeds of this offering will be used to repay outstanding debt. We
of this offering presently owe $2.3 million in subordinated debt to a commercial bank. This debt is not
will be used to pay due until July 1, 2012, but we are paying interest on that debt at a rate of 1.25% under
off our debt the prime rate. We may repay that debt early without penalty. This debt qualifies as
regulatory capital, so using proceeds of the offering to satisfy this debt will mean that
$2.3 million of the offering proceeds will not increase our regulatory capital. See
"Valley Financial's Subordinated Debt" on page 44.
Anti takeover Provisions of Virginia law and our Articles of Incorporation and Bylaws may make it more
provisions may difficult for anyone to acquire control of us without our board of directors' approval.
reduce the In many cases, shareholders receive a premium for their shares in a change of control, and
likelihood that you these provisions make it less likely that a change of control will occur unless our board
will receive a of directors agrees to that change of control. See "Description of Capital Stock -
takeover premium Summary of Shareholder Rights" and "--Virginia Anti-Takeover Statutes" beginning on page
42 for a discussion of these matters.
We do not expect to We have never paid a cash dividend. On January 20, 2000, we declared a 1.05 for 1.00
pay any dividends stock split on the outstanding shares of our common stock, effected in the form of a stock
to shareholders for dividend, paid on February 15, 2000 to shareholders of record as of January 31, 2000. We
the foreseeable can provide no assurance that we will pay cash or stock dividends in the future. We
future expect to retain our earnings to support the development and growth of our business. Our
board of directors will determine our future dividend policy based on an analysis of
factors that the board deems relevant. Our ability to pay dividends to our shareholders
is also limited by certain restrictions imposed by state and federal laws. See "Dividend
Policy" beginning on page 8.
You will experience The offering price of our common stock in this offering will be higher than the book value
substantial per share of the outstanding common stock. Purchasers of the shares of common stock will
dilution in the experience immediate dilution in the book value per share of their investment from the
book value of offering price. This dilution is estimated to be $6.96 per share using the book value of
shares of common Valley Financial at June 30, 2000 of $9,734,000 and the offering price of $17.50 per
stock immediately share. See "Dilution" on page 9 for further discussion of these calculations.
after the offering
</TABLE>
USE OF PROCEEDS
We estimate that we will receive approximately $2,787,000 in net proceeds
from the sale of 175,000 shares of our common stock, using the offering price of
$17.50 per share and after deducting the estimated underwriting discount and
other offering expenses totaling $276,000. Approximately $2.3 million of the
net proceeds will be used to repay our subordinated debt. For more information
on the terms and use of proceeds of this debt, see "Valley Financial's
Subordinated Debt" on page 44. We will contribute a substantial portion of the
remaining net proceeds to Valley Bank and retain the balance in Valley
Financial. The net proceeds retained by Valley Financial will be used for
working capital and other general corporate purposes, including providing
additional contributions to Valley Bank's capital, as needed.
MARKET FOR COMMON STOCK
The common stock is quoted under the symbol "VYFC" on the OTC Bulletin
Board, an electronic quotation and trade reporting service of the National
Association of Securities Dealers. According to information obtained by company
management and believed to be reliable, the quarterly range of closing prices
per share (adjusted for the 1.05 for 1.00 stock split effected in the form of a
stock dividend declared January 20, 2000 and paid on February 15, 2000) for our
common stock for the calendar periods presented was as follows:
7
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1998 High Low
---- ---- ---
1/st/ Quarter $14.29 $11.43
2/nd/ Quarter 14.52 13.10
3/rd/ Quarter 15.24 13.33
4/th/ Quarter 14.76 13.33
1999
----
1/st/ Quarter $15.71 $14.29
2/nd/ Quarter 16.67 14.76
3/rd/ Quarter 17.74 14.76
4/th/ Quarter 19.05 15.95
2000
----
1/st/ Quarter $20.00 $16.19
2/nd/ Quarter 19.50 18.00
3/rd/ Quarter 19.12 18.37
4/th/ Quarter (through November 14, 2000) 19.12 18.50
Trading volume in our common stock is low. Since January 1, 2000, an
average of approximately 1,400 shares was traded each week. As of November 14,
2000, there were approximately 533 shareholders of record and approximately 975
beneficial holders of our common stock.
DIVIDEND POLICY
We have not declared or paid cash dividends since our formation. For the
foreseeable future, we expect that we will retain our earnings to support the
development and growth of our business and will not pay any cash dividends to
shareholders. We may consider payment of dividends at some point in the future,
but declarations of dividends are at the discretion of the board of directors,
and there is no assurance that dividends will be declared at any time. On
January 20, 2000, we did declare a 1.05 for 1.00 stock split which was effected
in the form of a stock dividend, paid on February 15, 2000 to shareholders of
record as of January 31, 2000.
If we decide to pay dividends at a future date, we will depend on dividends
received from Valley Bank to fund dividends on our common stock. As a banking
corporation organized under Virginia law, Valley Bank is restricted as to the
maximum amount of dividends it may pay to Valley Financial. A Virginia bank may
not pay dividends from its original capital. All dividends must be paid out of
net undivided profits on hand, after deducting expenses, losses, interest, and
taxes accrued and contribution to capital necessary for Valley Bank's original
capital to be restored to its initial level. As of August 31, 2000, the net
profits of Valley Bank available for distribution to Valley Financial as
dividends without regulatory approval were approximately $1.1 million.
As a practical matter, the Board of Governors of the Federal Reserve System
recommends that banking organizations pay dividends only if the net income
available to shareholders in the past year fully funds those dividends and the
expected rate of earnings retention is consistent with capital needs, asset
quality, and overall financial condition. Valley Financial's dividend policy
complies with this recommendation.
CAPITALIZATION
The following table sets forth our consolidated capitalization at June 30,
2000 on an actual basis and as adjusted to reflect the receipt of $2,787,000 in
net proceeds from our sale of 175,000 shares of common stock at $17.50 per
share, assuming the underwriting discount and other offering expenses total
$276,000. The table assumes the sale of 60,000 shares of common stock to Valley
Financial's directors and 115,000 shares of common stock to the public in this
offering, but does not give effect to the possible exercise of the underwriter's
overallotment option.
8
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<TABLE>
<CAPTION>
At June 30, 2000
----------------
Actual As Adjusted
------ -----------
<S> <C> <C>
Subordinated debt.............................................. $2,300,000 $ -
========== ===========
Shareholders' equity:
Preferred stock, no par value; 10,000,000
shares authorized; none issued and outstanding.......... $ - $ -
Common stock, no par value; 10,000,000 shares authorized;
1,013,207 shares issued and outstanding,
1,188,207 shares issued and outstanding, as adjusted.... 9,099,000 11,886,000
Retained earnings.......................................... 1,618,000 1,618,000
Accumulated other comprehensive income (loss).............. (983,000) (983,000)
---------- -----------
Total shareholders' equity..................................... $9,734,000 $12,521,000
========== ===========
</TABLE>
DILUTION
Your investment will be immediately diluted because your purchase price per
share exceeds our net tangible book value per share. The net tangible book
value per share is determined by dividing our tangible net worth (tangible
assets less liabilities) by the total shares outstanding. Our net tangible book
value as of June 30, 2000 was $9,734,000 or $9.61 per share. The purchase price
per share in this offering will cause both an immediate dilution in net tangible
book value to new investors and an immediate increase in net tangible book value
to the existing shareholders of Valley Financial.
The following table illustrates this dilution per share given the sale of
175,000 shares of common stock at $17.50 per share, net of the estimated
underwriting discount and other offering expenses totaling $276,000. Of the
175,000 shares of common stock, 60,000 shares are assumed to be sold to Valley
Financial's directors and 115,000 shares to the public. The table does not give
effect to the possible exercise of the underwriter's overallotment option.
<TABLE>
<S> <C>
Offering price per share.............................................................. $17.50
======
Net tangible book value per share prior to the offering.......................... $ 9.61
Increase in net tangible book value per share attributable to the offering....... .93
------
Net tangible book value per share after the offering.................................. $10.54
======
Dilution per share to the new investors............................................... $ 6.96
======
</TABLE>
BUSINESS
General
Valley Financial Corporation was incorporated in Virginia in 1994,
primarily to own all of the capital stock of Valley Bank. We presently engage
in no business other than owning and managing Valley Bank. Valley Bank is a
state bank organized under Virginia law, and engages in the business of
commercial banking. Valley Bank opened for business on May 15, 1995. Its
deposits are insured by the FDIC and it is a member of the Federal Reserve
System. As of June 30, 2000, we had total assets of $152.0 million, net loans
of $105.8 million, total deposits of $121.5 million, and shareholders' equity of
$9.7 million.
We presently operate four offices and plan to open a fifth office in the
first quarter of 2001. Presented in the following table is the location of each
branch, the date it opened for business, and the deposits as of June 30, 2000.
Office Location Date Opened Deposits
---------------- --------------- ------------------ -----------
Main office City of Roanoke May 15, 1995 $40,999,000
Starkey Road Roanoke County September 11, 1995 48,354,000
South Roanoke City of Roanoke January 15, 1997 12,786,000
Salem City of Salem April 5, 1999 20,361,000
Hershberger Road City of Roanoke First quarter 2001 na
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Strategy
Our strategy is to enhance shareholder value by increasing net income
through continued loan growth, while controlling the cost of deposits and the
growth of non-interest expense. To achieve this goal, we plan to provide our
customers with products and services comparable to those offered by our
competitors and to continue to provide our customers with a high level of
personal service. We also intend to continue to expand our network of branches
and automated teller machines throughout the Roanoke Valley and to make
increased use of alternative delivery systems, such as the Internet and
telephone.
Market Area
Valley Bank's primary service area consists of the Roanoke Valley of
Virginia, including the cities of Roanoke and Salem and Roanoke County, and
portions of Botetourt, Bedford, and Montgomery County, Virginia. We conduct a
general commercial banking business, emphasizing the needs of small- to medium-
sized businesses, professional concerns, and individuals.
The Roanoke Metropolitan Statistical Area (MSA) is the commercial center
for southwest Virginia, and is located approximately 165 miles west of Richmond,
Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles east of
Charleston, West Virginia and 222 miles southwest of Washington, D.C. Hollins
University and Roanoke College, with student enrollments of approximately 1,100
and 1,700, respectively, are located in the Roanoke MSA. Virginia Tech, with a
student body of approximately 25,000, and Radford University, with a student
body of more than 8,500, are each a 45-minute drive away.
The population in the Roanoke MSA was estimated at 231,400 at year-end
1999. The Roanoke MSA's recent growth has been slower than that in other key
Virginia markets. The Virginia Employment Commission reported that from 1995
through 1999 the number of jobs in the Roanoke MSA increased 3.4%, compared with
a 10.4% increase for the state as a whole. The Roanoke MSA had an unemployment
rate of 2.0% in June 2000, compared with 2.9% for Virginia and 4.2% nationally.
Over 6,500 businesses operated in the Roanoke MSA at year-end 1999. The
business community in the Roanoke MSA is diverse. The principal components of
the economy are retail trade, services, transportation, manufacturing, finance,
insurance, and real estate. The Roanoke MSA's position as a regional center
creates a strong medical, legal, and business professional community. Carilion
Health System, Lewis-Gale Hospital, and the Veterans Administration Hospital are
among the area's largest employers. Other large employers include Norfolk
Southern Corporation, First Union Corporation, The Kroger Co., General Electric
Co., and American Electric Power.
Lending Services
Valley Bank offers a range of short- to medium-term commercial and personal
loans. Commercial loans include both secured and unsecured loans for working
capital (including inventory and receivables), business expansion (including
acquisition of real estate and improvements), and purchase of equipment and
machinery. Consumer loans include secured and unsecured loans for financing
automobiles, home improvements, education, and personal investments. Valley Bank
also makes various types of real estate loans.
Our lending efforts are directed primarily to making loans to individuals
and businesses in our market area. We believe that our lending and credit
policies are conservative. As of June 30, 2000, we had approximately $106.9
million in loans and $29.0 million in unfunded loan commitments outstanding.
Valley Bank's lending activities are subject to a variety of lending limits
imposed by state law. While different limits apply in certain circumstances
based on the type of loan or the nature of the borrower (including the
borrower's relationship to Valley Bank), in general Valley Bank is subject to a
loan-to-one borrower limit of 15% of Valley Bank's capital and surplus in the
case of loans which are not fully secured by readily marketable or other
permissible types of collateral. Valley Bank voluntarily may choose to impose a
policy limit on loans to a single borrower that is less than the legal lending
limit. Valley Bank's present legal lending limit is $1,725,000, which does
satisfy the credit needs of a large portion of its targeted market segment.
Valley Bank has established relationships with correspondent banks to
participate in loans when loan amounts exceed our legal lending limits or
internal lending policies.
Valley Bank attempts to react to prevailing market conditions and demands
in our lending activities, while avoiding excessive concentration in any
particular loan category. We have fixed specific goals as to lending
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concentration by type of loan. This mix of loans is intended to provide
sufficient diversification to balance the risks within the loan portfolio. We
manage the portfolio within the following ranges:
Real estate loans (commercial and residential) 40% to 80%
Commercial loans 25% to 50%
Consumer loans 10% to 25%
The risk of nonpayment of loans is inherent in all loans. However,
management carefully evaluates all loan applicants and attempts to minimize
credit risk-exposure with thorough loan application and approval procedures. In
determining whether to make a loan, Valley Bank lending personnel analyze the
borrower's income and ability to service the loan and credit history, and
evaluate the need for collateral to secure recovery in the event of default.
Valley Bank maintains an allowance for loan losses based upon management's
assumptions and judgments regarding the ultimate collectibility of loans in its
portfolio and based upon a percentage of the outstanding balances of specific
loans when their ultimate collectibility is considered questionable. Certain
risks with regard to specific categories of loans are described below.
Commercial Loans. Commercial lending activities are directed principally
toward businesses whose demand for funds will fall within Valley Bank's legal
lending limit. These businesses include small- to medium-sized professional
firms, retail and wholesale businesses, light industry, and manufacturing
concerns operating in and around the primary service area. The types of loans
provided include term loans with fixed and variable interest rates and working
capital lines of credit with variable rates secured by equipment, inventory,
accounts receivable, and commercial real estate. Valley Bank also offers to
commercial customers, through an affiliation with Private Business, Inc., an
automated accounts receivable-financing product designed to enhance a company's
cash flow.
Commercial business loans generally have a higher degree of risk than
residential mortgage loans, but have commensurately higher yields. To manage
these risks, Valley Bank generally secures appropriate collateral and monitors
the financial condition of its business borrowers. In addition, personal
guarantees are generally obtained from the principals of business borrowers
and/or third parties to further support the borrower's ability to service the
debt and reduce the risk of nonpayment. Residential mortgage loans generally
are made on the basis of the borrower's ability to make repayment from his
employment and other income and are secured by real estate whose value tends to
be easily ascertainable. In contrast, commercial business loans typically are
made on the basis of the borrower's ability to make repayment from cash flow
from its business and are secured by business assets. As a result, the
availability of funds for the repayment of commercial business loans may be
substantially dependent on the financial success of the business borrower
itself. Further, the collateral for commercial business loans may depreciate
over time and cannot be appraised with as much precision as residential real
estate.
Real Estate Loans. Real estate lending includes commercial and residential
development/construction loans, home improvement loans, home equity loans and
commercial and residential mortgage loans. Valley Bank also participates in the
origination of a limited number of fixed-rate residential mortgage loans that
are referred to mortgage brokers. Residential loans are secured by first
mortgages on one-to-four family residences in the primary service area. Home
improvement loans and home equity loans are generally secured by second
mortgages on single family residences in the primary service area. Commercial
mortgage loans are secured by first mortgages on commercial properties,
generally owner-occupied, in the primary service area.
The risk associated with residential mortgage lending varies based on
employment levels, consumer confidence, fluctuations in the value of real estate
and other conditions that affect the ability of borrowers to repay indebtedness.
Commercial real estate lending entails significant additional risk. Commercial
real estate loans typically involve larger loan balances concentrated with
single borrowers or groups of related borrowers. Additionally, the payment
experience on loans secured by income-producing properties is typically
dependent on the successful operation of a business or a real estate project and
thus may be subject, to a greater extent, to adverse conditions in the real
estate market or in the economy generally.
Consumer Loans. Consumer loans are made on a secured or unsecured basis
and are oriented primarily to the requirements of Valley Bank's customers, with
an emphasis on loans for automobiles, home improvements, debt consolidation, and
other personal needs.
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Consumer loans may entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured, such as lines of
credit, or secured by rapidly depreciable assets such as automobiles. In these
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. The remaining deficiency
often does not warrant further substantial collection efforts against the
borrower. In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on
these loans.
Deposit Products and Other Banking Services
Valley Bank offers deposit products that are typically available in most
banks including checking accounts, NOW accounts, savings accounts, Individual
Retirement Accounts, and other time deposits ranging from money market accounts
to longer-term certificates of deposit. The transaction accounts and time
deposits are tailored to our principal market area at rates competitive to those
offered in the area. All deposit accounts are insured by the FDIC up to the
maximum amount allowed by law (generally $100,000 per depositor, subject to
aggregation rules). Valley Bank solicits accounts from individuals, businesses,
associations and organizations, and governmental authorities.
Other bank services include safe deposit boxes, cash management services,
travelers checks, direct deposit of payroll and social security checks, and
automatic drafts for various accounts. Valley Bank is associated with the Star,
Cirrus, and The Exchange shared networks of automated teller machines that may
be used by bank customers throughout Virginia and other regions. Valley Bank
also offers VISA and MasterCard credit card services.
Valley Bank does not plan to exercise trust powers during the next several
years. Valley Bank may in the future offer a full-service trust department, but
cannot do so without the prior approval of its federal and state regulators.
Competition
Banking in the Roanoke Valley is highly competitive. Valley Bank competes
as a financial intermediary with other commercial banks, savings & loan
associations, credit unions, mortgage banking firms, consumer finance companies,
securities brokerage firms, insurance companies, money market mutual funds, and
other institutions operating in the Roanoke Valley and elsewhere.
Valley Bank's market area is a highly concentrated, highly branched banking
market. As of June 30, 2000 there were approximately 14 commercial banks and
savings and loan associations operating approximately 100 offices in the Roanoke
Valley. The only locally owned and operated commercial banks are Valley Bank and
Salem Bank & Trust Company. SunTrust Bank is a part of the SunTrust family of
banks, with a regional presence based in Richmond, and First Virginia Bank-
Southwest is a subsidiary of a holding company headquartered in Falls Church,
Virginia. Bank of America, First Union National Bank, Wachovia Bank, First
Citizens Bank, and BB&T Bank all are subsidiaries of holding companies
headquartered in North Carolina. In addition, four out-of-town Virginia based
community banks, Bank of Floyd, First National Exchange Bank, Bank of Botetourt,
and The Bank of Fincastle, have each opened one or more branches in our market
area. Also, numerous credit unions operate offices in the Roanoke Valley.
Further, various other financial companies, ranging from local to national
firms, provide financial services to residents of this market area.
We believe that Valley Bank will be able to compete effectively in this
market, and that the community will continue to respond to Valley Bank's
community bank focus and emphasis on service to small businesses, individuals,
and professional concerns.
Employees
At June 30, 2000, Valley Bank had 45 full-time employees, including its
officers. Valley Financial does not have any regular employees other than its
officers. We believe that our employee relations are excellent.
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Properties
Valley Bank leases approximately 13,750 square feet of recently-renovated
office space on the first three floors of a seven story office building in
downtown Roanoke for its main office. The lease expires December 31, 2004, with
options to renew for two additional five-year terms. Valley Bank owns its
Starkey Road office, a 2,700 square foot building constructed in 1995 on a one-
acre site at 4467 Starkey Road in southwest Roanoke County near Tanglewood Mall.
Valley Bank leases its South Roanoke office, a recently-renovated 914
square foot facility. That lease has an initial term of 12 years with one five-
year renewal option. We own the office located at 8 East Main Street in Salem.
That office is a newly-constructed Colonial Williamsburg style building with two
floors containing 6,000 square feet, of which we occupy the first story and
lease the second story. The structure is located on an approximately one-half
acre site near the center of the City of Salem.
In September of this year, we purchased from First Union National Bank for
$485,000 that bank's existing Hershberger Road branch office near Crossroads
Mall in Roanoke. We plan to remodel and equip the property at an additional cost
of about $265,000, and open for business in early 2001. In the opinion of Valley
Financial management, our properties are adequate for our current operations and
adequately covered by insurance.
Legal Proceedings
Neither Valley Bank nor Valley Financial is a party to any pending legal
proceeding or aware of any threatened legal proceeding where Valley Bank or
Valley Financial may be exposed to any material loss. From time to time in the
normal course of business Valley Bank files standard claims to collect loans.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion presents major components of Valley Financial's
business and presents an overview of its consolidated financial position at June
30, 2000 and December 31, 1999 and 1998 and its results of operations for the
six months ended June 30, 2000 and the years ended December 31, 1999 and 1998.
The discussion should be read in conjunction with Valley Financial's
consolidated financial statements and notes thereto, and other financial data
appearing elsewhere in this prospectus.
Valley Financial is not aware of any current recommendations by regulatory
authorities, which if implemented, would have a material effect on its
liquidity, capital resources or results of operations. Further, there are no
agreements between Valley Financial and the Federal Reserve, the Virginia State
Corporation Commission or the FDIC, nor has any regulatory agency made any
recommendations concerning the operations of Valley Financial that could have a
material effect on its liquidity, capital resources or results of operations.
Overview
Valley Financial was incorporated as a Virginia stock corporation on March
15, 1994 primarily to own and control all of the capital stock of Valley Bank.
