SOUTHERN FINANCIAL BANCORP INC /VA/ - 10-Q Quarterly Report

U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20459

FORM 10-Q

Quarterly Report under Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the Quarter Ended: September 30, 2002		Commission File No.: 0-22836

SOUTHERN FINANCIAL BANCORP, INC.

Virginia		54-1779978

(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

37 East Main Street Warrenton, Virginia		20186

(address of principal executive office)		(Zip Code)

Registrant’s Telephone Number, including area code: (540) 349-3900

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES

As of October 31, 2002, there were 4,700,092 shares of the registrant’s Common Stock outstanding.

SOUTHERN FINANCIAL BANCORP, INC.
QUARTERLY REPORT ON FORM 10-Q
September 30, 2002

TABLE OF CONTENTS

			Page Number

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements

		Consolidated Balance Sheets as of September 30, 2002 (Unaudited) and December 31, 2001	3

		Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2002 and 2001 (Unaudited)	4

		Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2002 and 2001 (Unaudited)	5

		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001 (Unaudited)	6

		Notes to Consolidated Financial Statements (Unaudited)	7 - 13

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14- 19

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		19 - 20

Item 4.	Controls and Procedures		20

PART II.		OTHER INFORMATION

Item 1.	Legal Proceedings		21

Item 2.	Changes in Securities		21

Item 3.	Defaults upon Senior Securities		21

Item 4.	Submission of Matters to a Vote of Security Holders		21

Item 5.	Other Information		21

Item 6.	Exhibits and Reports on Form 8-K		21

PART III.		SIGNATURES	22

SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

		September 30, 2002 (Unaudited)		December 31, 2001

Assets
Cash and due from banks		$	32,094,593	$	21,290,594
Overnight earning deposits			6,577,279		7,167,963
Investment securities - available for sale			238,255,994		306,611,560
Loans receivable, net			594,952,864		410,973,260
Cash surrender value of life insurance			21,994,918		16,160,787
Premises and equipment, net			8,100,957		6,796,246
Other assets			47,362,877		15,976,548

	Total assets	$	949,339,482	$	784,976,958

Liabilities and Stockholders’ Equity
Liabilities:
Deposits		$	804,008,003	$	633,325,894
Advances from Federal Home Loan Bank - short term			17,000,000		40,500,000
Advances from Federal Home Loan Bank - long term			15,000,000		15,000,000
Company-obligated mandatorily redeemable securities of subsidiary holding solely parent debentures			13,000,000		13,000,000
Securities sold under agreements to repurchase			5,682,320		—
Other liabilities			14,564,644		18,482,865

	Total liabilities		869,254,967		720,308,759

Stockholders’ equity:
Preferred stock			129		136
Common stock			46,943		42,846
Capital in excess of par			65,254,591		54,628,316
Retained earnings			13,815,865		7,986,380
Accumulated other comprehensive income			966,987		2,010,521

	Total stockholders’ equity		80,084,515		64,668,199

	Total liabilities and stockholders’ equity	$	949,339,482	$	784,976,958

The accompanying notes are an integral part of these consolidated financial statements.

SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)

CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended September 30,					Nine Months Ended September 30,

		2002			2001		2002			2001

Interest Income
Loans		$	9,698,587		$	7,750,290	$	26,089,278		$	23,195,325
Investment securities			2,940,438			6,537,908		11,665,316			16,546,311

	Total interest income		12,639,025			14,288,198		37,754,594			39,741,636

Interest Expense
Deposits			3,746,707			5,430,455		10,789,195			16,808,565
Borrowings			732,076			1,609,473		2,423,961			4,255,045

	Total interest expense		4,478,783			7,039,928		13,213,156			21,063,610

	Net interest income		8,160,242			7,248,270		24,541,438			18,678,026
Provision for loan losses			950,000			1,150,000		4,010,000			2,420,000

	Net interest income after provision for loan losses		7,210,242			6,098,270		20,531,438			16,258,026