Valley Bank opened for business on May 15, 1995. In July 1995, Valley Financial
completed its initial public offering of 964,040 shares (1,012,242 shares after
the effect of the 1.05 for 1.00 stock split effected in the form of a stock
dividend declared January 20, 2000 and paid February 15, 2000) of its no par
common stock at a price of $10.00 per share. The offering resulted in gross
proceeds to Valley Financial of $9.6 million, reduced by $551,000 of direct
stock issuance costs associated with the offering, for net proceeds of $9.1
million. As of June 30, 2000 $9.0 million has been invested in Valley Bank as
equity capital and the remainder retained at the parent company for working
capital needs.
Total assets at June 30, 2000 were $152.0 million, up $14.8 million or
10.8% from December 31, 1999. Total assets at December 31, 1999 were $137.2
million, up 30.4% from $105.2 million at December 31, 1998. The principal
components of Valley Financial's assets at June 30, 2000 were $34.9 million in
securities available-for-sale and $106.9 million in gross loans, representing
increases of 9.1% and 17.0%, respectively over their levels at December 31,
1999. Securities available-for-sale and gross loans were $32.0 million and $91.4
million, respectively, at December 31, 1999.
Total liabilities were $142.2 million at June 30, 2000, up $14.1 million or
11.0% from December 31, 1999. Total liabilities at December 31, 1999 were $128.1
million, up from $96.0 million at December 31, 1998, an increase of $32.1
million or 33.4%. The largest components of the increase in total liabilities
were a $2.3 million subordinated capital note finalized during the second
quarter of 2000, a second long-term FHLB advance in 1999 in the amount of $5.0
million, and the introduction of an overnight repurchase agreement program with
appropriate commercial customers in 1999 that increased total liabilities by
$992,000. Total deposits at June 30, 2000 were $121.5 million, an increase of
$6.0 million or 5.2% over their level at December 31, 1999. As part of this
increase, Valley Bank's commercial sweep program grew $3.2 million during the
first six months of 2000. Total deposits at December 31, 1999 were $115.5
million, up $25.5 million or 28.3% from $90.0 million at December 31, 1998.
Total shareholders' equity at June 30, 2000 was $9.7 million. Exclusive of
the unrealized losses on securities available-for-sale, shareholders' equity was
$10.7 million at June 30, 2000. Total shareholders' equity at December 31, 1999
was $9.1 million, consisting of $9.1 million in net proceeds from Valley
Financial's initial public offering, $10,000 in proceeds from the exercise of
stock options and retained earnings of $934,000, and including $978,000 of
unrealized losses on securities available-for-sale, net of related deferred tax
benefit. Exclusive of the unrealized losses on securities available-for-sale,
shareholders' equity was $10.0 million at December 31, 1999. At December 31,
1998 total shareholders' equity was $9.0 million exclusive of unrealized losses
on securities available-for-sale. See "- Investment Securities" on page 21 for
information on our investment portfolio.
Net income for the six months ended June 30, 2000 was $684,000, compared
with $414,000 for the six-month period ended June 30, 1999. Valley Financial had
net income of $1.0 million for the year ended December 31, 1999 compared with
$758,000 for the year ended December 31, 1998. The substantial improvement in
profitability results from a substantial increase in loans outstanding, an
improved net interest margin and a substantial increase in noninterest income,
partially offset by increased noninterest expenses in all major categories.
For the six-month period ended June 30, 2000, profitability as measured by
Valley Financial's annualized return on average assets (ROA) was .97% and
annualized return on average equity (ROE) was 13.22%. The ROA and ROE
14
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were .86% and 10.98% in 1999, respectively. The ROA and ROE ratios were .83% and
8.87% in 1998, respectively. The calculation of ROE excludes the effect of any
unrealized gains or losses on investment securities available-for-sale.
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 Valley Financial and
Valley Bank. 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 Valley Financial's cost of funds also affect net interest
income.
Six months ended June 30, 2000 and June 30, 1999
Net interest income was $2.7 million 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 35.0% from $2.0 million for the same period in
1999. The net interest margin on a fully taxable equivalent 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. Despite a rising interest rate environment
and fierce competition for deposits, Valley Financial has been successful in
increasing the net interest margin by offsetting cost of funds increases with
higher yields on loans and other earning assets.
Years ended December 31, 1999 and December 31, 1998
Net interest income was $4.3 million for 1999 and is attributable to
interest income from loans and securities exceeding the cost of interest paid on
deposits and borrowed funds. Net interest income increased $1.1 million or 32.8%
over the same period in 1998. Total interest income was $8.8 million for 1999 as
compared to $6.8 million in 1998, an increase of $2.0 million or 29.4%. This
increase is attributable to Valley Bank's reinvestment of the funds from the
increase in deposits into loans and securities. The net interest margin was
3.92% for the year ended 1999 as compared to 3.86% for the year ended 1998. This
increase in the net interest margin for the year ended December 31, 1999 is
largely attributable to controlling deposit costs in relation to income
generated on earning assets, as the cost of funds ratio decreased 26 basis
points from 4.28% in 1998 to 4.02% in 1999.
15
<PAGE>
The following tables present the major categories of interest-earning
assets, interest-bearing liabilities, and shareholders' equity with
corresponding average balances, related interest income or expense, and
resulting yields and rates for the periods indicated. Where appropriate, income
categories and yields have been adjusted in the table to their fully taxable
equivalent basis. The numbers included in the preceding discussion of net
interest income have not been adjusted to their fully taxable equivalent basis.
Net Interest Income and Average Balances (1)
(dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------------------------------------------------------
2000 1999
------------------------------------- --------------------------------
Average Interest Rate Average Interest Rate
Assets: Balance Income Earned Balance Income Earned
------------- --------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (2) (5) $ 98,403 $ 4,378 8.92% $ 77,822 $ 3,192 8.27%
Investment securities:
Taxable 28,166 907 6.46% 20,739 643 6.25%
Nontaxable (3) 8,140 297 7.32% 6,413 234 7.36%
Money market investments 804 25 6.24% 1,469 34 4.67%
------------- --------- -------- --------
Total interest-earning assets 135,513 5,607 8.30% 106,443 4,103 7.77%
Other assets:
Reserve for loan losses (977) (768)
Cash and due from banks 3,441 3,262
Other assets, net 2,875 3,416
------------- --------
Total assets $ 140,852 $112,353
============= ========
Average Interest Rate Average Interest Rate
Liabilities and shareholders' equity: Balance Expense Paid Balance Expense Paid
------------- --------- -------- -------- -------- --------
Interest-bearing liabilities:
Savings, NOW, and MMA $ 32,087 $ 524 3.28% $ 33,492 $ 539 3.25%
Time deposits 67,886 1,873 5.53% 49,505 1,309 5.33%
Repurchase agreements 2,673 64 4.80% - - -
FHLB advances 9,753 265 5.45% 6,326 157 5.00%
Subordinated capital note 13 - - - - -
Other borrowings 2,576 84 6.54% 642 17 5.34%
------------- --------- -------- --------
Total interest-bearing liabilities 114,988 2,810 4.90% 89,965 2,022 4.53%
Noninterest-bearing liabilities:
Demand deposits 15,043 12,087
Other liabilities 432 1,084
------------- --------
Total liabilities 130,463 103,136
Shareholders' equity, exclusive of
unrealized gains/losses on securities 10,389 9,217
------------- --------
Total liabilities and shareholders' equity $ 140,852 $112,353
============= ========
Net interest income $ 2,797 $ 2,081
========= ========
Net interest margin (4) 4.14% 3.94%
======= ======
</TABLE>
__________________________
(1) Averages are daily averages.
(2) Loan interest income includes loan fees of $281,000 and $109,000 for the
six-month periods ended June 30, 2000 and 1999, respectively.
(3) Nontaxable interest income is adjusted to its fully taxable equivalent
basis using a federal tax rate of 34% and a state tax rate of 6% where
applicable. The effective tax rate was 28% and 26% for the six-month
periods ended June 30, 2000 and 1999, respectively.
(4) The net interest margin is calculated by dividing net interest income (tax
equivalent basis) by average total earning assets.
(5) Non-accrual loans are included in the above yield calculation.
16
<PAGE>
Net Interest Income and Average Balances (1)
(dollars in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------------------
1999 1998
------------------------------------------------------------------------
Average Interest Rate Average Interest Rate
Assets: Balance Income Earned Balance Income Earned
------------- ---------- --------- -------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans (2) (5) $ 81,962 $ 6,823 8.32% $ 59,175 $ 5,059 8.55%
Investment securities:
Taxable 23,415 1,476 6.30% 20,888 1,365 6.53%
Nontaxable (3) 6,815 497 7.29% 4,104 295 7.19%
Money market investments 2,600 135 5.19% 2,892 151 5.22%
------------- ---------- -------- ---------
Total interest-earning assets 114,792 8,931 7.78% 87,059 6,870 7.89%
Other assets:
Reserve for loan losses (813) (571)
Cash and due from banks 3,336 2,451
Other assets, net 3,307 2,624
Total assets $ 120,622 $ 91,563
============= ========
Average Interest Rate Average Interest Rate
Liabilities and shareholders' equity Balance Expense Paid Balance Expense Paid
------------- ----------- ------- --------- --------- --------
Interest-bearing liabilities:
Savings, NOW, and MMA $ 32,814 $ 1,052 3.21% $ 25,461 $ 866 3.40%
Time deposits 55,570 2,932 5.28% 42,995 2,391 5.56%
Repurchase agreements 244 10 4.10% - - -
FHLB advances 8,233 415 5.04% 4,137 208 5.03%
Other borrowings 414 23 5.56% 839 47 5.60%
------------- ---------- --------- ---------
Total interest-bearing liabilities 97,275 4,432 4.56% 73,432 3,512 4.78%
Noninterest-bearing liabilities:
Demand deposits 13,044 8,602
Other liabilities 820 910
------------- ---------
Total liabilities 111,139 82,944
Shareholders' equity, exclusive of
unrealized gains/losses on securities 9,483 8,619
------------- ---------
Total liabilities and shareholders' equity $ 120,622 $ 91,563
============= =========
Net interest income $4,499 $ 3,358
========== =========
Net interest margin (4) 3.92% 3.86%
========== =======
</TABLE>
---------------------
(1) Averages are daily averages.
(2) Loan interest income includes loan fees of $230,000 and $156,000 for the
years ended 1999 and 1998, respectively.
(3) Nontaxable interest income is adjusted to its fully taxable equivalent
basis using a federal tax rate of 34%.
(4) The net interest margin is calculated by dividing net interest income (tax
equivalent basis) by average total earning assets.
(5) Non-accrual loans are included in the above yield calculation.
As discussed above, Valley Financial's net interest income is affected
by the change in the amount and mix of interest-earning assets and interest-
bearing liabilities (referred to as "volume change") as well as by changes in
yields earned on interest-earning assets and rates paid on deposits and borrowed
funds (referred to as "rate change"). The following tables present, for the
periods indicated, a summary of changes in interest income and interest expense
for the major categories of interest-earning assets and interest-bearing
liabilities and the amounts of change attributable to variations in volumes and
rates. Changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
17
<PAGE>
Rate/Volume Variance Analysis
(dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
2000 compared to 1999
-----------------------------------------------------------
Volume Rate Net
----------- ----------- -----------
<S> <C> <C> <C>
Interest earned on interest-earning assets:
Loans $ 914 $ 272 $ 1,186
Investment securities:
Taxable 238 26 264
Nontaxable 63 - 63
Money market investments (26) 17 (9)
----------- ----------- -----------
Total interest earned on interest-earning assets 1,189 315 1,504
----------- ----------- -----------
Interest paid on interest-bearing liabilities:
Savings and NOW accounts (19) 4 (15)
Time deposits 512 52 564
FHLB borrowings 93 15 108
Securities sold under agreements to repurchase 64 - 64
Other borrowings 62 5 67
----------- ----------- -----------
Total interest paid on interest-bearing liabilities 712 76 788
----------- ----------- -----------
Change in net interest income $ 477 $ 239 $ 716
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31, Year Ended December 31,
1999 compared to 1998 1998 compared to 1997
------------------------------------ --------------------------------------
Volume Rate Net Volume Rate Net
----------- ----------- -------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Interest earned on interest-earning assets:
Loans $ 1,896 $ (132) $ 1,764 $ 1,547 $ (46) $ 1,501
Investment securities:
Taxable 158 (47) 111 181 4 185
Nontaxable 197 5 202 295 - 295
Money market investments (15) (1) (16) 85 (2) 83
----------- ---------- -------- ---------- --------- ---------
Total interest earned on interest-earning assets 2,236 (175) 2,061 2,108 (44) 2,064
----------- ---------- -------- ---------- --------- ---------
Interest paid on interest-bearing liabilities:
Savings and NOW accounts 232 (45) 187 417 (36) 381
Time deposits 654 (113) 541 355 19 374
FHLB borrowings 207 - 207 208 - 208
Securities sold under agreements to repurchase 9 - 9 - - -
Other borrowings (24) - (24) 38 - 38
----------- ---------- -------- ---------- --------- ---------
Total interest paid on interest-bearing
liabilities 1,078 (158) 920 1,018 (17) 1,001
----------- ---------- -------- ---------- --------- ---------
Change in net interest income $ 1,158 $ (17) $ 1,141 $ 1,090 $ (27) $ 1,063
=========== ========== ======== ========== ======== =========
</TABLE>
Noninterest Income
Six months ended June 30, 2000 and June 30, 1999
Noninterest income of $195,000 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 $49,000 or 33.6% over the $146,000
reported for the same period one year earlier. For the three months ended June
30, 2000 noninterest income was $111,000, an increase of $39,000 or 54.2% over
the $72,000 reported for the second quarter of 1999.
18
<PAGE>
Years ended December 31, 1999 and December 31, 1998
Noninterest income of $354,000 in 1999 consisted of service charges and
fees on accounts, securities gains and losses, and other miscellaneous income,
and represented an increase of $90,000 or 34.1% over the 1998 level.
Future levels of noninterest income are expected to increase as a direct
result of business growth and expansion.
Noninterest Expense
Six months ended June 30, 2000 and June 30, 1999
Noninterest expense for the first six months of 2000 was $1.8 million, an
increase of $315,000 or 21.6% 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. Total full-time equivalent employees increased from 39 at June 30,
1999 to 45 as of June 30, 2000. Noninterest expense for the quarter ended June
30, 2000 was $901,000, an increase of $138,000 or 18.1% over the second quarter
of 1999.
Years ended December 31, 1999 and December 31, 1998
Noninterest expense for 1999 was $3.0 million, an increase of $777,000 or
34.5% over 1998. The largest components of the increase, which includes costs
associated with the opening of Valley Bank's Salem office on April 5, 1999, 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. Total full-time equivalent
employees increased from 30 at December 31, 1998 to 42 as of December 31, 1999,
a 40% increase.
Noninterest expenses are expected to increase in future years as a direct
result of business growth and expansion.
Income Taxes
Six months ended June 30, 2000 and June 30, 1999
To reflect Valley Financial's anticipated federal income tax liability, an
expense of $270,000 and $147,000 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 increased income tax in the six months ended June 30, 2000 is
a result of higher taxable income and a higher effective tax rate.
Years ended December 31, 1999 and December 31, 1998
During 1999 and 1998 Valley Financial recorded federal income tax
provisions in the amounts of $394,000 and $263,000, respectively. The increased
income tax in 1999 is a result of higher taxable income and a higher effective
tax rate.
Earning Assets
Six months ended June 30, 2000 and June 30, 1999
Average earning assets were $135.5 million at June 30, 2000 as compared to
$106.4 million as of June 30, 1999, an increase of $29.1 million, or 27.3%.
Total average earning assets were 96.2% of total average assets at June 30, 2000
as compared to 94.7% at June 30, 1999. Average loans represented the largest
component of average earning assets and increased 26.4% to $98.4 million at June
30, 2000, up from $77.8 million as of June 30, 1999. Average loans were 72.6%
of average earning assets and 69.9% of average total assets as of June 30, 2000,
as compared to 73.1% and 69.3%, respectively, one year earlier. Average
investment securities, including both taxable and nontaxable, increased 33.7% to
$36.3 million, up from $27.2 million as of June 30, 1999. Average investment
securities were 26.8% of average earning assets and 25.8% of average total
assets as of June 30, 2000, as compared to 25.5% and 24.2%, respectively, one
year earlier.
19
<PAGE>
Years ended December 31, 1999 and December 31, 1998
Average earning assets were $114.8 million at December 31, 1999 as compared
to $87.1 million as of December 31, 1998, an increase of $27.7 million, or
31.9%. Total average earning assets were 95.2% of total average assets at
December 31, 1999 as compared to 95.1% at December 31, 1998. Average loans
represented the largest component of average earning assets and increased 38.5%
to $82.0 million at December 31, 1999, up from $59.2 million as of December 31,
1998. Average loans were 71.4% of average earning assets and 67.9% of average
total assets as of December 31, 1999, as compared to 68.0% and 64.6%,
respectively, one year earlier. Average investment securities, including both
taxable and nontaxable, increased 21.0% to $30.2 million, up from $25.0 million
as of December 31, 1998. Average investment securities were 26.3% of average
earning assets and 25.1% of average total assets as of December 31, 1999, as
compared to 28.7% and 27.3%, respectively, one year earlier.
A summary of average assets as of June 30, 2000 and 1999 is shown in the
following table.
Average Asset Mix
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
----------------------------------- -----------------------------------
Average Average
Balance Percent Balance Percent
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Earning assets:
Loans, total $ 98,403 69.86% $ 77,822 69.26%
Investment securities:
Taxable 28,166 20.00 20,739 18.46
Nontaxable 8,140 5.78 6,413 5.71
Money market investments 804 0.57 1,469 1.31
-------------- -------------- -------------- --------------
Total earning assets 135,513 96.21 106,443 94.74
-------------- -------------- -------------- --------------
Nonearning assets:
Cash and due from banks 3,441 2.44 3,262 2.90
Other assets 1,898 1.35 2,648 2.36
Total nonearning assets 5,339 3.79 5,910 5.26
-------------- -------------- -------------- --------------
Total assets $ 140,852 100.00% $ 112,353 100.00%
============== ============== ============== ==============
</TABLE>
A summary of average assets as of December 31, 1999 and 1998 is shown in
the following table.
Average Asset Mix
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------------------------- -----------------------------------
Average Average
Balance Percent Balance Percent
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Earning assets:
Loans, total $ 81,962 67.95% $ 59,175 64.63%
Investment securities:
Taxable 23,415 19.41 20,888 22.81
Nontaxable 6,815 5.65 4,104 4.48
Money market investments 2,600 2.16 2,892 3.16
-------------- -------------- -------------- --------------
Total earning assets 114,792 95.17 87,059 95.08
-------------- -------------- -------------- --------------
Nonearning assets:
Cash and due from banks 3,336 2.76 2,451 2.68
Other assets 2,494 2.07 2,053 2.24
-------------- -------------- -------------- --------------
Total nonearning assets 5,830 4.83 4,504 4.92
-------------- -------------- -------------- --------------
Total assets $ 120,622 100.00% $ 91,563 100.00%
============== ============== ============== ==============
</TABLE>
20
<PAGE>
Investment Securities
Valley Financial's investment portfolio is used both for investment income
and liquidity purposes. See "--Liquidity" on page 35 for a discussion of the
liquidity provided by the investment portfolio. 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 both callable and 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. Equity securities include shares
of the Federal Reserve Bank of Richmond, Federal Home Loan Bank of Atlanta,
Community Bankers Bank, and corporate preferred stocks. Valley Financial 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. Unrealized gains and losses on securities
available-for-sale are recognized as direct increases or decreases in
shareholders' equity.
Six months ended June 30, 2000 and June 30, 1999
Investment securities at June 30, 2000 were $34.9 million, an increase of
$2.9 million or 9.2% from their level of $32.0 million on December 31, 1999.
This increase resulted from the purchase of securities 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 actually decreased $227,000 in
the second quarter of 2000, primarily due to principal prepayments on asset-
backed securities.
Years ended December 31, 1999 and December 31, 1998
Investment securities at December 31, 1999 were $32.0 million, an increase
of $5.9 million or 22.4% from their level of $26.1 million on December 31, 1998.
The increase was primarily due to the purchase of investment securities with the
proceeds from a $5.0 million FHLB advance in the second quarter of 1999.
The following table presents the investment portfolio at June 30, 2000 and
1999 by major types of investments.
Investment Portfolio - Category Distribution
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
--------------------------------------- ---------------------------------------
Amortized Approximate Amortized Approximate
Cost Fair Values Cost Fair Values
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. Treasury $ 200 $ 199 $ 199 $ 199
U.S. Government agencies 23,283 22,229 21,866 21,237
Mortgage-backed securities 3,496 3,429 2,738 2,729
States and political subdivisions 8,154 7,801 7,077 6,892
Corporate debt securities 100 99 100 100
Equity securities 1,168 1,153 997 995
--------------- --------------- --------------- ---------------
Total $ 36,401 $ 34,910 $ 32,977 $ 32,152
=============== =============== =============== ===============
</TABLE>
21
<PAGE>
The following table presents the investment portfolio at December 31, 1999
and 1998 by major types of investments.
Investment Portfolio - Category Distribution
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
--------------------------------------- --------------------------------------
Amortized Approximate Amortized Approximate
Cost Fair Values Cost Fair Values
--------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. Treasury $ 200 $ 198 $ 199 $ 202
U.S. Government agencies 22,182 21,179 14,680 14,725
Mortgage-backed securities 2,675 2,642 3,841 3,851
States and political subdivisions 7,292 6,874 6,105 6,298
Corporate debt securities 99 99 100 102
Equity securities 997 972 935 940
--------------- --------------- -------------- ---------------
Total $ 33,445 $ 31,964 $ 25,860 $ 26,118
=============== =============== ============== ===============
</TABLE>
The following tables present the maturity ranges of the investment
portfolio as of June 30, 2000 and December 31, 1999. Maturities may differ from
scheduled maturities in mortgage-backed securities because the mortgages
underlying the securities may be called or repaid prior to the scheduled
maturity date. Maturities on all other securities are based on the contractual
maturity.
Investment Portfolio - Maturity Distribution
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
------------------------------------------------------
Amortized Fair
Costs Value Yield
--------------- --------------- --------------
<S> <C> <C> <C>
Available-for-sale
U. S. Treasury securities and obligations of U. S.
Government corporations:
Within one year $ 200 $ 199 5.47%
After one but within five years 7,131 6,889 6.19%
After five but within ten years 14,492 13,674 6.43%
After ten years 1,661 1,667 7.82%
Obligations of states and subdivisions:
After one but within five years 300 295 6.92%
After five but within ten years 1,453 1,428 6.95%
After ten years 6,400 6,077 7.32%
Corporate securities:
After one but within five years 100 99 7.05%
Other securities:
Within one year 60 60 -%
After five but within ten years 650 650 7.46%
After ten years 458 443 6.83%
Mortgage-backed securities 3,496 3,429 6.67%
--------------- ---------------
Total $ 36,401 $ 34,910 6.64%
=============== ===============
Total securities by maturity period*
Within one year $ 260 $ 259 5.47%
After one but within five years 7,531 7,283 6.23%
After five but within ten years 16,595 15,752 6.52%
After ten years 8,519 8,187 7.40%
--------------- ---------------
Total $ 32,905 $ 31,481 6.63%
=============== ===============
</TABLE>
_______________________
* Maturities on the mortgage-backed securities are not presented in this table
because maturities may differ substantially from contractual terms due to early
repayments of principal.
22
<PAGE>
Investment Portfolio - Maturity Distribution
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999
--------------------------------------------------------
Amortized Fair
Costs Value Yield
---------------- ---------------- --------------
<S> <C> <C> <C>
Available-for-sale
U. S. Treasury securities and obligations of U. S.
Government corporations:
After one but within five years $ 6,328 $ 6,144 6.14%
After five but within ten years 15,491 14,673 6.43%
After ten years 562 559 6.44%
Obligations of states and subdivisions:
After one but within five years 300 297 7.37%
After five but within ten years 839 816 7.19%
After ten years 6,153 5,761 7.74%
Corporate securities:
After one but within five years 100 99 7.05%
Other securities:
Within one year 60 60 -%
After one but within five years 500 500 7.50%
After ten years 437 412 6.86%
Mortgage-backed securities 2,675 2,643 6.37%
--------------- ---------------
Total $ 33,445 $ 31,964 6.50%
=============== ===============
Total securities by maturity period*
Within one year $ 60 $ 60 -%
After one but within five years 7,228 7,040 6.19%
After five but within ten years 16,330 15,489 6.42%
After ten years 7,152 6,732 7.50%
--------------- ---------------
Total $ 30,770 $ 29,321 6.53%
=============== ===============
</TABLE>
_______________________
* Maturities on the mortgage-backed securities are not presented in this table
because maturities may differ substantially from contractual terms due to early
repayments of principal.
Loan Portfolio
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. Valley Financial adjusts its mix of loans and the terms of its loan
programs according to economic and market conditions, asset/liability management
considerations and other factors. More than 90% of our loans are made to
businesses and individuals located within Valley Financial's primary market
area, most of whom maintain deposit accounts with Valley 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.
Valley Financial 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. Management seeks to maintain the
ratio of loans to deposits in a range of 70% to 85%.
Six months ended June 30, 2000 and June 30, 1999
Valley Financial's total gross loans were $106.9 million at June 30, 2000,
an increase of $15.5 million or 17.0% from the $91.4 million reported at
December 31, 1999. Valley Financial's ratio of total loans to total deposits
stood at 88.0% at June 30, 2000 and 79.1% at December 31, 1999. The ratio at
June 30, 2000 reflects stronger loan growth than deposit growth for the first
six months of the year.
Years ended December 31, 1999 and December 31, 1998
Valley Financial's total gross loans were $91.4 million at December 31,
1999, an increase of $19.8 million or 27.6% from the $71.6 million reported one
year earlier. Valley Financial's ratio of total loans to total deposits was
79.1% at December 31, 1999 and 79.6% at December 31, 1998.
23
<PAGE>
The following table summarizes the loan portfolio by category as of the
six-month periods ended June 30, 2000 and 1999 and the years ended December 31,
1999 and 1998.
Loan Portfolio Summary
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
----------------------------------- -----------------------------------
2000 1999 1999 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Commercial and industrial loans $ 27,771 $ 21,419 $ 24,651 $ 17,794
Commercial real estate 37,673 29,523 33,485 22,040
Real estate construction 7,596 4,813 5,225 4,711
Residential real estate 18,404 14,533 14,548 14,429
Loans to individuals 15,490 13,396 13,481 12,648
--------------- --------------- --------------- ---------------
Total loans $ 106,934 $ 83,684 $ 91,390 $ 71,622
=============== =============== =============== ===============
</TABLE>
The following tables present the maturity distribution of the loan
portfolio based on scheduled repayments at June 30, 2000 and December 31, 1999.
Maturity Schedule of Loans
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
---------------------------------------------------------------------------
Due Within Due One to Due After
One Year Five Years Five Years Total
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Commercial and industrial loans $ 15,995 $ 9,193 $ 2,583 $ 27,771
Commercial real estate 3,053 18,847 15,773 37,673
Real estate construction 3,237 605 3,754 7,596
Residential real estate 1,485 3,538 13,381 18,404
Loans to individuals 1,411 3,017 11,062 15,490
--------------- --------------- --------------- ---------------
Total loans $ 25,181 $ 35,200 $ 46,553 $ 106,934
=============== =============== =============== ===============
<CAPTION>
December 31, 1999
---------------------------------------------------------------------------
Due Within Due One to Due After
One Year Five Years Five Years Total
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Commercial and industrial loans $ 12,852 $ 8,258 $ 3,541 $ 24,651
Commercial real estate 1,578 17,328 14,579 33,485
Real estate construction 3,205 56 1,964 5,225
Residential real estate 167 4,502 9,879 14,548
Loans to individuals 1,315 2,392 9,774 13,481
--------------- --------------- --------------- ---------------
Total loans $ 19,117 $ 32,536 $ 39,737 $ 91,390
=============== =============== =============== ===============
</TABLE>
24
<PAGE>
The following tables present commercial and industrial and real estate
construction loans that are due after one year, broken out by fixed and variable
rate loans.
Fixed and Variable Rate Loans
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
-----------------------------------------------------------------------------------
Fixed Variable
------------------------------------- --------------------------------------
Due One to Due After Due One to Due After
Five Years Five Years Five Years Five Years
---------------- ---------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Commercial and industrial $ 5,702 $ 1,771 $ 3,491 $ 812
Real estate construction 231 2,938 374 816
---------------- ---------------- ---------------- -----------------
Total $ 5,933 $ 4,709 $ 3,865 $ 1,628
================ ================ ================ =================
<CAPTION>
December 31, 1999
----------------------------------------------------------------------------------
Fixed Variable
------------------------------------- -------------------------------------
Due One to Due After Due One to Due After
Five Years Five Years Five Years Five Years
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Commercial and industrial $ 6,709 $ 1,834 $ 1,549 $ 1,707
Real estate construction 56 1,841 - 123
---------------- ---------------- ---------------- ----------------
Total $ 6,765 $ 3,675 $ 1,549 $ 1,830
================ ================ ================ ================
</TABLE>
Loan Category Analysis
Commercial Loans. Commercial and industrial loans accounted for 26.0% of
the loan portfolio as of June 30, 2000 and stood at $27.8 million versus $21.4
million at June 30, 1999. As of December 31, 1999, commercial and industrial
loans accounted for 27.0% of the loan portfolio and stood at $24.7 million
versus $17.8 million one year earlier. Such loans generally are made to provide
operating lines of credit, to finance the purchase of inventory or equipment,
and for other business purposes. The creditworthiness of the borrower is
analyzed and re-evaluated on a periodic basis. Most commercial loans are
collateralized with business assets such as accounts receivable, inventory, and
equipment. Even with substantial collateral such as all the assets of the
business and personal guarantees, commercial lending involves considerable risk
of loss in the event of a business downturn or failure of the business.
Commercial Real Estate Loans. Commercial real estate mortgages represent
financing of commercial properties that are secured by real estate, and were
35.2% of total loans at June 30, 2000 and 36.6% at December 31, 1999.
Outstanding loans in this category equaled $37.7 million at June 30, 2000, $29.5
million at June 30, 1999, $33.5 million at December 31, 1999, and $22.0 million
at December 31, 1998. Valley Financial prefers to make commercial real estate
loans secured by owner-occupied properties, and as of June 30, 2000 over 60% of
these loans are secured in that manner. Such borrowers are generally 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.
Real Estate Construction Loans. Real estate construction loans represent
interim financing on residential and commercial properties under construction,
and are secured by real estate. Once construction is completed and the loan
becomes permanent, the loans are reclassified as commercial real estate loans
which are secured by commercial property or residential real estate loans which
are secured by first deeds of trust. Outstanding loans in this category
accounted for 7.1% of total loans and totaled $7.6 million at June 30, 2000 as
compared to 5.7% of total loans and $5.2 million at December 31, 1999.
Outstanding real estate construction loans were $4.8 million and $4.7 million at
June 30, 1999 and December 31, 1998, respectively.
Residential Real Estate Loans. Residential real estate loans are secured
by first deeds of trust on 1 to 4 family residential properties. This category
accounted for 17.2% of total loans and stood at $18.4 million at June 30, 2000,
$14.5 million at June 30, 1999, $14.6 million at December 31, 1999, and $14.4
million at December 31, 1998. To mitigate interest rate risk, Valley Financial
usually limits the final maturity of residential real estate loans held for its
own portfolio to 15 to 20 years and offers a bi-weekly payment option to
encourage faster repayment. Residential real estate lending involves certain
risks, including the risk of late payments and 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
25
<PAGE>
remodeling or higher education, or for other consumer purposes. Loans to
individuals accounted for 14.5% of total loans and totaled $15.5 million at June
30, 2000, $13.4 million at June 30, 1999, $13.5 million at December 31, 1999,
and $12.7 million at December 31, 1998.
Summary of Allowance for Loan Losses
Certain credit risks are inherent in making loans. We prudently assess
these risks and attempt to manage them effectively. We also attempt to reduce
repayment risks 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 our
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 our loans and other assets to assess their quality. The
provision for loan losses is charged to income in an amount necessary to
maintain an allowance for loan losses adequate to provide for expected losses in
our loan portfolio. Loans we deem uncollectible are charged to the allowance for
loan losses and recoveries on loans previously charged off are added to the
allowance for loan losses. We believe the allowance for loan losses is adequate
to provide for any losses in our loan portfolio.
Six months ended June 30, 2000 and June 30, 1999
A provision for loan losses of $163,000 was made during the six months
ended June 30, 2000, an increase of $36,000 or 28.3% over the same period in
1999, in recognition of management's estimate of inherent risks associated with
lending activities. Due to Valley Bank's limited operating history, this
estimate was primarily based on industry practices and consideration of local
economic factors. The allowance for loan losses was $1.1 million as of June 30,
2000 and represented approximately 1.0% of net loans outstanding versus 1.0% of
net loans outstanding at December 31, 1999.
Years ended December 31, 1999 and December 31, 1998
A provision for loan losses of $216,000 and $249,000 was provided during
1999 and 1998, respectively, in recognition of management's estimate of inherent
risks associated with lending activities. Due to Valley Bank's limited operating
history, these estimates were primarily based on industry practices and
consideration of local economic factors. The allowance for loan losses was
$910,000 and $708,000 as of December 31, 1999 and 1998, respectively, and
represented approximately 1.0% and 1.0%, respectively, of net loans outstanding.
The decrease in provision expense is due to the decrease in the rate of loan
growth from 53.6% for 1998 to 27.6% for 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 Valley Financial 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.
The following table summarizes the loan loss experience for the six-month
periods ended June 30, 2000 and 1999, and the years ended December 31, 1999 and
1998.
Allowance for Loan Losses
(dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30, Year Ended December 31,
--------------------------------------- ----------------------------------------
2000 1999 1999 1998
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Beginning balance $ 910 $ 708 $ 708 $ 459
Provision for loan losses 163 127 216 249
Recoveries - - - -
Charged off loans:
Loans to individuals - (2) (2) -
Credit Cards - - (12) -
----------------- ----------------- ----------------- -----------------
Ending balance $ 1,073 $ 833 $ 910 $ 708
================= ================= ================= =================
</TABLE>
26
<PAGE>
The following table summarizes the allocation of the allowance for loan
losses for the six-month periods ended June 30, 2000 and 1999.
Allocation of the Allowance for Loan Losses
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
----------------------------------- -----------------------------------
Amount Percent Amount Percent
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance at end of period applicable to:
Commercial and industrial loans $ 279 25.97% $ 213 25.59%
Commercial real estate 378 35.23 294 35.28
Real estate construction 76 7.10 48 5.75
Residential real estate 185 17.21 145 17.37
Loans to individuals 155 14.49 133 16.01
--------------- --------------- --------------- ---------------
Total $ 1,073 100.00% $ 833 100.00%
=============== =============== =============== ===============
</TABLE>
The following table summarizes the allocation of the allowance for loan
losses for the years ended December 31, 1999 and 1998.
Allocation of the Allowance for Loan Losses
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------------------------- -----------------------------------
Amount Percent Amount Percent
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance at end of period applicable to:
Commercial and industrial loans $ 246 26.97% $ 176 24.84%
Commercial real estate 333 36.64 217 30.77
Real estate construction 52 5.72 47 6.58
Residential real estate 145 15.92 143 20.15
Loans to individuals 134 14.75 125 17.66
--------------- --------------- --------------- ---------------
Total $ 910 100.00% $ 708 100.00%
=============== =============== =============== ===============
</TABLE>
During 1999, Valley Financial charged off loans in the amount of $14,000.
Prior to 1999 Valley Financial had not experienced any charge-offs since the
inception of operations in 1995. The $14,000 in loans charged off in 1999 is
comprised of $12,000 in credit card loans and $2,000 in installment loans to
individuals.
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. The entire balance of
restructured loans at June 30, 2000, 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 loans as deemed
necessary, Valley Financial believes at the present time that all amounts of
principal and interest as detailed in the contractual terms will be collected.
However, Valley Financial 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 Valley
Bank's watch list to determine proper action and reporting of any loans
identified as substandard by the credit quality review.
27
<PAGE>
Nonperforming assets at June 30, 2000, June 30, 1999, December 31, 1999,
and December 31, 1998 are presented in the following table.
Nonperforming Assets
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
------------------------------- ------------------------------------
2000 1999 1999 1998
------------- ------------- --------------- ----------------
<S> <C> <C> <C> <C>
Nonaccrual loans $ 402 $ 225 $ 87 $ -
Loans past due 90 days or more 1 - - 200
Restructured loans 770 - - -
------------- ------------- --------------- ----------------
Total nonperforming loans 1,173 225 87 200
------------- ------------- --------------- ----------------
Foreclosed, repossessed and idled properties - - - -
------------- ------------- --------------- ----------------
Total nonperforming assets $ 1,173 $ 225 $ 87 $ 200
============= ============= =============== ================
</TABLE>
Total nonaccrual loans increased by $316,000 during the six months ended
June 30, 2000. Of the $316,000 increase, $297,000 is the result of the
deterioration of one commercial loan customer in the second quarter of 2000.
If the nonaccrual loans disclosed above had performed in accordance with
their original terms, additional interest income in the amount of $5,000,
$8,000, $4,000, and $0 would have been recorded for the six month periods ended
June 30, 2000 and June 30, 1999, and the years ended December 31, 1999 and
December 31, 1998, respectively.
Valley Bank had $770,000 in restructured loans at June 30, 2000. There were
no such loans at December 31, 1999, June 30, 1999, or December 31, 1998.
The total recorded investment in impaired loans was $1.4 million, $225,000,
$103,000, and $0 for the six-month periods ended June 30, 2000 and June 30,
1999, and the years ended December 31, 1999 and December 31, 1998, respectively.
The related loan loss allowance allocated to impaired loans was $30,000,
$10,000, $10,000, and $0 for the above-referenced time periods, respectively.
Management believes that the above allocated reserves are adequate for the
impaired loans in Valley Financial's portfolio based upon a detailed review of
the quality and pledged collateral of each individual loan considered impaired
at each of the above-referenced periods.
Deposits
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 Valley Bank. 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. Despite these pricing and market
strategies, the ratio of certificates of deposit to total deposits increased
from 51.1% at December 31, 1998 to 59.1% at December 31, 1999. However,
management was able to reduce the cost of funds ratio by 26 basis points from
1998, primarily by controlling the rates paid on time deposits. The ratio of
certificates of deposit to total deposits remained at the same 1999 year-end
percentage of 59.0% as of June 30, 2000. However, during the first six months of
2000, the cost of funds ratio increased by 31 basis points over the first six
months of 1999 ratio of 4.0% due to higher interest rates and fierce competition
for deposits.
Six months ended June 30, 2000 and June 30, 1999
As of June 30, 2000 total deposits were $121.5 million, an increase of $6.0
million or 5.2% 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 $5.1 million and $3.3 million, respectively,
partially offset by declines in the other categories. Of the $5.1 million
increase in non-interest bearing demand deposits, $2.3 million is attributable
to an increase in official checks, which include internally generated expense
checks, cashiers checks, and money orders. The increase in official checks was
primarily due to the issuance of loan proceeds to Valley Bank customers for
closings that occurred at the end of the period.
At June 30, 2000 noninterest-bearing demand deposits were $19.4 million or
16.0% 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 $50.1 million or 41.2% of total
deposits at June 30, 2000, compared with $47.3 million or 41.0% of total
28
<PAGE>
deposits at December 31, 1999. Total interest bearing deposits stood at $102.1
million at June 30, 2000, an increase of $976,000 or 1.0% over their level of
$101.2 million at December 31, 1999.
For the six months ended June 30, 2000 average noninterest bearing demand
deposits were $15.0 million or 13.1% of average total deposits. For the six
months ended June 30, 1999, average noninterest bearing demand deposits were
$12.1 million or 12.7% of average total deposits. Nonmaturity deposits
(noninterest bearing demand deposits, interest bearing demand deposits, money
market accounts, and savings accounts) averaged $47.1 million or 41.0% of
average total deposits in the six months ended June 30, 2000, up from $45.6
million or 48.0% of average total deposits in the six months ended June 30,
1999. Total interest bearing deposits averaged $100.0 million for the six months
ended June 30, 2000, an increase of $17.0 million or 20.4% over their level of
$83.0 million for the six months ended June 30, 1999. Total time deposits
averaged $67.9 million in the six months ended June 30, 2000 or 59.0% of average
total deposits, up from $49.5 million or 52.1% of average total deposits in the
six months ended June 30, 1999.
Years ended December 31, 1999 and December 31, 1998
As of December 31, 1999 total deposits were $115.5 million, an increase of
$25.5 million or 28.3% from their level of $90.0 million one year earlier.
Average deposits were $101.4 million for 1999, an increase of $24.4 million or
31.2% over 1998's average deposits of $77.1 million. The increase in average
deposits during 1999 was primarily due to increases in previously existing
accounts as well as new accounts opened during the year.
For the year ended December 31, 1999 average noninterest bearing demand
deposits were $13.0 million or 12.9% of average total deposits. For the prior
year, average noninterest bearing demand deposits were $8.6 million or 11.2% of
average total deposits. Nonmaturity deposits averaged $45.9 million or 45.3% of
average total deposits in 1999, up from $34.1 million or 44.3% of average total
deposits in 1998. Total interest bearing deposits averaged $88.4 million for the
year ended December 31, 1999, an increase of $19.9 million or 29.1% over their
level of $68.5 million for the year ended December 31, 1998.
The following table summarizes average deposits for the six-month periods
ended June 30, 2000 and 1999.
Deposit Mix
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 June 30, 1999
----------------------------------- -----------------------------------
Average Average
Balance Percent Balance Percent
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Interest bearing deposits:
NOW accounts $ 7,658 6.66% $ 6,997 7.36%
Money market accounts 22,947 19.95 25,351 26.66
Savings accounts 1,482 1.29 1,144 1.20
Time deposits over $100,000 12,612 10.96 8,880 9.34
Time deposits under $100,000 55,274 48.06 40,625 42.73
--------------- --------------- --------------- ---------------
Total interest bearing deposits 99,973 86.92 82,997 87.29
--------------- --------------- --------------- ---------------
Noninterest bearing deposits:
Demand deposits 15,043 13.08 12,087 12.71
--------------- --------------- --------------- ---------------
Total deposits $ 115,016 100.00% $ 95,084 100.00%
=============== =============== =============== ===============
</TABLE>
29
<PAGE>
The following table summarizes average deposits for the years ended
December 31, 1999 and 1998.
Deposit Mix
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999 December 31, 1998
----------------------------------- -----------------------------------
Average Average
Balance Percent Balance Percent
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Interest bearing deposits:
NOW accounts $ 7,175 7.08% $ 6,720 8.72%
Money market accounts 24,386 24.04 17,887 23.22
Savings accounts 1,253 1.24 854 1.11
Time deposits over $100,000 10,035 9.89 7,115 9.23
Time deposits under $100,000 45,535 44.89 35,880 46.56
--------------- --------------- --------------- ---------------
Total interest bearing deposits 88,384 87.14 68,456 88.84
--------------- --------------- --------------- ---------------
Noninterest bearing deposits:
Demand deposits 13,044 12.86 8,602 11.16
--------------- --------------- --------------- ---------------
Total deposits $ 101,428 100.00% $ 77,058 100.00%
=============== =============== =============== ===============
</TABLE>
The following table presents the maturity schedule of certificates of
deposit over $100,000 as of June 30, 2000 and December 31, 1999.
Maturity Schedule of Certificates of Deposit Over $100,000
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000 December 31, 1999
------------------- -----------------------
<S> <C> <C>
Three months or less $ 3,053 $ 1,793
Over three through six months 1,614 3,366
Over six through 12 months 7,614 4,911
Over 12 months 1,876 2,904
---------------- -----------------
Total $ 14,157 $ 12,974
================ =================
</TABLE>
Short-Term Borrowings
Valley Bank placed in service a commercial sweep account program in the
third quarter of 1999. The balances in the program grew by $3.2 million from
their level of $992,000 at December 31, 1999 to a total of $4.2 million as of
June 30, 2000. The program consists of establishing a demand deposit account in
which Valley Bank invests available balances daily in securities on an overnight
basis subject to repurchase. On the following business day, Valley 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 the
repurchase agreement is not a deposit and therefore is not insured by the FDIC.
Therefore, these repurchase balances are not reported as deposits but as short-
term borrowings.
30
<PAGE>
The following table presents information on each category of Valley
Financial's short-term borrowings which generally mature within one to seven
days from the transaction date.
Short-Term Borrowings
(dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended Year Ended
June 30, December 31,
-------------------------------- -------------------------------
2000 1999 1999 1998
------------ ------------- -------------- -------------
<S> <C> <C> <C> <C>
Actual amount outstanding at period end:
Short-term borrowings $ 3,000 $ 4,597 $ - $ -
Securities sold under agreements to repurchase 4,167 - 992 -
Weighted average actual interest rate at period end:
Short-term borrowings 7.40% 6.01% -% -%
Securities sold under agreements to repurchase 4.84 - 4.05 -
Maximum amount outstanding at any month-end in period:
Short-term borrowings $ 5,000 $ 4,597 $ 4,597 $ 4,531
Securities sold under agreements to repurchase 4,167 - 992 -
Average amount outstanding during period end:
Short-term borrowings $ 2,576 $ 642 $ 414 $ 839
Securities sold under agreements to repurchase 2,673 - 244 -
Weighted average interest rate during the period:
Short-term borrowings 6.49% 5.22% 5.27% 5.60%
Securities sold under agreements to repurchase 4.80 - 4.05 -
</TABLE>
Other Debt
Valley Financial has outstanding debt with the Federal Home 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 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 Valley Financial 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 regulatory requirements to qualify
as Tier 2 capital, and is the primary reason for the increase in Valley
Financial's total capital ratio at June 30, 2000. See "Valley Financial's
Subordinated Debt" on page 44.
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
31
<PAGE>
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. We believe 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 directly 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, Valley Financial 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 Valley Financial's own
experience.
At least quarterly, Valley Financial calculates Valley 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.
Management's objective is to keep the one year "income statement gap" at or
below 15% of total assets under a 200 basis point interest rate change scenario.
Six months ended June 30, 2000
Utilizing this methodology and assuming a 200 basis point increase in
Prime, Valley Bank at June 30, 2000 had a negative one-year gap of $26.7 million
or 17.6% of total assets. At that same date and assuming a 200 basis point
decrease in Prime, Valley Bank had a positive one-year gap of $11.9 million or
7.9% of total assets.
Years ended December 31, 1999 and December 31, 1998
Utilizing the methodology above and assuming a 200 basis point increase in
Prime, Valley Bank at December 31, 1999 had a negative one-year gap of $14.4
million or 10.6% of total assets. At that same date and assuming a 200 basis
point decrease in Prime, Valley Bank had a positive one-year gap of $21.8
million or 16.0% of total assets.
Utilizing the same methodology as above and assuming a 200 basis point
increase in Prime, Valley Bank at December 31, 1998 had a negative one-year gap
of $2.9 million or 2.8% of total assets. At that same date, assuming a 200 basis
point decrease in Prime, Valley Bank had a positive one-year gap of $7.8 million
or 7.5% of total assets.
32
<PAGE>
The following tables show the interest rate sensitivity of Valley
Financial's balance sheet at the dates indicated, but are not necessarily
indicative of the position on other dates.
Interest Rate Sensitivity
Maturities/Repricing
(dollars in thousands)
<TABLE>
<CAPTION>
June 30, 2000
---------------------------------------------------------------------
1-3 4-12 13-60 Over 60
Months Months Months Months Total
----------- ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Earning assets:
Loans, excluding nonaccruals $ 38,757 $ 3,669 $ 31,098 $ 33,008 $ 106,532
Investment securities 1,667 1,010 7,809 24,424 34,910
Federal funds sold 1,309 - - - 1,309
Interest bearing balances 75 - - - 75
----------- ----------- ------------ ------------ -----------
Total earning assets 41,808 4,679 38,907 57,432 142,826
----------- ----------- ------------ ------------ -----------
Interest bearing liabilities:
NOW accounts 7,448 - - - 7,448
Money market accounts 21,698 - - - 21,698
Savings 1,543 - - - 1,543
Certificates of deposit 16,682 42,768 11,986 - 71,436
----------- ----------- ------------ ------------ -----------
Total deposits 47,371 42,768 11,986 - 102,125
----------- ----------- ------------ ------------ -----------
Short-term borrowings 3,000 - - - 3,000
Repurchase agreements 4,167 - - - 4,167
Subordinated capital note - - - 2,300 2,300
FHLB advances - 10,000 - - 10,000
----------- ----------- ------------ ------------ -----------
Total interest bearing liabilities 54,538 52,768 11,986 2,300 121,592
----------- ----------- ------------ ------------ -----------
Interest rate gap $ (12,730) $ (48,089) $ 26,921 $ 55,132 $ 21,234
=========== =========== ============ ============ ===========
Cumulative interest sensitivity gap $ (12,730) $ (60,819) $ (33,898) $ 21,234 -
Ratio of sensitivity gap to total earning assets (8.91%) (33.67%) 18.85% 38.60% 14.87%
Cumulative ratio of sensitivity gap to total earning (8.91%) (42.58%) (23.73%) 14.87% -
assets
</TABLE>
33
<PAGE>
Interest Rate Sensitivity
Maturities/Repricing
(dollars in thousands)
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------------------------------------
1-3 4-12 13-60 Over 60
Months Months Months Months Total
---------- ----------- ------------ ------------ ----------
<S> <C> <C> <C> <C> <C>
Earning assets:
Loans, excluding nonaccruals $ 31,183 $ 2,002 $ 29,803 $ 28,315 $ 91,303
Investment securities 560 975 7,145 23,284 31,964
Federal funds sold 6,034 - - - 6,034
Interest bearing balances 71 - - - 71
---------- ----------- ------------ ------------ ----------
Total earning assets 37,848 2,977 36,948 51,599 129,372
---------- ----------- ------------ ------------ ----------
Interest bearing liabilities:
NOW accounts 9,423 - - - 9,423
Money market accounts 22,178 - - - 22,178
Savings 1,357 - - - 1,357
Certificates of deposit 6,278 47,229 14,684 - 68,191
---------- ----------- ------------ ------------ ----------
Total deposits 39,236 47,229 14,684 - 101,149
---------- ----------- ------------ ------------ ----------
Repurchase agreements 992 - - - 992
FHLB advances - 10,000 - - 10,000
---------- ----------- ------------ ------------ ----------
Total interest bearing liabilities 40,228 57,229 14,684 - 112,141
---------- ----------- ------------ ------------ ----------
Interest rate gap $ (2,380) $ (54,252) $ 22,264 $ 51,599 $ 17,231
========== =========== ============ ============ ==========
Cumulative interest sensitivity gap $ (2,380) $ (56,632) $ (34,368) $ 17,231 -
Ratio of sensitivity gap to total earning assets (1.84%) (41.93%) 17.21% 39.88% 13.32%
Cumulative ratio of sensitivity gap to total earning (1.84%) (43.77%) (26.56%) 13.32% -
assets
</TABLE>
Capital Adequacy
Valley Financial's financial position at June 30, 2000 and December 31,
1999 reflects liquidity and capital levels currently adequate to fund
anticipated short-term business expansion. Capital ratios are in excess of
required regulatory minimums for a well-capitalized institution. The adequacy of
Valley Financial'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.
Six months ended June 30, 2000 and June 30, 1999
Total shareholders' equity was $9.7 million at June 30, 2000 compared with
$9.1 million at December 31, 1999, an increase of $679,000 or 7.4%. The increase
is attributable to net income for the first six months of $684,000, offset by a
$5,000 increase in accumulated other comprehensive loss. Exclusive of
accumulated other comprehensive loss, which is comprised exclusively of net
unrealized losses on investment securities, shareholders' equity was $10.7
million at June 30, 2000 and $10.0 million at December 31, 1999.
Years ended December 31, 1999 and December 31, 1998
Total shareholders' equity was $9.1 million at December 31, 1999 compared
with $9.2 million at December 31, 1998, a decrease of $102,000 or 1.1%. The
$102,000 decrease is attributable to 1999's net income of $1.0 million, a $1.2
million decrease over the level at December 31, 1998 in accumulated other
comprehensive income, which is comprised exclusively of unrealized gains
(losses) on available-for-sale investment securities, and proceeds from the
issuance of common stock under Valley Financial's Incentive Stock Plan in the
amount of $4,000. Exclusive of accumulated other comprehensive income (loss),
which is comprised exclusively of the unrealized gains (losses) on available-
for-sale securities, total shareholders' equity would have been $10.0 million
and $9.0 million at December 31, 1999 and 1998, respectively, an increase of
$1.0 million or 11.6%.
34
<PAGE>
For the periods indicated, Valley Financial had the risk-based capital and
leverage ratios relative to regulatory minimums set forth in the following
table. See "Supervision and Regulation - Supervision and Regulation of Valley
Bank - Bank Capital Guidelines" on page 47.
Capital Ratios
June 30, December 31, Regulatory
------------------ -------------------
2000 1999 1999 1998 Minimum
-------- ------ -------- -------- --------------
Tier 1 9.2% 10.1% 9.8% 11.3% 4.0%
Total 12.1% 11.0% 10.7% 12.2% 8.0%
Leverage 7.3% 8.0% 7.6% 8.7% 4.0%
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 Valley Financial's interest sensitivity position, to manage the
impact of interest rate fluctuations on net interest income. See "- Interest
Rate Risk" on page 31.
Liquidity measures the ability of Valley Financial 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.
Valley Financial's asset liquidity is provided by cash and due from banks,
federal funds sold, investments available for sale, and through the management
of investment maturities/prepayments and loan repayments.
The level of deposits may fluctuate, perhaps significantly due to seasonal
cycles of deposit 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, Valley Financial 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. Valley Bank has established a credit line though the discount window
of the Federal Reserve Bank of Richmond as an additional source of liquidity. As
a result of Valley Financial's management of liquid assets and the ability to
generate liquidity through alternative funding sources, management believes
Valley Financial maintains overall liquidity sufficient to meet its depositors'
requirements and satisfy its customers' credit needs.
Six months ended June 30, 2000 and June 30, 1999
Valley Financial's ratio of liquid assets to deposits and short-term
borrowings was 32.2% at June 30, 2000 and 36.1% at December 31, 1999. Valley
Financial sells excess funds as overnight federal funds sold to provide an
immediate source of liquidity. Valley Financial had federal funds sold of $1.3
million at June 30, 2000, a decrease of $4.7 million from federal funds sold of
$6.0 million at December 31, 1999. The decrease in federal funds sold during the
first six months of 2000 was primarily due to loan growth in the amount of $15.5
million, and was despite deposit growth of $6.0 million, securities sold under
agreements to repurchase growth of $3.2 million, and a daily rollover adjustable
rate advance obtained from the Federal Home Loan Bank of Atlanta during the
second quarter in the amount of $3.0 million.
One aspect of liquidity that we have been closely examining is our
investment portfolio. As of June 30, 2000, Valley Financial had unrealized
losses of $1.5 million, gross of tax benefit, on $36.4 million of securities
available-for-sale. We do not currently intend to sell these securities, as a
sale would cause these unrealized losses to be recognized. We are currently
considering certain swap-related transactions in order to shorten the average
maturity of our portfolio and to reallocate certain funds into other types of
securities.
As of June 30, 2000, Valley Financial had pledged approximately $9.5
million of its investment portfolio as collateral for a line of credit from the
Federal Home Loan Bank. As of that date, Valley Financial had approximately $7.6
million in available overnight credit from the Federal Home Loan Bank under that
arrangement. In addition, Valley
35
<PAGE>
Financial has an additional $20.0 million in bonds, and $61.0 million in loans,
approximately, available as collateral for additional borrowings to provide
additional liquidity.
Years ended December 31, 1999 and December 31, 1998
Valley Financial's ratio of liquid assets to deposits and short-term
borrowings was 36.1% at December 31, 1999 and 34.8% at December 31, 1998. The
ratio increased due to a 34.4% increase in liquid assets as compared to a 29.4%
increase in deposits and short-term borrowings in 1999 over 1998. Federal funds
sold at December 31, 1999 were $6.0 million compared to $1.7 million at December
31, 1998.
Year 2000
Valley Financial 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 six 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 Valley Financial and Valley
Bank are monetary in nature. As a result, interest rates have a greater impact
on Valley Financial'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.
Financial Ratios
The following table presents certain financial ratios for the periods
indicated.
Key Financial Ratios
<TABLE>
<CAPTION>
Six Months Ended Years Ended
June 30, December 31,
--------------------------- --------------------------
2000 1999 1999 1998
---------- ------------ ---------- ----------
<S> <C> <C> <C> <C>
Return on average assets (1) .97% .74% .86% .83%
Return on average equity (1) 13.22% 9.07% 10.98% 8.87%
Average equity to average assets 7.38% 8.20% 7.86% 9.32%
</TABLE>
_______________________
(1) Ratios for six-month periods have been annualized.
Return on average assets and return on average equity for the quarter ended
June 30, 2000 were 1.00% and 13.71%, respectively.
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.
36
<PAGE>
Statement 133 shall be effective for all fiscal quarters of all fiscal
years beginning after June 15, 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 Valley Bank's consolidated financial position, results of
operations or liquidity.
37
<PAGE>
MANAGEMENT
Information Concerning Directors and Executive Officers
The following information, including the principal occupation during the
past five years, is given with respect to our directors and executive officers.
Share ownership is as of November 14, 2000. Our directors are divided into three
classes and generally are elected to three-year terms. All of these individuals
serve as directors of Valley Financial and of Valley Bank.
<TABLE>
<CAPTION>
Name, Age and Year Shares Percent
First Became Director Principal Occupation Owned of Class(13)
--------------------- -------------------- ----- --------
(Class A - to serve until 2001 Annual Meeting)
<S> <C> <C> <C>
Eddie F. Hearp President, National Financial 26,754(1) 2.64%
Age 56, Director since 1994 Services, Inc. (personal and
business insurance, retirement
benefit planning), Roanoke, VA
Anna L. Lawson Anthropologist, Daleville, VA 32,025(2) 3.16%
Age 56, Director since 1994
John W. Starr, M.D. Cardiologist, Consultants in 27,230(3) 2.69%
Age 53, Director since 1994 Cardiology, P.C., Roanoke, VA
Michael E. Warner Private investor, Roanoke, VA 23,205(4) 2.29%
Age 64, Director since 1994
(Class B - to serve until 2002 Annual Meeting)
Abney S. Boxley, III*(5) President and Chief Executive 21,000 2.07%
Age 42, Director since 1994 Officer, Boxley Company, Inc.
(construction materials supplier),
Roanoke, VA
William D. Elliot* Chairman and President, AEW, 47,250(6) 4.67%
Age 52, Director since 1994 Inc. (specialists in construction
and maintenance of overhead electric
power lines, industrial electric wiring
and industrial process controls) since
1997; previously, Chairman and President,
Davis H. Elliot Co. (a subsidiary of AEW,
Inc.), Roanoke, VA
Barbara B. Lemon Civic leader, Roanoke, VA 21,000 2.07%
Age 61, Director since 1994
Ward W. Stevens, M.D.* Retired since 1997; previously 28,875(7) 2.85%
Age 64, Director since 1994 Neurosurgeon, Neurosurgical
Associates of Roanoke, Inc.,
Roanoke, VA
(Class C - to serve until 2003 Annual Meeting)
Ellis L. Gutshall* President and Chief Executive 42,336(8) 4.04%
Age 50, Director since 1996 Officer of Valley Financial since
1996; previously Senior Vice
President and Chief Lending Officer
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
Name, Age and Year Shares Percent
First Became Director Principal Occupation Owned of Class(13)
--------------------- -------------------- ----- --------
(Class C - to serve until 2003 Annual Meeting)
<S> <C> <C> <C>
Mason Haynesworth Retired since March 2000; previously 525(9) 0.05%
Age 59, Director since 1997 Director of Specialized Audits,
Norfolk Southern Corporation,
Roanoke, VA
A. Wayne Lewis* Executive Vice President, Chief 46,116(10) 4.40%
Age 56, Director since 1994 Operating Officer, Chief
Financial Officer and Corporate
Secretary of Valley Financial since
1996; previously, Senior Vice
President
George W. Logan*(11) Chairman of the Board of 96,000 9.47%
Age 55, Director since 1994 Directors of Valley Financial;
Chairman, Alliance Industrial
Centers (developer of commercial
distribution warehouses), Roanoke, VA
Executive Officer
-----------------
J. Randy Woodson Senior Vice President and Chief 4,432(12) 0.44%
Age 39 Lending Officer of Valley Bank
since 1999; previously Senior Vice
President since 1998; previously Senior
Vice President, Crestar Bank, Roanoke, VA
13 Directors and Executive 416,688 38.35%
Officers as a group
</TABLE>
________________________
* Member of the Executive Committee
(1) Includes 262 shares held by Mr. Hearp's spouse.
(2) Includes 2,100 shares held by Mrs. Lawson's son and 1,050 shares held by
her spouse.
(3) Includes 1,050 shares held by Dr. Starr's spouse and 24,605 shares owned
beneficially by Dr. Starr through the Consultants in Cardiology, P.C.
Profit Sharing Plan.
(4) Includes 21,000 shares held jointly by Mr. Warner with his spouse.
(5) Mr. Boxley is also a director of Roanoke Gas Company.
(6) Includes 15,000 shares held by AEW, Inc., of which Mr. Elliot is Chairman
and President.
(7) Includes 27,500 shares held beneficially by Dr. Stevens through the
Neurosurgical Associates of Roanoke, Inc. Profit Sharing Plan.
(8) Includes 210 shares held by Mr. Gutshall as custodian for his children and
35,616 shares Mr. Gutshall may acquire within 60 days through the exercise
of stock options.
(9) Includes 25 shares held jointly by Mr. Haynesworth with his spouse.
(10) Includes 34,566 shares Mr. Lewis may acquire within 60 days through the
exercise of stock options.
(11) Mr. Logan is also a director of Roanoke Electric Steel Corporation.
(12) Includes 2,730 shares Mr. Woodson may acquire within 60 days through
exercise of stock options.
(13) Computed in accordance with SEC Rule 13d-3 to reflect stock options
exercisable within 60 days.
39
<PAGE>
Security Ownership of Certain Beneficial Owners
The following table sets forth certain information as to persons believed
by management of Valley Financial to be beneficial owners of more than 5% of the
outstanding common stock. Other than as disclosed below, Valley Financial is
not aware of any person or group, as those terms are defined in the Securities
Exchange Act of 1934, who beneficially owned more than 5% of the outstanding
common stock as of November 14, 2000.
Name and Address Number of Percent of
Title of Class of Beneficial Owner Shares Owned Class
-------------- ------------------- ------------ -----
Common Stock George W. Logan 96,000 9.47%
P.O. Box 1190
Salem, VA 24153
Executive Management
Ellis L. Gutshall is the President and Chief Executive Officer of Valley
Financial. He is a veteran banker with more than 26 years banking experience,
including 24 years in the Roanoke Valley. He joined First Virginia Bank in 1974,
as a management trainee, and held various positions of increasing responsibility
until being named Executive Vice President of First Virginia Bank- Southwest in
Roanoke in 1991, with responsibility for a $350 million loan portfolio. He
joined Valley Financial in 1995 as Senior Vice President and Chief Lending
Officer. He was promoted to President and CEO in 1996. Mr. Gutshall holds a B.S.
in Economics from Washington & Lee University.
A. Wayne Lewis is the Executive Vice President, Chief Operating Officer,
Chief Financial Officer, and Corporate Secretary of Valley Financial. Mr. Lewis
has more than 38 years banking experience, all in the Roanoke Valley. He joined
First National Exchange Bank in 1962 as a teller. That bank formed a holding
company and through various acquisitions became Dominion Bankshares, Inc., a
$10.6 billion financial institution. Mr. Lewis was Executive Vice President and
Corporate Secretary of Dominion in 1993, when it was acquired by First Union
Corporation. Mr. Lewis joined the Valley Financial team in 1993 prior to the
formation of Valley Financial in 1994, and became Senior Vice President and
Chief Operating Officer when Valley Financial and Valley Bank began operating in
1995. Mr. Lewis holds a B.B.A. degree in Business Administration from Roanoke
College.
J. Randy Woodson is Senior Vice President and Chief Lending Officer of
Valley Bank. Mr. Woodson has more than 16 years banking experience, including 10
years in the Roanoke Valley. He joined Crestar Bank (now SunTrust Bank) in 1984
as a management trainee. Mr. Woodson was a Senior Vice President of Crestar Bank
with responsibility for a $100 million loan portfolio prior to joining Valley
Bank in 1998. Mr. Woodson has been the Chief Lending Officer of Valley Bank
since 1999. Mr. Woodson holds a B.S. degree in finance and marketing from
Virginia Tech.
40
<PAGE>
Executive Compensation
The following table shows the compensation paid by Valley Financial to its
executive officers for the three years ended December 31, 1999.
Summary Compensation Table
<TABLE>
<CAPTION>
Long Term Compensation
----------------------
Securities
Annual Compensation Underlying
-------------------
Name and Principal Position Year Salary Bonus Options Other*
--------------------------- ---- ------ ----- ------- ------
<S> <C> <C> <C> <C> <C>
Ellis L. Gutshall 1999 $145,400 $54,000 11,697 $4,899
President and Chief Executive 1998 124,373 30,000 10,122 1,009
Officer 1997 117,879 19,500 10,122 0
A. Wayne Lewis 1999 120,150 36,000 1,575 5,443
Executive Vice President and 1998 108,150 20,000 10,122 1,638
Chief Operating Officer 1997 102,248 12,500 20,244 0
J. Randy Woodson** 1999 94,125 17,000 3,938 4,252
Senior Vice President and 1998 80,480 10,000 5,250 1,265
Chief Lending Officer -
Valley Bank
</TABLE>
_______________________
* Represents 401(k) plan employer matching contributions.
**Mr. Woodson joined Valley Bank in February, 1998.
Stock Options
We are authorized to grant stock options to our officers and employees
through the Valley Financial Corporation Incentive Stock Plan. The Incentive
Stock Plan currently authorizes the issuance of up to 103,950 shares of our
common stock and, as of June 30, 2000, options to purchase 59,063 shares have
been granted and 44,887 shares remain available for grants and awards under the
Incentive Stock Plan. In addition, we have also granted options to certain
executive officers under individual stock option agreements.
The following tables set forth certain information regarding options held
by our executive officers as of December 31, 1999, including options granted
under the Incentive Stock Plan and individual stock option agreements. No stock
options were exercised by any of our executive officers during 1999.
Stock Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Percent of
Number of Options Granted to
Securities Underlying Employees During Exercise or Base Expiration
Name Options Granted Fiscal Year Price Per Share Date
------------------- --------------------- ------------------ ---------------- ----------
<S> <C> <C> <C> <C>
Ellis L. Gutshall 1,575 4.96% $16.63 12/16/09
A. Wayne Lewis 1,575 4.96 16.63 12/16/09
J. Randy Woodson 3,150 9.92 15.20 01/21/09
J. Randy Woodson 788 2.48 16.63 12/16/09
</TABLE>
41
<PAGE>
Aggregate Fiscal Year-End Option Values
Number of Securities Underlying Value of Unexercised In-the-
Unexercised Options at 12/31/99 Money Options at 12/31/99
------------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Ellis L. Gutshall 34,566 2,625 $362,336 $16,341
A. Wayne Lewis 33,516 3,675 355,052 29,859
J. Randy Woodson 2,730 6,458 18,341 37,731
Employment Contracts, Termination and Change-in-Control Agreements
Valley Financial has entered into employment agreements with Mr. Lewis and
Mr. Gutshall, each with an initial term of three years and automatic renewals of
that term each year unless either party gives sufficient prior notice. Each
agreement provides a minimum salary level that may be increased by the board at
its annual evaluation, as well as group benefits provided to other executives,
the establishment of a life insurance policy financing facility, and certain
stock options described above. Each agreement also contains change-in-control
provisions entitling each executive to certain benefits in the event his
employment is terminated within three years of a change in control of Valley
Financial for reasons other than death, retirement, disability, cause, voluntary
resignation other than for good reason, or pursuant to notice of termination
given prior to the change in control. If either executive is terminated
following a change in control, he will receive a lump-sum payment equal to 2.99
times average annual compensation for the most recent five years, provided that
if the payment is or will be subject to the excise tax imposed by Section 4999
of the Internal Revenue Code or any similar tax, the amount of the payment will
be reduced to avoid that excise tax.
As an inducement for Mr. Woodson to join Valley Financial in February 1998,
Valley Financial entered into a change-in-control severance agreement with him.
The initial date of that agreement was February 9, 1998, and it had an initial
five-year term. That agreement provides that if there is a change in control of
Valley Financial during the term of that agreement, Mr. Woodson will be entitled
to receive effectively the same protections and compensation terms provided to
Messrs. Gutshall and Lewis, outlined in the preceding paragraph.
Certain Relationships and Related Transactions
Anna L. Lawson, a Class A Director, is the sister of George W. Logan, a
Class C Director and Chairman of the Board of Directors. Otherwise, there are
no family relationships among the directors and executive officers of Valley
Financial.
Valley Bank has had and expects to have loan transactions with certain of
the directors and officers and their affiliates. Such loans were made in the
ordinary course of business, on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons, and do not involve more than normal risk of
collectibility or have other unfavorable features. As of June 30, 2000, we had
a total of $5.1 million in loans outstanding or committed to our directors and
executive officers.
DESCRIPTION OF CAPITAL STOCK
Valley Financial's Articles of Incorporation authorize 10 million shares of
common stock, of which 1,013,207 shares were issued and outstanding on November
14, 2000. As of November 14, 2000, there were approximately 533 shareholders of
record of our common stock and approximately 975 beneficial holders. In
addition, our Articles authorize 10 million shares of preferred stock. There
are no shares of preferred stock outstanding. The board may issue shares of
common stock and preferred stock as the board deems advisable without further
shareholder approval, except, for example, in the case of an acquisition of or
combination with another bank or company. In other words, the board may decide
to issue additional stock and dilute your ownership interest.
Summary of Shareholder Rights
Dividend Rights. Valley Financial may pay dividends as declared from time
to time by the board out of funds that are legally available, subject to certain
restrictions imposed by state and federal laws. We do not expect to pay
dividends in the near future, but rather to retain our earnings to provide funds
to operate and expand our business. See "Dividend Policy" on page 8.
42
<PAGE>
Voting Rights. In all elections of directors, a shareholder has the right
to cast one vote for each share of stock held by him or her for as many persons
as there are directors to be elected. We do not have cumulative voting rights.
On any other question to be determined by a vote of shares at any meeting of
shareholders, each shareholder is entitled to one vote for each share of stock
held by him or her and entitled to vote.
Preemptive Rights. Holders of common stock do not have preemptive rights
with respect to issues of common stock. Accordingly, your share ownership may
be diluted if the board decides to issue additional stock in the future.
Liquidation Rights. Upon liquidation, after payment of all creditors, the
remaining assets of our company would be distributed to the holders of common
stock on a pro-rata basis.
Calls and Assessments. All common stock outstanding is fully paid and non-
assessable.
Indemnification of Officers and Directors. The Articles of Incorporation
provide for the indemnification of our officers and directors for their actions
unless a court finds them liable for willful misconduct or a knowing violation
of the criminal law. In any proceeding brought by shareholders against an
officer or director in connection with his or her position with Valley Financial
or Valley Bank, no damages may be assessed against that officer or director
unless he or she is liable for willful misconduct or a knowing violation of
criminal or securities laws. We are advised that in the opinion of the
Securities and Exchange Commission indemnification of directors, officers, and
controlling persons for liabilities under the Securities Act of 1933 is against
public policy and is, therefore, unenforceable.
Reports to Shareholders. We furnish shareholders with annual reports,
including audited financial statements, and quarterly reports containing
unaudited financial information.
Virginia Anti-Takeover Statutes
State Anti-Takeover Statutes. Virginia law restricts transactions between
a Virginia corporation and its affiliates and potential acquirers. The
following discussion summarizes the two Virginia statutes that may discourage an
attempt to acquire control of Valley Financial. We encourage you to read the
entire statutes referenced below.
Affiliated Transactions. Virginia Code Sections 13.1-725 - 727.1 govern
"Affiliated Transactions." These provisions, with several exceptions discussed
below, require approval by the holders of at least two-thirds of the remaining
voting shares of material acquisition transactions between a Virginia
corporation and any holder of more than 10% of any class of its outstanding
voting shares. Affiliated Transactions include mergers, share exchanges,
material dispositions of corporate assets not in the ordinary course of
business, any dissolution of the corporation proposed by or on behalf of an
interested shareholder, or any reclassification, including a reverse stock
split, recapitalization, or merger of the corporation with its subsidiaries
which increases the percentage of voting shares owned beneficially by any 10%
shareholder by more than 5%.
For three years following the time that a shareholder becomes an owner of
10% of the outstanding voting shares, a Virginia corporation cannot engage in an
Affiliated Transaction with that shareholder without approval of two-thirds of
the voting shares other than those shares beneficially owned by that
shareholder, and majority approval of the disinterested directors. A
disinterested director is a member of the Valley Financial board of directors
who was (i) a member on the date the shareholder acquired more than 10% and (ii)
recommended for election by, or was elected to fill a vacancy and received the
affirmative vote of, a majority of the disinterested directors then on the
board. At the expiration of the three-year period, the statute requires
approval of Affiliated Transactions by two-thirds of the voting shares other
than those beneficially owned by the 10% shareholder.
The principal exceptions to the special voting requirement apply to
transactions proposed after the three-year period has expired and require either
that the transaction be approved by a majority of the corporation's
disinterested directors or that the transaction satisfy the fair-price
requirement of the statute. In general, the fair-price requirement provides
that in a two-step acquisition transaction, the 10% shareholder must pay the
shareholders in the second step either the same amount of cash or the same
amount and type of consideration paid to acquire the Virginia corporation's
shares in the first step.
None of the foregoing limitations and special voting requirements applies
to a transaction with any 10% shareholder whose acquisition of shares taking him
or her over 10% was approved by a majority of the corporation's disinterested
directors.
43
<PAGE>
These provisions were designed to deter certain takeovers of Virginia
corporations. In addition, the statute provides that, by affirmative vote of a
majority of the voting shares other than shares owned by any 10% shareholder, a
corporation can adopt an amendment to its articles of incorporation or bylaws
providing that the Affiliated Transactions provisions shall not apply to the
corporation. We have not "opted out" of the Affiliated Transactions provisions.
Control Share Acquisitions. Virginia law also provides that shares
acquired in a transaction that would cause the acquiring person's voting
strength to meet or exceed any of the three thresholds (20%, 33 1/3% or 50%)
have no voting rights for those shares exceeding that threshold, unless granted
by a majority vote of shares not owned by the acquiring person. This provision
empowers an acquiring person to require the Virginia corporation to hold a
special meeting of shareholders to consider the matter within 50 days of the
request.
Both of these statutes provide impediments to a hostile or unwelcome
takeover of Valley Financial. In doing so, they may discourage transactions
that some shareholders may feel are in their best interest.
VALLEY FINANCIAL'S SUBORDINATED DEBT
On June 30, 2000, Valley Financial issued subordinated debt in the
principal amount of $2.3 million to a commercial bank. Of the proceeds of the
note, $1.0 million was downstreamed to Valley 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 Valley Bank.
Under the Federal Reserve's risk-based capital guidelines, bank holding
companies like Valley Financial may include in Tier 2 capital long-term
subordinated debt that meet certain conditions. The $2.3 million subordinated
debt is intended to be treated as capital rather than debt of Valley Financial
for purposes of these capital adequacy guidelines.
The subordinated debt principal amount must be paid back on July 1, 2012,
although Valley Financial has the right to prepay the debt at any time except in
limited, specified circumstances where prepayment might adversely affect the
payment of senior debt. Valley Financial has no senior debt at this time, so
nothing prevents prepayment of this subordinated debt. Quarterly payments of
accrued interest are required. Interest accrues at a variable annual rate of
1.25% below the Wall Street Journal "prime rate."
This debt is subordinated to Valley Financial's general creditors, is
unsecured and does not contain provisions that permit the holder to require
payment of principal prior to maturity except in the event of Valley Financial's
bankruptcy or receivership.
In the event of the insolvency of Valley Financial, this subordinated debt
would be paid after general creditors but before any distribution to
shareholders. Consequently, the subordinated debt would reduce dollar for
dollar any insolvency or bankruptcy distribution that would otherwise be paid to
shareholders. In the event that we failed to pay the subordinated debt at
maturity, the holder could exercise its rights as a creditor to collect the
subordinated debt. Such an action could cause Valley Financial to go into
bankruptcy or other insolvency proceedings that would reduce or eliminate any
bankruptcy or insolvency distribution. We intend to prepay this subordinated
debt with a portion of the proceeds of this offering. Since this debt is
already included in our regulatory capital calculation, paying off this debt
with proceeds of this offering will mean that $2.3 million of the offering
proceeds will not increase our regulatory capital.
SUPERVISION AND REGULATION
We provide the following as a summary of statutes and regulations affecting
bank holding companies like Valley Financial and banks like Valley Bank.
Federal and state laws and regulations provide regulatory oversight for
virtually all aspects of operations. This summary is qualified in its entirety
by reference to these statutes and regulations.
Supervision and Regulation of Valley Financial
General Banking Regulation. Valley Financial is a bank holding company
within the meaning of the Federal Bank Holding Company Act of 1956 and the
Virginia Banking Act. As a bank holding company, Valley Financial is required
to file with the Federal Reserve periodic reports and information regarding its
business operations and those of Valley Bank. Valley Financial also must
provide the Virginia Bureau of Financial Institutions with information regarding
itself and Valley Bank. Valley Financial and Valley Bank also are examined by
the Federal Reserve and by the Virginia Bureau of Financial Institutions.
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<PAGE>
A bank holding company is required to obtain prior approval from the
Federal Reserve before acquiring control of substantially all the assets of any
non-affiliated bank or more than 5% of the voting shares of any bank it does not
already own, or before it merges or consolidates with another institution or
engages in any business other than banking or managing, controlling or
furnishing services to banks and other subsidiaries, and a limited list of
activities closely related to or incidental to banking. Similarly, approval of
the Virginia Bureau of Financial Institutions is required for certain
acquisitions of other banks and bank holding companies. The Federal Reserve
will approve the ownership by a bank holding company of shares in a company
engaged in activities determined by order or regulation to be so closely related
to banking or to managing or controlling banks as to be a proper incident
thereto. In other words, regulatory involvement, and frequently approval, is
required if we engage in non-banking activities.
Valley Financial would be compelled by the Federal Reserve to invest
additional capital in the event Valley Bank experiences either significant loan
losses or rapid growth of loans or deposits. The Federal Reserve requires a
bank holding company to act as a source of financial strength and to take
measures to preserve and protect its bank subsidiaries.
Holding Company Capital Guidelines. As a bank holding company, we operate
under the capital adequacy guidelines established by the Federal Reserve. Under
the Federal Reserve's current risk-based capital guidelines for bank holding
companies, the minimum required ratio for total capital to risk weighted assets
we are required to maintain is 8%, with at least 4% consisting of Tier 1
capital. Tier 1 capital consists of common and qualifying preferred stock,
certain other qualifying instruments, and minority interests in equity accounts
of consolidated subsidiaries, less goodwill and other intangible assets. These
risk-based capital guidelines establish minimum standards, and bank holding
companies generally are expected to operate well above the minimum standards.
We may raise this capital with certain types of debt, as we did with our
subordinated debt, and we may raise capital by selling company stock, as we are
doing with this offering.
Financial Modernization Legislation. A bank holding company generally is
restricted to activities related or incidental to banking. In the past, bank
holding companies were specifically prohibited from engaging in the issue,
flotation, underwriting, public sale, or distribution of third party securities.
Limits also were placed on underwriting and selling insurance. The activities
permissible to bank holding companies and their affiliates were substantially
expanded by the Gramm-Leach-Bliley Act, which became effective in March of this
year. This new Act repeals the banking/securities industry anti-affiliation
rules and permits the common ownership of commercial banks, investment banks,
and insurance companies. Under this new law, a bank holding company can elect
to be treated as a financial holding company, which may engage in any activity
that the Federal Reserve determines is financial in nature. A financial holding
company also may engage in any activity that is complementary to a financial
activity and does not pose a substantial risk to the safety and soundness of the
related depository institutions or the financial system generally.
In order for a bank holding company to qualify as a financial holding
company, all of its depository subsidiaries (i.e., banks and thrifts) must be
well capitalized and well managed, and must meet their Community Reinvestment
Act (CRA) obligations, as explained below. The bank holding company also must
declare its intention to become a financial holding company to the Federal
Reserve and certify that it meets the requirements. Banks and thrifts acquired
by a financial holding company within 12 months prior to the date on which the
election is filed may be excluded from this test if they have less than a
satisfactory CRA rating, but they must submit a plan to the applicable federal
banking agency describing how the CRA rating will be brought into conformance.
Financial holding company powers that are either specified in the statute
or have been determined by the Federal Reserve to be financial in nature include
the following:
. underwriting insurance or annuities;
. providing financial or investment advice;
. underwriting, dealing in, or making markets in securities;
. merchant banking, subject to limitations on size and capital
restrictions;
. insurance portfolio investing, subject to limitations; and
. any other activities previously found to be closely related to
banking by the Federal Reserve.
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The Act also establishes a system of functional regulation for financial
holding companies and banks providing regulation of securities by the Securities
and Exchange Commission and state securities regulators, regulation of futures
by the Commodity Futures Trading Commission, and regulation of insurance
activities by the state insurance regulators. Banks may sell title insurance
only when specifically permitted under the applicable state law.
This new law also imposes new customer privacy requirements on financial
institutions. Financial institutions generally are prohibited from disclosing
customer information to non-affiliated third parties, unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions must disclose their specific privacy policies to their
customers annually. Upon making such disclosure, there is no specific
restriction on financial institutions disclosing customer information to
affiliated parties. Financial institutions must comply with state law, however,
if it protects customer privacy more fully than federal law. Specific privacy
regulations are expected to be effective early in 2001.
The new law also revises the present Federal Home Loan Bank system,
imposing new capital requirements on Federal Home Loan Banks and authorizing
them to issue two classes of stock with differing dividend rates and redemption
requirements. Permissible uses of Federal Home Loan Bank advances by community
financial institutions (under $500 million in assets) have been expanded to
include funding loans to small businesses, and small farms and agribusiness.
Valley Bank uses Federal Home Loan Bank loans extensively to fund our lending
opportunities.
The new law contains a variety of other provisions. Automated teller
machine surcharges are prohibited unless the customer first has been provided
notice of the imposition and amount of the fee. Community Reinvestment Act
examinations for smaller institutions (including Valley Bank) will be less
frequent. Certain reporting requirements are now imposed on depository
institutions that make payments to non-governmental entities in connection with
the Community Reinvestment Act.
Valley Financial does not currently intend to become a "financial holding
company" under the terms of this new law. We are unable to predict the impact
of this new law on our competition or our operations at this time.
Securities. Valley Financial also must comply with the requirements of the
Securities Exchange Act of 1934, which include the filing of annual, quarterly
and other reports with the Securities and Exchange Commission.
Supervision and Regulation of Valley Bank
General. Valley Bank is a state bank and member of the Federal Reserve
System. Valley Bank will be examined and regulated by the Federal Reserve and
the Virginia Bureau of Financial Institutions. The Federal Reserve and the
Virginia Bureau regulate and monitor all significant aspects of Valley Bank's
operations. The Federal Reserve requires quarterly reports on Valley Bank's
financial condition, and both federal and state regulators conduct periodic
examinations of the bank. The cost of complying with these regulations and
reporting requirements can be significant. In addition, some of these
regulations impact investors directly. For example, Valley Bank may pay
dividends only out of its net undivided profits after deducting expenses, bad
debts, losses, interest and taxes accrued, and contribution to capital necessary
for the bank's original capital to be restored. The Federal Reserve recommends
that banks pay dividends only if the net income available to shareholders in the
past year fully funds those dividends, and the expected rate of earnings
retention is consistent with capital needs, asset quality, and overall financial
condition. Regulatory restrictions on Valley Bank's ability to pay dividends may
adversely impact Valley Financial's ability to pay dividends to its
shareholders.
As a member of the Federal Reserve, Valley Bank also will have to comply
with rules that restrict preferential loans by the bank to "insiders," require
Valley Bank to keep information on loans to principal shareholders and executive
officers, and prohibit certain director and officer interlocks between financial
institutions. Valley Bank's loan operations, particularly for consumer and
residential real estate loans, are also subject to numerous legal requirements
as are its deposit activities. In addition to regulatory compliance costs,
these laws may create the risk of liability to Valley Bank for noncompliance.
FDIC Insurance. Valley Bank's deposits will be insured by the FDIC for a
maximum of $100,000 per depositor. For this protection, Valley Bank pays a
semi-annual statutory assessment and must comply with the rules and regulations
of the FDIC. Valley Bank's recent annual FDIC deposit insurance premium
assessments were zero, reflecting the industry's improved health. However,
these assessments can change, affecting Valley Bank's costs, depending on the
solvency of the banking industry as a whole. In addition, the cost of complying
with FDIC rules and regulations may negatively impact Valley Bank's
profitability. For member banks like Valley Bank, the Federal Reserve has the
authority to prevent the continuance or development of unsound and unsafe
banking practices and to approve conversions, mergers
46
<PAGE>
and consolidations. Obtaining regulatory approval of these transactions can be
expensive, time-consuming, and ultimately may not be successful.
Bank Capital Guidelines. Federal bank regulatory authorities have adopted
risk-based capital adequacy guidelines that redefine traditional capital ratios
to take into account assessments of risks related to each balance sheet
category, as well as off-balance sheet financing activities. This represents an
effort to measure capital adequacy in a way that is more sensitive to the
individual risk profiles of specific financial institutions. The risk-weighted
asset base is equal to the sum of the aggregate dollar value of assets and
certain off-balance sheet items (such as currency or interest rate swaps) in
each of the four separate risk categories, multiplied by the risk weight
assigned to each specific asset category. After the items in each category have
been totaled and multiplied by the category's risk factor, category totals are
aggregated to derive the total risk-weighted assets, and the total adjusted
capital base is divided by the total risk-weighted assets to derive a ratio.
Under the Federal Reserve's current risk-based capital guidelines for
member banks, Valley Bank will be required to maintain a minimum ratio of total
capital to risk weighted assets of 8%, with at least 4% consisting of Tier 1
capital. Tier 1 capital consists of common and qualifying preferred stock,
certain other qualifying instruments, and minority interests in equity accounts
of consolidated subsidiaries, less goodwill and other intangible assets. In
addition, the Federal Reserve requires its member banks to maintain a minimum
ratio of Tier 1 capital to average total assets. This capital measure generally
is referred to as the leverage capital ratio. The minimum required leverage
capital ratio is 4% if the Federal Reserve determines that the institution is
not anticipating or experiencing significant growth and has well-diversified
risks -- including no undue interest rate exposure, excellent asset quality,
high liquidity and good earnings -- and, in general, is considered a strong
banking organization and rated Composite 1 under the Uniform Financial
Institutions Rating Systems. If Valley Bank does not satisfy any of these
criteria it may be required to maintain a ratio of total capital to risk-based
assets of 10% and a ratio of Tier 1 capital to risk-based assets of at least 6%.
Valley Bank would then be required to maintain a 5% leverage capital ratio.
These regulations can impact Valley Bank by requiring it to hold more capital
and thereby inhibit its ability to grow. At June 30, 2000 Valley Financial and
Valley Bank had the following risk-based capital and leverage ratios relative to
regulatory minimums:
Ratio Valley Financial Valley Bank Minimum
----- ---------------- ----------- -------
Tier 1 9.2% 9.9% 4.0%
Total 12.1 10.8 8.0
Leverage 7.3 7.9 4.0
Affiliate Transactions and Branching. The Federal Reserve Act restricts
loans, investments, asset purchases and other transactions between banks and
their affiliates, including placing collateral requirements and requiring that
those transactions are on terms and under conditions substantially the same as
those prevailing at the time for comparable transactions with non-affiliates.
Valley Bank may branch without geographic restriction in Virginia, and it may
acquire branches or banks or merge across state lines in most cases. Valley
Bank does not currently intend to expand outside of Virginia.
Community Reinvestment Act. The federal Community Reinvestment Act (CRA)
requires that the federal banking regulators evaluate the record of the
financial institutions in meeting the credit needs of their local communities,
including low and moderate income neighborhoods, consistent with the safe and
sound operation of those institutions. These factors are also considered in
evaluating mergers, acquisitions, and applications to open a branch or facility.
Recent legislative and regulatory changes have reduced the paperwork and
regulatory burden of CRA on smaller institutions such as Valley Bank. Valley
Bank received a "Satisfactory" CRA rating in its latest CRA examination.
Other Regulation. Valley Bank is subject to a variety of other
regulations. State and federal laws restrict interest rates on loans,
potentially affecting our income. The Truth in Lending Act and the Home
Mortgage Disclosure Act impose information requirements on Valley Bank in making
loans. The Equal Credit Opportunity Act prohibits discrimination in lending on
the basis of race, creed, or other prohibited factors. The Fair Credit
Reporting Act governs the use and release of information to credit reporting
agencies. The Truth in Savings Act requires disclosure of yields and costs of
deposits and deposit accounts. Other acts govern confidentiality of consumer
financial records, automatic deposits and withdrawals, check settlement,
endorsement and presentment, and disclosure of cash transactions exceeding
$10,000 to the Internal Revenue Service.
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<PAGE>
Monetary Policy
Banking is a business that depends on interest rate differentials. The
difference between the interest rates paid by Valley Bank on its deposits and
other borrowings and the interest rates received on loans extended to its
customers and on securities held in its portfolio comprises the major portion of
Valley Bank's earnings.
The earnings and growth of Valley Bank will be affected not only by general
economic conditions, both domestic and foreign, but also by the monetary and
fiscal policies of the United States and its agencies, particularly the Federal
Reserve. The Federal Reserve implements national monetary policy by its open
market operations in United States government securities, adjustments in the
amount of industry reserves that banks and other financial institutions are
required to maintain and adjustments to the discount rates applicable to
borrowings by banks from the Federal Reserve. The actions of the Federal
Reserve in these areas influence the growth of bank loans, investments, and
deposits and also affect interest rates charged and paid on deposits. We cannot
predict the nature and impact of any future changes in monetary policies.
Recent Legislative Developments
The United States Congress periodically adopts legislation that impacts
both banks and other financial institutions. Legislation of this type could
further deregulate the financial services industry and lift remaining geographic
restrictions on banks and bank holding companies and current prohibitions
against banks engaging in certain non-banking activities and nonbanks engaging
in banking activities. These legislative changes could place us in more direct
competition with other financial institutions, including mutual funds,
securities brokerage firms, insurance companies, and investment banking firms.
On the other hand, legislation could impose further restrictions on banks which
might limit the services or products banks offer, the manner in which they may
be offered, or the cost of offering them. Because of these uncertainties, we
cannot predict what legislation might be enacted, and, if enacted, the effect
thereof.
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UNDERWRITING
Valley Financial has entered into an underwriting agreement with Davenport
& Company LLC with respect to the shares being offered. This is a firm
commitment underwriting. This means that the underwriter has agreed to purchase
all of the shares offered by this prospectus (other than those offered by the
over-allotment option described below) if any are purchased.
If the underwriter sells more than the 175,000 shares, the underwriter has
an over-allotment option to buy up to an additional 26,250 shares of common
stock from us to cover such sales. The underwriter may exercise this option for
30 days from the date of this prospectus at the public offering price set forth
on the cover page of this prospectus less the underwriting discount.
At our request the underwriter has reserved approximately 60,000 shares of
common stock for sale to our current directors at the public offering price on
the cover of this prospectus. The number of shares available for sale to the
general public in the offering will be reduced to the extent these persons
purchase these reserved shares. Any reserved shares not purchased will be
offered to the general public on the same basis as the other shares offered by
this prospectus.
The following table shows the per share and total underwriting discount to
be paid to the underwriter by us. The underwriter will receive an underwriting
discount of 1% of the public offering price on approximately 60,000 shares sold
to our current directors and 7% of the public offering price for all other
shares sold. Such amounts are shown assuming both no exercise and full exercise
of the underwriter's option to purchase 26,250 additional shares.
No Exercise Full Exercise
----------- -------------
Per share to public......... $ 1.23 $ 1.23
Per share to directors...... .18 .18
Weighted average per share.. .87 .91
Total....................... $151,375.00 $183,531.25
We estimate that the total expenses of this offering payable by us will be
approximately $125,000, excluding the underwriting discount.
The underwriter has advised us that it proposes to offer the shares
directly to the public at the public offering price set forth on the cover page
of this prospectus. The underwriter may offer some of the shares directly to
certain securities dealers at such price less a concession of $.75 per share.
The underwriter may also allow, and such dealers may reallow, a concession not
in excess of $.10 per share to certain other dealers. If all the shares are not
sold at the initial public offering price, the underwriter may change the
offering price and the other selling terms.
Valley Financial, its directors and senior officers have agreed with the
underwriter not to dispose of or hedge any of their common stock and securities
that are exchangeable or exercisable for shares of common stock for a period of
180 days after the date of this prospectus, without the prior written consent of
the underwriter.
There is a limited public market for our common stock, with an approximate
average trading volume of only 3,000 shares per week since January 1, 2000. See
"Market for Common Stock" on page 7. The public offering price for the shares
will be determined by negotiations between the underwriter and us. We and the
underwriter expect to consider a number of factors including prevailing market
conditions, the current market for our stock, market prices and demand for
common stock of other similar publicly-traded companies, the history of and
prospects for our industry and for financial institutions generally, an
assessment of our management, our present operations, our historical results of
operations, the trend of our revenues and earnings and our earnings prospects.
Neither we nor the underwriter can assure investors that an active trading
market will develop for the common stock, or that the common stock will trade in
the public market at or above the public offering price.
In connection with this offering, the underwriter may purchase and sell
shares of our common stock in the open market. These transactions may include
short sales, stabilizing transactions and purchases to cover positions created
by short sales. Short sales involve the sale by the underwriter of a greater
number of shares than they are required to purchase in this offering.
Stabilizing transactions consist of certain bids or purchases made for the
purpose of preventing or retarding a decline in the market price of the common
stock while this offering is in process.
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<PAGE>
The underwriter may also impose a penalty bid. This occurs when a
particular selected dealer repays to the underwriter a portion of the
underwriting discount received by it because the underwriter has repurchased
shares sold by or for the account of such selected dealer in stabilizing or
short covering transactions.
These activities by the underwriter may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriter at any time. These transactions may be effected on the OTC Bulletin
Board or otherwise.
The underwriter and other dealers may engage in passive market-making
transactions in our stock in accordance with Rule 103 of Regulation M,
promulgated by the SEC. In general, a passive market maker may not purchase or
bid for common stock at a price that exceeds the highest independent bid. The
net daily purchases made by any passive market maker generally may not exceed
30% of its average daily trading volume in the stock during a specified two-
month period, or 200 shares, whichever is greater. A passive market maker must
identify passive market-making bids as such on the Nasdaq reporting system.
Passive market making may stabilize or maintain the market price of our common
stock above independent levels. The underwriter and dealers are not required to
engage in these activities and may cease doing so at any time.
The underwriter presently makes a market in our common stock and intends to
continue doing so after completing this offering.
Valley Financial has also agreed to reimburse the underwriter for up to
$25,000 of its out-of-pocket costs and expenses and to indemnify the underwriter
against certain liabilities, including liabilities under the Securities Act of
1933.
LEGAL MATTERS
Certain matters in this offering, including the legality of the common
stock offered in this prospectus, will be passed upon for Valley Financial by
Flippin, Densmore, Morse and Jessee, a Professional Corporation. Certain
matters in this offering will be passed upon for Davenport & Company LLC by
Williams, Mullen, Clark & Dobbins, P.C.
EXPERTS
Larrowe & Company, P.L.C., independent auditors, audited the consolidated
financial statements of Valley Financial as of December 31, 1999 and for the
year then ended included in this prospectus. Their report on the financial
statements referred to in the preceding sentence included in this prospectus is
included in reliance on the report of Larrowe & Company, P.L.C., given on their
authority as experts in accounting and auditing.
The consolidated financial statements of Valley Financial Corporation and
subsidiary as of December 31, 1998, and for the year then ended, have been
included herein and in the registration statement in reliance upon the report of
KPMG LLP, independent certified public accountants, appearing elsewhere herein,
and upon the authority of said firm as experts in accounting and auditing.
ADDITIONAL INFORMATION
Valley Financial is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended, and, in accordance with that act
files reports, proxy statements, information statements, and other information
with the Securities and Exchange Commission. All of those reports, proxy
statements, information statements, and other information, when filed, can be
inspected and copied at the public reference facilities maintained by the SEC at
Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and the SEC's regional
offices in New York (7 World Trade Center, Suite 1300, New York, New York 10048)
and Chicago (Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661). The SEC also maintains a Web site that contains reports, proxy
and information statements, and other information regarding registrants that
file electronically with the SEC, including Valley Financial, and the address of
that site is http://www.sec.gov. In addition, the common stock of Valley
Financial is listed on the OTC Bulletin Board, and reports, proxy statements,
and other information concerning Valley Financial can be inspected at the
offices of the National Association of Securities Dealers, Inc., 1735 K Street,
N.W., Washington, D.C. 20006.
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Valley Financial has filed a Registration Statement on Form SB-2 under the
Securities Act of 1933 to register this common stock with the SEC. This
prospectus is a part of that Registration Statement. As allowed by SEC rules,
this prospectus does not contain all the information that interested persons can
find in the Registration Statement or the exhibits and schedules to the
Registration Statement. For further information about Valley Financial or the
common stock offered in this prospectus, you should read the Registration
Statement, including its exhibits, financial statements, and schedules.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this prospectus that are subject to
risks and uncertainties. These forward-looking statements include statements
regarding profitability, liquidity, allowance for loan losses, interest rate
sensitivity, market risk, and financial and other goals. The words "believes",
"expects", "may", "will", "should", "projects", "contemplates", "anticipates",
"forecasts", "intends", or other similar words or terms, are intended to
identify forward looking statements.
These forward-looking statements are subject to significant uncertainties
because they are based upon or are affected by factors including:
. Continued levels of loan quality and origination volume;
. Interest rate fluctuations and other economic conditions;
. Competition in product offerings and product pricing;
. Continued relationships with major customers;
. Future laws and regulations; and
. Other factors, including those matters discussed in the "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" sections of this prospectus.
Because of these uncertainties, our actual future results may be materially
different from the results indicated by these forward-looking statements. In
addition, our past results of operations do not necessarily indicate our future
results.
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VALLEY FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INTERIM PERIODS (UNAUDITED)
---------------------------
Consolidated Balance Sheets as of June 30, 2000...................... F-2
Consolidated Statements of Income for the six months
ended June 30, 2000 and 1999.................................... F-3
Consolidated Statements of Cash Flows for the six
months ended June 30, 2000 and 1999............................. F-4
Condensed Notes to Consolidated Financial Statements................. F-5
FULL FISCAL YEARS (AUDITED)
---------------------------
Independent Auditors' Report - Larrowe & Company, P.L.C.............. F-10
Independent Auditors' Report - KPMG LLP.............................. F-11
Consolidated Balance Sheets as of December 31, 1999
and 1998........................................................ F-12
Consolidated Statements of Income and Comprehensive
Income (Loss) for the years ended December 31,
1999 and 1998................................................... F-13
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31, 1999
and 1998........................................................ F-14
Consolidated Statements of Cash Flows for the years
Ended December 31, 1999 and 1998................................ F-15
Notes to Consolidated Financial Statements........................... F-16
F-1
<PAGE>
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>
______
* greater than sign
See accompanying notes to consolidated financial statements.
F-2
<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>
_______
* greater than sign
See accompanying notes to consolidated financial statements.
F-3
<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
F-4
<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.
F-5
<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
F-6
<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.
F-7
<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>
F-8
<PAGE>
Independent Auditors' Report
The Board of Directors
Valley Financial Corporation:
We have audited the accompanying consolidated balance sheet of Valley Financial
Corporation and subsidiary as of December 31, 1999 and the related consolidated
statements of income and comprehensive loss, changes in shareholders' equity and
cash flows for the year then ended. These consolidated financial statements are
the responsibility of the Corporation's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit. The consolidated financial statements of Valley Financial Corporation and
subsidiary for the year ended December 31, 1998 were audited by other auditors
whose report dated January 22, 1999 expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1999 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Valley
Financial Corporation and subsidiary as of December 31, 1999 and the results of
its operations and cash flows for the year then ended in conformity with
generally accepted accounting principles.
Larrowe & Company, PLC
Galax, Virginia
January 14, 2000, except for Note 15, as to which the date is February 2, 2000
and Note 18, as to which the date is January 20,2000.
F-9
<PAGE>
Independent Auditors' Report
The Board of Directors
Valley Financial Corporation:
We have audited the accompanying consolidated balance sheet of Valley Financial
Corporation and subsidiary as of December 31, 1998, and the related consolidated
statements of income and comprehensive income, changes in shareholders' equity,
and cash flows for the year then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Valley Financial
Corporation and subsidiary as of December 31, 1998, and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
KPMG LLP
Roanoke, Virginia
January 22, 1999
F-10
<PAGE>
VALLEY FINANCIAL CORPORATION
Consolidated Balance Sheets
December 31, 1999 and 1998
(In thousands, except share data)
<TABLE>
1999 1998
------------- --------------
<S> <C> <C>
Assets
Cash and due from banks $ 4,027 $ 3,462
Money market investments Federal funds sold 6,034 1,699
Interest-bearing deposits in other banks 71 44
Securities available-for-sale Loans 31,964 26,118
Commercial loans 24,651 17,794
Commercial real estate loans 33,485 22,040
Residential real estate loans 19,773 19,140
Loans to individuals 13,481 12,648
------------- --------------
Total loans 91,390 71,622
Less unearned fees (32) (39)
Less allowance for loan losses (910) (708)
------------- --------------
Loans, net 90,448 70,875
Premises and equipment, net 2,629 1,830
Accrued interest receivable 989 804
Other assets 994 277
Organizational expenses, net - 77
------------- --------------
Total assets $ 137,156 $ 105,186
============= ==============
Liabilities and Shareholders' Equity
Noninterest-bearing deposits $ 14,328 $ 10,437
Interest-bearing demand deposits 9,423 7,687
Savings deposits 1,357 1,106
Money market deposits 22,178 24,826
Time deposits greater than $100,000 12,974 8,048
Other time deposits 55,217 37,922
------------- --------------
Total deposits 115,477 90,026
Securities sold under agreements to repurchase 992 -
Accrued interest payable 1,034 679
Other liabilities 598 324
Federal Home Loan Bank advances 10,000 5,000
------------- --------------
Total liabilities 128,101 96,029
------------- --------------
Commitments and other matters
Shareholders' equity:
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 shares and 964,590 shares in 1999 and
1998, respectively 9,099 9,095
Retained earnings (deficit) 934 (108)
Accumulated other comprehensive income (loss) (978) 170
------------- --------------
Total shareholders' equity 9,055 9,157
------------- --------------
Total liabilities and shareholders' equity $ 137,156 $ 105,186
============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-11
<PAGE>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Income and Comprehensive Income (Loss)
Years Ended December 31, 1999 and 1998
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 6,823 $ 5,059
Interest on securities - taxable 1,476 1,365
Interest on securities - nontaxable 325 195
Interest on money market investments 135 151
------------- --------------
Total interest income 8,759 6,770
------------- --------------
Interest expense:
Interest on certificates of deposit of
$100,000 or more 549 397
Interest on other deposits 3,445 2,860
Interest on Federal Home Loan Bank advances 415 208
Interest on other borrowed funds 23 47
------------- --------------
Total interest expense 4,432 3,512
------------- --------------
Net interest income 4,327 3,258
Provision for loan losses 216 249
------------- --------------
Net interest income after provision
for loan losses 4,111 3,009
------------- --------------
Noninterest income:
Service charges on deposit accounts 220 165
Gain on sale of securities - 10
Other income 134 89
------------- --------------
Total noninterest income 354 264
------------- --------------
Noninterest expense:
Personnel 1,649 1,177
Occupancy 213 168
Data processing and equipment 348 260
Advertising and promotion 115 90
Supplies 82 57
Amortization of organizational expenses 77 57
Other expense 545 443
------------- --------------
Total noninterest expense 3,029 2,252
------------- --------------
Income before income taxes 1,436 1,021
Income tax expense 394 263
------------- --------------
Net income 1,042 758
Other comprehensive income (loss), net of deferred tax (expense) benefit:
Net unrealized gains (losses) on securities
available-for-sale (1,148) 114
------------- --------------
Comprehensive income (loss) $ (106) $ 872
============= ==============
Net income per share:
Basic net income per share $ 1.03 $ .75
============= ==============
Diluted net income per share $ .99 $ .73
============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-12
<PAGE>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 1999 and 1998
(In thousands, except share data)
<TABLE>
<CAPTION>
Accum-
ulated
Other Total
Compre- Share-
Common Common Retained hensive holders'
Shares Stock Earnings Income Equity
(Deficit) (Loss)
------------- -------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1997 964,040 $ 9,089 $ (866) $ 56 $ 8,279
Net income - - 758 - 758
Stock options exercised 550 6 - - 6
Unrealized gains on
securities available-
for-sale, net of
deferred tax expense
of $59 - - - 114 114
------------- -------------- ------------- ------------- --------------
Balances at December 31, 1998 964,590 9,095 (108) 170 9,157
Net income - - 1,042 - 1,042
Stock options exercised 400 4 - - 4
Stock split 48,217 - - - -
Unrealized losses on
securities available-
for-sale, net of
deferred tax benefit
of $591 - - - (1,148) (1,148)
------------- -------------- ------------- ------------- --------------
Balances at December 31, 1999 1,013,207 $ 9,099 $ 934 $ (978) $ 9,055
============= ============== ============= ============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-13
<PAGE>
VALLEY FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
Years Ended December 31, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,042 $ 758
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 216 249
Depreciation and amortization of
premises and equipment 206 153
Deferred income tax (61) 189
Amortization of organizational expenses 77 57
Gain on sale of securities - (10)
Amortization (accretion) of premiums/discounts, net 29 1
Increase (decrease) in unearned fees (7) 1
Increase in accrued interest receivable (185) (168)
Increase in other assets (83) (24)
Increase in accrued interest payable 355 169
Increase in other liabilities 274 24
------------- --------------
Net cash provided by operating activities 1,863 1,399
------------- --------------
Cash flows from investing activities:
Net increase in money market investments (4,362) (270)
Purchases of premises and equipment (1,005) (668)
Purchases of securities available-for-sale (15,608) (34,587)
Proceeds from sales, calls and maturities of
securities available-for-sale 7,994 29,795
Increase in loans, net (19,764) (24,975)
------------- --------------
Net cash used in investing activities (32,745) (30,705)
------------- --------------
Cash flows from financing activities:
Increase in time deposits greater than $100,000 4,926 1,567
Increase in other time deposits 17,295 5,819
Net increase in other deposits 3,230 17,052
Federal Home Loan Bank advances 5,000 5,000
Increase in securities sold under
agreements to repurchase 992 -
Proceeds from exercise of stock options 4 6
------------- --------------
Net cash provided by financing activities 31,447 29,444
------------- --------------
Net increase in cash and due from banks 565 138
Cash and due from banks at beginning of year 3,462 3,324
------------- --------------
Cash and due from banks at end of year $ 4,027 $ 3,462
============= ==============
Supplemental disclosure of cash flows information:
Cash paid during the year for interest $ 4,077 $ 3,343
============= ==============
Cash paid during the year for income taxes $ 243 $ 2
============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE>
VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
December 31, 1999 and 1998
(In thousands except share and per share data)
(1) Summary of Significant Accounting Policies
(a) General
The accounting and reporting policies of Valley Financial
Corporation ("the Company") and Valley Bank ("the Bank") conform
to generally accepted accounting principles and to general
banking industry practices. The Bank provides traditional
commercial banking services concentrated primarily in the Roanoke
Valley. The Bank does not currently offer trust services;
however, the Bank does refer customers to a provider of trust
services in exchange for a fee.
The following is a summary of the more significant accounting
policies:
(b) Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiary, the Bank, collectively
referred to hereinafter as the Corporation. All significant
inter-company balances and transactions have been eliminated.
(c) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash and due from banks.
(d) Securities
Investments are classified in three categories and accounted for
as follows: (1) debt securities that the Corporation has the
positive intent and ability to hold to maturity are classified as
securities held-to-maturity" and reported at amortized cost; (2)
debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified
as "trading securities" and reported at fair value, with
unrealized gains and losses included in net income; and (3) debt
and equity securities not classified as either held-to-maturity
securities or trading securities are classified as "securities
available-for-sale" and reported at fair value, with unrealized
gains and losses excluded from net income and reported in a
separate component of shareholders' equity.
The Corporation does not currently maintain a trading securities
portfolio and there were no securities classified as held-to-
maturity at December 31, 1999 or 1998. Gains or losses on
disposition, if any, are based on the net proceeds and adjusted
carrying values of the securities called or sold, using the
specific identification method. A decline in value of any
available-for-sale or held-to-maturity security below cost deemed
other than temporary is charged directly to net income, resulting
in the establishment of a new cost basis for the security.
(e) Required Investments
F-15
<PAGE>
As members of the Federal Reserve and the Federal Home Loan Bank
(FHLB) of Atlanta, the Bank is required to maintain certain
minimum investments in the common stock of those entities.
Required levels of investment are based upon the Bank's capital
and a percentage of qualifying assets. In addition, the Bank is
eligible to borrow from the FHLB with borrowings collateralized
by qualifying assets, primarily residential mortgage loans, and
the Bank's capital stock investment in the FHLB (see notes 3 and
4). At December 31, 1999, the Bank's available borrowing limit
was approximately $15,000. The Bank had $10,000 in borrowings
outstanding at December 31, 1999. Advances of $5,000 were
outstanding at December 31, 1998.
The borrowing consists of two $5,000 advances. One advance is due
in 2004 and bears interest at a fixed rate of 4.92 percent. The
other advance is due 2009 and bears interest at a fixed rate of
5.46 percent. After the first year, both advances are convertible
to variable rate at the prevailing three month LIBOR, at the
option of the FHLB.
(f) Loans, Allowance for Loan Losses, Loan Fees and Costs
Loans are stated at the amount of unpaid principal, reduced by
unearned fees on loans, and an allowance for loan losses. Income
is recognized over the terms of the loans using methods which
approximate the level yield method. The allowance for loan losses
is a valuation allowance consisting of the cumulative effect of
the provision for loan losses, plus any amounts recovered on
loans previously charged off, minus loans charged off. The
provision for loan losses charged to operating expenses is the
amount necessary in management's judgment to maintain the
allowance for loan losses at a level it believes sufficient to
cover losses in the collection of its loans. Management
determines the adequacy of the allowance based upon reviews of
individual credits, recent loss experience, delinquencies,
current economic conditions, the risk characteristics of the
various categories of loans and other pertinent factors. Loans
are charged against the allowance for loan losses when management
believes the collectibility of the principal is unlikely. While
management uses available information to recognize losses on
loans, future additions to the allowance for loan losses may be
necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for
loan losses. Such agencies may require the Bank to recognize
additions to the allowance for loan losses based on their
judgments about information available to them at the time of
their examinations.
Interest related to nonaccrual loans is recognized on the cash
basis. Loans are generally placed in nonaccrual status when the
collection of principal and interest is 90 days or more past due,
unless the obligation is both well-secured and in the process of
collection.
Impaired loans are presented in the financial statements at the
present value of the expected future cash flows or at the fair
value of the loan's collateral. Homogeneous loans such as real
estate mortgage loans, individual consumer loans, home equity
loans and bankcard loans are evaluated collectively for
impairment. Management, considering current information and
events regarding the borrowers ability to repay their
obligations, considers a loan to be impaired when it is probable
that the Bank will be unable to collect all amounts due according
to the contractual terms of the loan agreement.
F-16
<PAGE>
Impairment losses are included in the allowance for loan losses
through a charge to the provision for loan losses. Cash receipts
on impaired loans receivable are applied first to reduce interest
on such loans to the extent of interest contractually due and any
remaining amounts are applied to principal.
Loan origination and commitment fees and certain direct loan
origination costs charged by the Bank are deferred and the net
amount amortized as an adjustment of the related loan's yield
over the contractual life of the related loan or, in the case of
demand loans, over the estimated life. Net fees related to
letters of credit are recognized over the commitment period.
(g) Premises and Equipment
Premises and equipment are stated at cost, net of accumulated
depreciation and amortization. Depreciation on buildings,
equipment, furniture and fixtures, and amortization of leasehold
improvements is computed by straight-line over the shorter of the
estimated useful lives of the assets or the related lease term.
Estimated useful lives for assets include land improvements and
leasehold improvements, 3 to 15 years, buildings, 30 years, and
furniture, fixtures and equipment, 3 to 10 years. The cost of
assets retired and sold and the related accumulated depreciation
and amortization are eliminated from the accounts and the
resulting gains or losses are included in determining net income.
Expenditures for maintenance and repairs are charged to expense
as incurred, and improvements are capitalized.
(h) Organizational Costs
Organizational costs incurred during the development stage of the
Corporation have been capitalized and are being amortized using
the straight-line method over five years.
(i) Income Taxes
Income taxes are accounted for under the asset and liability
method, whereby deferred tax assets and liabilities are
recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases
and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in net income in the period that includes
the enactment date.
(j) Stock Options
The Corporation accounts for its stock option plan in accordance
with the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, which permits entities to recognize as expense over
the vesting period the fair value of all stock-based awards on
the date of grant. Alternatively, SFAS No. 123 also allows
entities to continue to apply the provisions of APB Opinion 25,
which requires compensation expense to be recorded on the date of
grant only if the current market price of the underlying stock
exceeds the exercise price, and provide pro forma net
F-17
<PAGE>
income and pro forma earnings per share disclosures for employee
stock option grants made in 1995 and future years as if the fair-
value-based method defined in SFAS No. 123 had been applied. The
Corporation has elected to continue to apply the provisions of
APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123.
(k) Net Income Per Share
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, Earnings per
Share. Statement 128 establishes new standards for computing and
presenting earnings per share (EPS) and applies to entities with
publicly held common stock or potential common stock. It replaces
the presentation of primary EPS with a presentation of basic EPS.
It also requires dual presentation of basic and diluted EPS on
the face of the income statement for all entities with complex
capital structures and requires a reconciliation of the numerator
and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number
of common shares outstanding for the period. Diluted EPS reflects
the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. The following is a
reconciliation of the numerators and denominators of the basic
and diluted EPS computations for the periods indicated:
<TABLE>
<CAPTION>
Per
Net Share
Income Shares Amount
============== ============= ==============
<S> <C> <C> <C>
Year Ended December 31, 1999
Basic net income per share $ 1,042 1,013,176 $ 1.03
==============
Effect of dilutive stock options - 37,094
-------------- -------------
Diluted net income per share $ 1,042 1,050,270 $ .99
============== ============= ==============
Year Ended December 31, 1998
Basic net income per share $ 758 1,012,323 $ .75
==============
Effect of dilutive stock options - 20,837
-------------- -------------
Diluted net income per share $ 758 1,033,160 $ .73
============== ============= ==============
</TABLE>
(l) Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into
off-balance-sheet financial instruments consisting of commitments
to extend credit and standby letters of credit. Such financial
instruments are recorded in the financial statements when they
become payable.
(m) Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities
The Corporation adopted the provisions of Statement No. 125,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, on January 1, 1997. This
Statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments
of liabilities based on consistent application of a financial-
components approach that
F-18
<PAGE>
focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. This Statement
provides consistent standards for distinguishing transfers of
financial assets that are sales from transfers that are secured
borrowings. This Statement also provides implementation guidance
for assessing isolation of transferred assets and for accounting
for transfers of partial interests, servicing of financial
assets, securitizations, transfers of sales-type and direct
financing lease receivables, securities lending transactions,
repurchase agreements including "dollar rolls," "wash sales,"
loan syndications and participations, risk participations in
banker's acceptances, factoring arrangements, transfers of
receivables with recourse, and extinguishments of liabilities.
Statement No. 127, Deferral of the Effective Date of Certain
Provisions of Statement 125, issued in December 1996, deferred
until January 1, 1998 the effective date (a) of paragraph 15 of
Statement 125 and (b) for repurchase agreement, dollar-roll,
securities lending, and similar transactions, of paragraphs 9 -12
and 237(b) of Statement 125. Statement 125 was required to be
adopted on a prospective basis and its adoption did not have a
material impact on the Corporation's financial position, results
of operations or liquidity.
(n) Comprehensive Income
On January 1, 1998, the Corporation 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 Corporation 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 and present the accumulated balance of other
comprehensive income (loss) 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.
In accordance with the provisions of the Statement, the
Corporation has included Consolidated Statements of Income and
Comprehensive Income (Loss) in the accompanying consolidated
financial statements. Comprehensive income (loss) consists of net
income and net unrealized gains and losses on securities
available for sale. Also, accumulated other comprehensive income
(loss) is included as a separate disclosure within the
Consolidated Statements of Changes in Shareholders' Equity in the
accompanying consolidated financial statements. The adoption of
Statement 130 did not have any effect on the Corporation's
consolidated financial position, results of operation or
liquidity.
(o) Use of Estimates
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities as of the dates of the
consolidated balance
F-19
<PAGE>
sheets and the reported amounts of revenues and expenses for the
years presented. Actual results could differ significantly from
those estimates.
A material estimate that is particularly susceptible to
significant change in the near term relates to the determination
of the allowance for loan losses. In connection with the
determination of the allowance for loan losses, management
obtains independent appraisals for significant properties.
Management believes the allowance for loan losses is adequate.
While management uses available information to recognize losses
on loans, future additions to the allowance for loan losses may
be necessary based on changes in economic conditions. In
addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Bank's
allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance for loan losses based on
their judgments about information available to them at the time
of their examinations.
(p) Reclassifications
Certain reclassifications have been made to prior years'
consolidated financial statements to place them on a basis
comparable with the 1999 consolidated financial statements.
(q) Recent Accounting Developments
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 establishes 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 June 15, 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.
(2) Restrictions on Cash
To comply with Federal Reserve regulations, the Bank will be required
to maintain certain average reserve balances. There were no daily
reserve requirements for the weeks including December 31, 1999 and 1998
as the Bank had not met minimum average deposit levels under the
current provisions of the regulations.
F-20
<PAGE>
(3) Securities
The amortized costs, gross unrealized gains and losses, and proximate
fair values of securities available-for-sale as of December 31, 1999
and 1998 were as follows:
1999
========================================
Gross Gross Approx-
Amort- Unreal- Unreal- imate
ized ized ized Fair
Costs Gains Losses Values
======= ========== ======= =======
U.S. Treasury $ 200 $ -- $ 2 $ 198
U.S. Government agencies and
corporations 22,182 -- 1,003 21,179
Mortgage-backed securities 2,675 2 35 2,642
States and political subdivisions 7,292 -- 418 6,874
Corporate obligations 99 -- -- 99
Federal Home Loan Bank stock 500 -- -- 500
Other equity securities 497 -- 25 472
======= ========== ======= =======
Total securities $33,445 $ 2 $ 1,483 $31,964
======= ========== ======= =======
F-21
<PAGE>
1998
=========================================
Gross Gross Approx-
Amort- Unreal- Unreal- imate
ized ized ized Fair
Costs Gains Losses Values
------- ------- ----------- -------
U.S. Treasury $ 199 $ 3 $ -- $ 202
U.S. Government agencies and
corporations 14,680 47 2 14,725
Mortgage-backed securities 3,841 10 -- 3,851
States and political subdivisions 6,105 193 -- 6,298
Corporate obligations 100 2 -- 102
Federal Home Loan Bank stock 450 -- -- 450
Other equity securities 485 5 -- 490
------- ------- ----------- -------
Total securities $25,860 $ 260 $ 2 $26,118
======= ======= =========== =======
The amortized costs and approximate fair values of available-for-sale
securities as of December 31, 1999, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with
or without call or prepayment penalties.
Approx-
Amort- imate
ized Fair
Costs Values
======= =======
Due in one year or less $ -- $ --
Due after one year through five years 6,728 6,540
Due after five years through ten years 16,330 15,490
Due after ten years 6,715 6,320
Mortgage-backed securities 2,675 2,642
Equity securities 997 972
------- -------
Total $33,445 $31,964
======= =======
Securities with amortized costs of $4,596 and $1,220 as of December 31,
1999 and 1998, respectively, were pledged as collateral for public
deposits and for other purposes as required or permitted by law.
The Federal Home Loan Bank stock is carried at cost and collateralizes
lines of credit available from Federal Home Loan Bank.
(4) Loans and Allowance for Loan Losses
In the normal course of business, the Bank has made loans to officers,
directors and/or related interests. At December 31, 1999 and 1998,
$3,736 and $3,482, respectively, represented direct loans to officers
and directors and $691 and $1,109, respectively, represented loans made
to related interests of officers or directors and/or endorsed by
officers or directors.
F-22
<PAGE>
The following table will summarize activity and amounts receivable from
officers, directors and/or related interests:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Balances at beginning of year $ 4,591 $ 4,869
Additions 396 2,052
Repayments (560) (2,330)
------------- --------------
Balances at beginning of year $ 4,427 $ 4,591
============= ==============
</TABLE>
Activity in the allowance for loan losses is summarized as
follows:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Balances at beginning of year $ 708 $ 459
Provision for loan losses 216 249
Loan charge-offs (14) -
------------- --------------
Balances at end of year $ 910 $ 708
============= ==============
</TABLE>
Nonperforming assets at December 31, 1999 and 1998 are detailed
as follows:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Nonaccrual loans $ 87 $ -
Restructured loans - -
Loans past due 90 days or more - 200
------------- --------------
Total nonperforming loans 87 200
Foreclosed, repossessed and idled properties - -
------------- --------------
Total nonperforming assets $ 87 $ 200
============= ==============
</TABLE>
Gross interest income that would have been recognized for each year if
the nonaccrual loans and restructured loans had been current in
accordance with their original terms and had been outstanding
throughout the period or since origination, or if held part of the
period, is detailed below. Applicable interest income that was actually
collected and included in net income for each year is summarized below:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Interest income, original terms $ 5 $ -
Interest income, recognized $ 1 $ -
</TABLE>
The Bank has no restructured loans during the years ended December 31,
1999 or 1998.
An allowance determined in accordance with SFAS No. 114 and No. 118 is
provided for all impaired loans. The total recorded investment in
impaired loans and the related allowance for loan losses at December
31, the average annual recorded investment in impaired loans and
interest income recognized on impaired loans for the year (all
approximate) are summarized below:
F-23
<PAGE>
<TABLE>
<CAPTION>
1999 1998
------------- ---------------
<S> <C> <C>
Recorded investment at December 31, $ 103 $ -
Allowance for loan losses $ 10 $ -
Average recorded investment for the year $ 187 $ -
Interest income recognized for the year $ 2 $ -
</TABLE>
The Bank is not committed to lend additional funds to debtors whose
loans have been modified.
Loans approximating $12,435 and $12,896 and consisting primarily of
residential mortgage loans collaterialized the line of credit available
from the Federal Home Loan Bank at December 31, 1999 and 1998,
respectively. In order to meet potential funding demands as a result
Y2K issues the Bank established a line of credit at the Federal Reserve
Bank of Richmond of approximately $22 million. The line of credit is
collaterialized by the Bank's commercial real estate loans of
approximately $34 million at December 31, 1999. The line was not drawn
against and was closed subsequent to year end.
(5) Premises and Equipment
Components of premises and equipment and total accumulated depreciation
and amortization as of December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Land and improvements $ 654 $ 293
Building 1,257 477
Furniture, fixtures and equipment 1,090 635
Leasehold improvements 328 310
Construction in progress - 618
------------- --------------
3,329 2,333
Less accumulated depreciation
and amortization 700 503
------------- --------------
$ 2,629 $ 1,830
============= ==============
</TABLE>
The Bank currently leases its main office location under a non-
cancelable operating lease. The lease for the main office has an
original term of five years with the option of two additional renewal
terms of five years each. In addition, the Bank has entered into a
lease for a branch location which opened in January 1997. The original
lease term is for twelve years with an option to renew for one
additional five-year term. Rental expenses under operating leases were
approximately $107 and $94 for 1999 and 1998, respectively. Future
minimum lease payments under non-cancelable operating leases were as
follows at December 31, 1999:
2000 $ 126
2001 126
2002 126
2003 126
2004 126
Subsequent years 45
-------------
$ 675
=============
F-24
<PAGE>
(6) Income Taxes
Total income tax expense (benefit) for the years ended December 31,
1999 and 1998 is allocated as follows:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Income $ 394 $ 263
Shareholders' equity for unrealized
gains (losses) on available-for-sale securities
recognized for financial statement purposes (591) 59
------------- --------------
$ (197) $ 322
============= ==============
Income tax expense (benefit) consists of:
Current $ 455 $ 74
Deferred (61) 189
------------- --------------
$ 394 $ 263
============= ==============
</TABLE>
Total income tax expense (benefit) differed from the "expected" amount
computed by applying the U.S. Federal income tax rate of 34 percent to
income before income taxes as a result of the following:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Computed "expected" tax expense $ 488 $ 347
Increase (decrease) in income taxes
resulting from:
Tax-exempt interest income (110) (66)
Tax exempt interest disallowance 16 9
Other - (27)
------------- --------------
Reported income tax expense $ 394 $ 263
============= ==============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Deferred tax assets:
Net unrealized losses on available-
for-sale securities $ 503 $ -
Loans, principally due to allowance
for loan losses 275 207
Preopening expenses due to capitalization
for income tax purposes 14 50
Depreciation 11 -
------------- --------------
Deferred tax assets 803 257
Deferred tax liabilities:
Net unrealized gains on available-
for-sale securities - 88
Other 2 20
------------- --------------
Deferred tax liabilities 2 108
------------- --------------
Net deferred tax assets $ 801 $ 149
============= ==============
</TABLE>
F-25
<PAGE>
(7) Employee Benefit Plan
The Corporation has a defined contribution plan (the Plan) qualifying
under IRS Code Section 401(k). Eligible participants in the Plan can
contribute up to 15 percent of their total annual compensation to the
Plan. Employee contributions are matched by the Corporation based on a
percentage of 25 percent in 1998, and 75 percent in 1999 of the
employee's contribution up to a total of 6 percent of the employee's
salary. For the years ended December 31, 1999, and 1998 the Corporation
contributed $36 and $10 to the Plan, respectively.
(8) Stock Options
The Company has an Incentive Stock Plan (the Plan) pursuant to which
the Human Resource Committee of the Company's Board of Directors may
grant stock options to officers and key employees. The Plan authorizes
grants of options to purchase up to 103,950 shares (adjusted for stock
split) of the Company's authorized, but unissued common stock.
Accordingly, 103,950 shares of authorized, but unissued common stock
are reserved for use in the Plan. All stock options have been granted
with an exercise price equal to the stock's fair market value at the
date of grant. Stock options generally have 10-year terms, vest at the
rate of 20 percent per year, and become fully exercisable five years
from the date of grant. In addition, certain options for 10,122 and
20,244 shares (adjusted for stock split) based on meeting certain
performance criteria were granted to executive officers during 1999 and
1998, respectively.
The per share weighted average fair value of stock options granted
during 1999 and 1998 was $7.66 and $8.14, respectively, on the date of
grant utilizing the Black-Scholes option-pricing model with the
following weighted average assumptions:
1999 1998
---------- ----------
Expected split yield 0% 0%
Risk-free interest rate 7.0% 6.25%
Expected life of options (in years) 10 7.5
Expected volatility of stock price 12% 30%
As previously mentioned, the Company applies APB Opinion No. 25 in
accounting for its Plan and, accordingly, no compensation cost has been
recognized for its stock options in the consolidated financial
statements. Had the Company determined compensation cost based on the
fair value of its stock options at the grant date under SFAS No. 123,
the Company's net income and net income per share would have decreased
to the pro forma amounts indicated below:
F-26
<PAGE>
1999 1998
------------- ------------
Net income:
As reported $ 1,042 $ 758
Pro forma 971 716
Basic net income per share:
As reported $ 1.03 $ .75
Pro forma $ .96 $ .71
Diluted net income per share:
As reported $ .99 $ .73
Pro forma $ .92 $ .69
Stock option activity during the years ended December 31, 1999 and 1998
(adjusted for stock split) is as follows:
Exercise
Shares Prices
============ ============
Balance at December 31, 1997 55,304 9.36
Granted 25,494 10.19
Exercised (578) 9.76
Expired/forfeited (630) 9.76
------------
Balance at December 31, 1998 79,590 9.72
Granted 41,885 14.20
Exercised (420) 9.76
Expired/forfeited (1,260) 9.76
------------
Balance at December 31, 1999 119,795 11.29
============
At December 31, 1999, the range of exercise prices and weighted average
remaining contractual life of outstanding options was $8.33 - $16.67
and 7.5 years, respectively (adjusted for stock split).
At December 31, 1999 and 1998, the number of options exercisable was
74,487 and 59,241, respectively, and the weighted average exercise
price of those options was $9.51 and $9.49, respectively (adjusted for
stock split).
(9) Restrictions on Payments of Dividends and Capital Requirements
The Company's principal source of funds for dividend payments is
dividends received from the Bank. The amount of dividends that may be
paid by the Bank to the Company will depend on the Bank's earnings and
capital position and is limited by state law, regulations and policies.
A state bank may not pay dividends from its capital; all dividends must
be paid out of net undivided profits then on hand. Before any dividend
is declared, any deficit in capital funds originally paid in shall have
been restored by earnings to their initial level, and no dividend shall
be declared or paid by any bank which would impair the paid-in-capital
of the bank. As of December 31,1999, the amount available for payment
of dividends is $934. As of December 31, 1998, the Bank was in a
deficit position, and, accordingly, no amounts were available for
payment of dividends.
The Company and the Bank are subject to various regulatory capital
requirements administered by the federal and state banking agencies.
Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the
F-27
<PAGE>
Corporation's consolidated financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action,
the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting
practices. The Company's and the Bank's capital amounts and
classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts
and ratios (set forth in the table below) of total and Tier I capital
(as defined in the regulations) to risk-weighted assets (as defined),
and of Tier I capital (as defined) to average assets (as defined).
Management believes, as of December 31, 1999, that the Company and the
Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1999, the Company and the Bank were categorized as
well capitalized as defined by applicable regulations. To be
categorized as well capitalized the Company and Bank must maintain
minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the table below. There are no conditions or events
since that date that management believes have changed the Company's or
the Bank's category.
The Company's and the Bank's actual capital amounts and ratios are also
presented in the table below.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1999:
Total Capital
(to Risk Weighted
Assets):
Consolidated $10,943 10.68% 8,195 8.0% N/A N/A
Valley Bank 10,309 10.08% 8,185 8.0% 10,232 10.0%
Tier I Capital
(to Risk Weighted
Assets):
Consolidated 10,033 9.79% 4,098 4.0% N/A N/A
Valley Bank 9,399 9.19% 4,093 4.0% 6,139 6.0%
Tier I Capital (Leverage)
(to Average Assets):
Consolidated 10,033 7.55% 5,316 4.0% N/A N/A
Valley Bank 9,399 7.14% 5,264 4.0% 6,580 5.0%
F-28
<PAGE>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
-------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1998:
Total Capital
(to Risk Weighted
Assets):
Consolidated $9,618 12.24% 6,288 8.0% N/A N/A
Valley Bank 8,320 10.68% 6,234 8.0% 7,793 10.0%
Tier I Capital
(to Risk Weighted
Assets):
Consolidated 8,910 11.34% 3,144 4.0% N/A N/A
Valley Bank 7,612 9.77% 3,117 4.0% 4,676 6.0%
Tier I Capital (Leverage)
(to Average Assets):
Consolidated 8,910 8.65% 4,122 4.0% N/A N/A
Valley Bank 7,612 7.47% 4,071 4.0% 5,094 5.0%
(10) Parent Company Financial Information
Condensed financial information of Valley Financial Corporation is
presented below:
Condensed Balance Sheets
December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Assets
Cash $ 69 $ 65
Securities available-for-sale 735 1,266
Investment in subsidiary, at equity 8,452 7,677
Other assets 316 597
------------- --------------
Total assets $ 9,572 $ 9,605
============= ==============
Liabilities and Shareholders' Equity
Total liabilities $ 517 $ 448
------------- --------------
Commitments and other matters - -
Shareholders' equity (notes 3, 7 and 8):
Preferred stock, no par value. Authorized
10,000,000 shares; none issued and outstanding - -
Common stock of no par value. Authorized
10,000,000 shares; issued and outstanding
1,013,207 shares and 964,590 shares in 1999
and 1998, respectively 9,099 9,095
Retained earnings (deficit) 934 (108)
Accumulated other comprehensive income (loss) (978) 170
------------- --------------
Total shareholders' equity 9,055 9,157
------------- --------------
Total liabilities and shareholders' equity $ 9,572 $ 9,605
============= ==============
</TABLE>
F-29
<PAGE>
Condensed Statements of Income and Comprehensive Income (Loss)
Year Ended December 31, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Income:
Interest income $ 105 $ 79
------------- --------------
Expenses:
Interest expense 41 6
Other expenses 48 40
------------- --------------
89 46
Income before income taxes and equity in
undistributed net income of subsidiary 16 33
Income tax expense (benefit) (5) 12
------------- --------------
Income before equity in undistributed
net income of subsidiary 21 21
Equity in net income of subsidiary 1,021 737
------------- --------------
Net income 1,042 758
Equity in other comprehensive income (loss), net of deferred tax
(expense) benefit:
Net unrealized gains(losses) on securities
available-for-sale (1,148) 114
------------- --------------
Comprehensive income(loss) $ (106) $ 872
============= ==============
Condensed Statements of Cash Flows
Years Ended December 31, 1999 and 1998
1999 1998
------------- --------------
Cash flows from operating activities:
Net income $ 1,042 $ 758
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Equity in net income of subsidiary (1,021) (737)
Amortization of other assets 9 9
(Increase) decrease in other assets 70 (542)
Increase in other liabilities 69 306
------------- --------------
Net cash provided by (used in)
operating activities 169 (206)
------------- --------------
Cash flows from investing activities:
Purchases of securities available-for-sale (125) (1,219)
Proceeds from sales, maturities and calls
of securities available-for-sale - 1,350
Investment in subsidiary (44) -
------------- --------------
Net cash provided by (used in) investing activities (169) 131
------------- --------------
Cash flows from financing activities:
Proceeds from exercise of stock options 4 6
------------- --------------
Net cash provided by financing
activities 4 6
------------- --------------
Net increase (decrease) in cash 4 (69)
Cash at beginning of year 65 134
------------- --------------
Cash at end of year $ 69 $ 65
============= ==============
</TABLE>
(11) Financial Instruments with Off-Balance-Sheet Risk
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments may
involve, to
F-30
<PAGE>
varying degrees, credit risk in excess of the amount recognized in the
balance sheets. The contract amounts of these instruments reflect the
extent of involvement the Bank has in particular classes of financial
instruments.
Credit risk is defined as the possibility of sustaining a loss because
the other parties to a financial instrument fail to perform in
accordance with the terms of the contract. The Bank's maximum exposure
to credit loss under commitments to extend credit and standby letters
of credit is represented by the contractual amount of these
instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
The Bank requires collateral to support financial instruments when it
is deemed necessary. The Bank evaluates customers' creditworthiness on
a case-by-case basis. The amount of collateral obtained upon extension
of credit is based on management's credit evaluation of the customer.
Collateral may include deposits held in financial institutions, U.S.
Treasury securities, other marketable securities, real estate, accounts
receivable, inventory, and property, plant and equipment. Financial
instruments whose contract amounts represent credit risk as of December
31 are as follows:
1999 1998
------------- --------------
Commitments to extend credit $ 24,904 $ 18,542
Standby letters of credit $ 659 $ 1,361
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Commitments may
be at fixed or variable rates and generally expire within one year.
Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent
future cash requirements.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements, including bond financing and similar transactions. Unless
renewed, substantially all of the Bank's credit commitments at December
31, 1999 will expire within one year. Management does not anticipate
any material losses as a result of these transactions. The credit risk
involved in issuing letters of credit is essentially the same as that
involved in extending loans to customers.
F-31
<PAGE>
(12) Concentrations of Credit Risk
The Bank grants commercial, residential and consumer loans to customers
primarily in the Roanoke Valley area. The Bank has a diversified loan
portfolio which is not dependent upon any particular economic or
industry sector. As a whole, the portfolio could be affected by general
economic conditions in the Roanoke Valley region.
A detailed composition of the Bank's loan portfolio is provided in the
consolidated financial statements. The Bank's commercial loan portfolio
is diversified, with no significant concentrations of credit.
Commercial real estate loans are generally collateralized by the
related property. The residential real estate loan portfolio consists
principally of loans collateralized by 1-4 family residential property.
The loans to individuals portfolio consists of consumer loans primarily
for home improvements, automobiles, personal property and other
consumer purposes. These loans are generally collateralized by the
related property. Overall, the Bank's loan portfolio is not
concentrated within a single industry or group of industries, the loss
of any one or more of which would generate a materially adverse impact
on the business of the Bank.
The Bank has established operating policies relating to the credit
process and collateral in loan originations. Loans to purchase real and
personal property are generally collateralized by the related property.
Credit approval is principally a function of collateral and the
evaluation of the creditworthiness of the borrower based on available
financial information.
(13) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures about
Fair Value of Financial Instruments, requires the Corporation to
disclose estimated fair values of its financial instruments.
The following methods and assumptions were used to estimate the
approximate fair value of each class of financial instrument for which
it is practicable to estimate that value:
(a) Cash and Due from Banks and Money Market Investments
The carrying amounts are a reasonable estimate of fair value.
(b) Securities
The fair value of securities, except certain state and municipal
securities, is estimated based on bid prices published in
financial newspapers or bid quotations received from securities
dealers.
The fair value of certain state and municipal securities is not
readily available through market sources other than dealer
quotations, so fair value estimates are based on quoted market
prices of similar instruments, adjusted for differences between
the quoted instruments and the instruments being valued.
(c) Loans
Fair values are estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as
F-32
<PAGE>
commercial, commercial real estate, residential real estate and
loans to individuals. Each loan category is further segmented into
fixed and adjustable rate interest terms.
The fair value of loans is calculated by discounting scheduled
cash flows through the estimated maturity using estimated market
discount rates that reflect the credit and interest rate risk
inherent in the loan as well as estimates for prepayments. The
estimate of maturity is based on the Bank's industry experience
with repayments for each loan classification, modified, as
required, by an estimate of the effect of current economic and
lending conditions.
(d) Deposits
The fair value of noninterest-bearing deposits, interest-bearing
deposits and savings deposits is the amount payable on demand. The
fair value of fixed maturity time deposits and certificates of
deposit is estimated using the rates currently offered for
deposits with similar remaining maturities.
(e) Commitments to Extend Credit and Standby Letters of Credit
The only amounts recorded for commitments to extend credit and
standby letters of credit are the deferred fees arising from these
unrecognized financial instruments. These deferred fees are not
deemed significant at December 31, 1999 and 1998, and as such, the
related fair values have not been estimated.
(f) Federal Home Loan Bank Advances
The fair value of fixed rate borrowings are estimated using
discounted cash flows based on current incremental borrowing rates
for similar types of borrowing arrangements.
(g) Securities Sold Under Agreements to Repurchase
These agreements generally mature within one to seven days. The
carrying amounts are a reasonable estimate of fair value.
The carrying amounts and approximate fair values of the Corporation's
financial instruments are as follows at December 31, 1999 and 1998:
F-33
<PAGE>
<TABLE>
<CAPTION>
1999 1998
----------------------------- -----------------------------
Approx- Approx-
imate imate
Carrying Fair Carrying Fair
Amounts Values Amounts Values
============== ============= ============= ==============
<S> <C> <C> <C> <C>
Financial assets:
Cash and due from banks $ 4,027 $ 4,027 $ 3,462 $ 3,462
Money market investments 6,105 6,105 1,743 1,743
Securities available-for-sale 31,964 31,964 26,118 26,118
Loans, net 90,448 90,118 70,875 71,333
-------------- ------------- ------------- --------------
Total financial assets $ 132,544 $ 132,214 $ 102,198 $ 102,656
============== ============= ============= ==============
Financial liabilities:
Deposits $ 115,477 $ 116,051 $ 90,026 $ 90,576
Federal Home Loan Bank advances 10,000 10,000 5,000 5,012
Securities sold under agreements
to repurchase 992 992 - -
-------------- ------------- ------------- --------------
Total financial
liabilities $ 126,469 $ 127,043 $ 95,026 $ 95,588
============== ============= ============= ==============
</TABLE>
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Corporation's entire
holdings of a particular financial instrument. Because no market exists
for a significant portion of the Corporation's financial instruments,
fair value estimates are based on judgments regarding future expected
loss experience, current economic conditions, risk characteristics of
various financial instruments and other factors. These estimates are
subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that
are not considered financial instruments. Significant assets that are
not considered financial assets include deferred tax assets and premises
and equipment. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant
effect on fair value estimates and have not been considered in the
estimates.
(14) Time Deposits
At December 31, 1999, the approximate scheduled maturities of time
deposits are as follows:
1999 $ 53,420
2000 4,156
2001 4,068
2002 3,631
2003 2,916
-------------
$ 68,191
=============
(15) Commitments
F-34
<PAGE>
On February 2, 2000 the Bank executed an agreement to purchase a branch
from a large regional bank holding company. The purchase price is
$485,000 and the branch is located in Roanoke, Virginia.
At December 31, 1998, the Corporation had outstanding contractual
commitments of approximately $400,000 related to construction of a new
branch.
(16) Short-term Borrowing
Short-term debt consists of securities under agreements to repurchase
and federal funds purchased, which generally mature within one to seven
days from the transaction date. Additional is summarized below:
1999 1998
--------- ----------
Outstanding balance at December 31 $ 992 $ -
Year-end weighted average rate 5.56% -
Daily average outstanding during the period $ 658 $ 839
Average rate for the period 5.56% 5.60%
Maximum outstanding at any month-end during
the period $ 4,597 $ 4,531
(17) Other Comprehensive Income (Loss)
Other comprehensive income (loss) net of income taxes and net of
reclassification adjustments between net income and other comprehensive
income (loss) relating to securities available-for-sale are reported in
the Consolidated Statements of Income and Comprehensive Income (Loss).
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.
<TABLE>
<CAPTION>
1999 1998
------------- --------------
<S> <C> <C>
Net unrealized gains (losses) on securities available-for-sale:
Net unrealized holding gains (losses) during
the year $ (1,739) $ 190
Less reclassification adjustments for gains
included in net income - (17)
Income tax (expense) benefit 591 (59)
------------- --------------
Other comprehensive income (loss), net
of income taxes $ (1,148) $ 114
============= ==============
</TABLE>
(18) Subsequent Event - Stock Split
On January 20, 2000, the Company declared a 1.05 for 1 stock split
effected in the form of a dividend payable on February 15, 2000 to
shareholders of record on January 31, 2000. All prior period weighted
average shares outstanding, net income per share, and stock option data
has been adjusted to reflect the effects of the Company's stock split.
F-35
<PAGE>
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We have not authorized any dealer, salesperson or other person to give any
information or to represent anything not contained in this prospectus. You
must not rely on any unauthorized information or representations. This
prospectus is an offer to sell only the securities offered hereby, but only
under circumstances and in jurisdictions where it is lawful to do so. The
information contained in this prospectus is current only as of its date.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary................................................................... 1
Recent Developments....................................................... 3
Selected Consolidated Financial Data...................................... 3
Risk Factors.............................................................. 5
Use of Proceeds........................................................... 7
Market for Common Stock................................................... 7
Dividend Policy........................................................... 8
Capitalization............................................................ 8
Dilution.................................................................. 9
Business.................................................................. 9
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 14
Management................................................................ 38
Description of Capital Stock.............................................. 42
Valley Financial's Subordinated Debt...................................... 44
Supervision and Regulation................................................ 44
Underwriting.............................................................. 49
Legal Matters............................................................. 50
Experts................................................................... 50
Additional Information.................................................... 50
Special Note Regarding Forward-Looking Statements......................... 51
Financial Statements...................................................... F-1
</TABLE>
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175,000 Shares
Valley Financial Corporation
The Holding Company for
[Valley Bank Logo]
Common Stock
---------------
PROSPECTUS
---------------
Davenport & Company llc
November 14, 2000
-------------------------------------------------------------------------------
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<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
Article 10 of Chapter 9 of Title 13.1 of the Code of Virginia, 1950, as
amended (the "Code"), permits a Virginia corporation to indemnify any director
or officer for reasonable expenses incurred in any legal proceeding in advance
of final disposition of the proceeding, if the director or officer furnishes the
corporation a written statement of his good faith belief that he has met the
standard of conduct prescribed by the Code, and a determination is made by the
board of directors that such standard has been met. In a proceeding by or in
the right of the corporation, no indemnification shall be made in respect of any
matter as to which an officer or director is adjudged to be liable to the
corporation, unless the court in which the proceeding took place determines
that, despite such liability, such person is reasonably entitled to
indemnification in view of all the relevant circumstances. In any other
proceeding, no indemnification shall be made if the director or officer is
adjudged liable to the corporation on the basis that personal benefit was
improperly received by him. Corporations are given the power to make any other
or further indemnity, including advances of expenses, to any director or officer
that may be authorized by the articles of incorporation or any bylaw made by the
shareholder, or any resolution adopted, before or after the event, by the
shareholders, except an indemnity against willful misconduct or a knowing
violation of the criminal law. Unless limited by its articles of incorporation,
indemnification of a director or officer is mandatory when he or she entirely
prevails in the defense of any proceeding to which he is a party because he is
or was a director or officer.
<TABLE>
<S> <C>
Item 25. Other Expenses of Issuance and Distribution
Securities and Exchange Commission Registration Fee* $ 1,124
National Association of Securities Dealers Examination Fee* 923
Printing Expenses 15,000
Accounting Fees and Expenses 35,000
Legal Fees and Expenses 35,000
Blue Sky Fees and Expenses 9,000
Miscellaneous Expenses 28,953
-----------
Total $ 125,000
===========
</TABLE>
-------------------------
* Represents actual expenses. All other expenses are estimates.
Item 26. Recent Sales of Unregistered Securities
None.
Item 27. Exhibits
The following exhibits are filed on behalf of the Registrant as part
of this Registration statement:
1 Form of Underwriting Agreement
3.1 Articles of Incorporation (incorporated herein by reference to Exhibit
3.1 of Registration Statement No. 33-77568, on Form S-1, as amended).
3.2 Articles of Incorporation (incorporated herein by reference to Exhibit
3.2 of Registration Statement No. 33-77568, on Form S-1, as amended).
5.1 Opinion of Flippin, Densmore, Morse & Jessee, P.C.
23.1 Consent of Larrowe & Company, P.L.C.
II-1
<PAGE>
23.2 Consent of KPMG LLP.
23.3 Consent of Flippin, Densmore, Morse & Jessee, P.C. (included in Exhibit
5).
27 Financial Data Schedule (incorporated herein by reference to Exhibit 27
to the Company's June 30, 2000 Form 10-QSB).
II-2
<PAGE>
Item 28. Undertakings
The undersigned Registrant hereby undertakes as follows:
(1) The Registrant will file, during any period in which it offers or
sells securities, a post-effective amendment to this Registration
Statement to:
(i) include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933, as amended (the "Securities Act");
(ii) reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the Registration Statement; and
(iii) include any additional or changed material information in the
plan of distribution.
(2) The Registrant will, for determining any liability under the
Securities Act, treat each post-effective amendment as a new
registration statement of the securities offered, and the Offering of
the securities at that time to be the initial bona fide Offering.
(3) The Registrant will file a post-effective amendment to remove from
registration any of the securities that remain unsold at the end of
the Offering.
(4) Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the
Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and
will be governed by the final adjudication of such issue.
(5) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained
in a form of prospectus filed by the registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to
be part of this Registration Statement as of the time it was declared
effective.
II-3
<PAGE>
SIGNATURES
The Registrant. Pursuant to the requirements of the Securities Act of 1933,
--------------
the Registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form SB-2 and has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Roanoke, Commonwealth of Virginia, on the 16th
day of November, 2000.
VALLEY FINANICAL CORPORATION
By: /s/ Ellis L. Gutshall* By: /s/ A. Wayne Lewis*
------------------------- ----------------------
Ellis L. Gutshall* A. Wayne Lewis*
President & Chief Executive Office Executive Vice President & Chief
(Principal Executive Office) Financial Officer (Principal
Financial and Accounting Officer)
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Ellis L. Gutshall* President & Chief Executive November 16, 2000
------------------------- Officer and Director
Ellis L. Gutshall*
/s/ A. Wayne Lewis* Executive Vice President & November 16, 2000
------------------------- Chief Operating Officer, Chief
A. Wayne Lewis* Financial Officer (Principal
Financial Officer), and Director
Director November 16, 2000
-------------------------
Abney S. Boxley, III
/s/ William D. Elliot* Director November 16, 2000
-------------------------
William D. Elliot
/s/ Mason Haynesworth* Director November 16, 2000
-------------------------
Mason Haynesworth
/s/ Eddie F. Hearp* Director November 16, 2000
-------------------------
Eddie F. Hearp
/s/ Anna L. Lawson* Director November 16, 2000
-------------------------
Anna L. Lawson
/s/ Barbara B. Lemon* Director November 16, 2000
-------------------------
Barbara B. Lemon
Director November 16, 2000
-------------------------
George W. Logan
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Dr. John W. Starr* Director November 16, 2000
--------------------------
Dr. John W. Starr
/s/ Dr. Ward W. Stevens** Director November 16, 2000
--------------------------
Dr. Ward W. Stevens
/s/ Michael F. Warner* Director November 16, 2000
--------------------------
Michael F. Warner
</TABLE>
* Executed by Power of Attorney, found at Exhibit 24.