Other Income
Account maintenance and electronic banking fees			674,906			540,633		1,959,699			1,637,060
Commercial service fees			150,073			82,024		391,553			226,894
Other loan fees			89,157			91,119		296,673			312,194
System maintenance and license fees			43,455			50,900		176,307			170,971
Income from bank owned life insurance			292,500			232,500		834,131			697,500
Gain on sale of loans			217,093			110,400		464,800			512,723
Gain (loss) on investment securities, net			(103,018	)		362,879		(405,360	)		1,513,670
Other income (loss)			(15,515	)		42,745		(12,249	)		125,269

	Total other income		1,348,651			1,513,200		3,705,554			5,196,281

Other Expense
Employee compensation and benefits			2,556,605			2,098,105		7,281,265			6,402,549
Premises, equipment and data processing			1,361,951			1,139,338		3,825,309			3,262,951
Other			718,732			1,034,776		2,117,767			2,995,495

	Total other expense		4,637,288			4,272,219		13,224,341			12,660,995

	Income before income taxes		3,921,605			3,339,251		11,012,651			8,793,312
Provision for income taxes			1,246,400			1,061,900		3,501,400			2,760,500

	Net income	$	2,675,205		$	2,277,351	$	7,511,251		$	6,032,812

Earnings per common share:
	Basic	$	0.60		$	0.68	$	1.72		$	1.82
	Diluted		0.57			0.65		1.65			1.75
Dividends declared per common share Weighted average shares outstanding:			0.12			0.11		0.36			0.33
	Basic		4,482,585			3,330,518		4,352,442			3,321,036
	Diluted		4,722,059			3,497,666		4,564,858			3,442,133

The accompanying notes are an integral part of these consolidated financial statements

SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

		Three Months Ended September 30,						Nine Months Ended September 30,

		2002			2001			2002			2001

Net income		$	2,675,205		$	2,277,351		$	7,511,251		$	6,032,812
Other comprehensive income:
Cash flow hedge:
	Unrealized holding gain/(loss)		(545,464	)		(1,009,688	)		(1,135,989	)		(1,406,253	)
	Reclassification adjustment for net interest expense included in net income		176,010			125,084			513,616			151,063
Available-for-sale securities:
	Unrealized holding gain/(loss)		(256,380	)		4,018,804			(1,388,426	)		6,912,821
	Reclassification adjustment for net (gains)/losses included in net income		103,018			(362,879	)		405,360			(1,513,670	)

Other comprehensive income (loss) before tax			(522,816	)		2,771,321			(1,605,439	)		4,143,961
Income tax expense (benefit) related to items of other comprehensive income			(182,985	)		942,249			(561,905	)		1,408,947

Other comprehensive income (loss), net of tax			(339,831	)		1,829,072			(1,043,534	)		2,735,014
Comprehensive income		$	2,335,374		$	4,106,423		$	6,467,717		$	8,767,826

The accompanying notes are an integral part of these consolidated financial statements

SOUTHERN FINANCIAL BANCORP, INC.
FINANCIAL STATEMENTS (UNAUDITED)

CONSOLIDATED STATEMENTS OF CASH FLOWS

			Nine Months Ended September 30,

			2002			2001

Cash flows from operating activities:
Net Income			$	7,511,251		$	6,032,812
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization				1,188,516			1,113,955
(Accretion) amortization of discounts or premiums on investment securities and loans, net				4,387,838			(771,515	)
Provision for loan losses				4,010,000			2,420,000
Gain on sale of loans				(464,800	)		(512,723	)
(Gain) loss on sale of securities				405,360			(1,513,670	)
Accretion of deferred loan fees				(956,287	)		(611,724	)
Loans originated - held for sale				(5,820,100	)		(6,791,176	)
Loans sold - held for sale				5,851,647			6,338,370
Increase in other assets				(6,454,762	)		(875,155	)
Increase (decrease) in other liabilities				(8,059,688	)		2,358,993

		Net cash provided by operating activities		1,598,975			7,188,167

Cash flows from investing activities:
Increase in loans receivable				(117,098,382	)		(31,122,728	)
Purchase of investment securities, available-for-sale				(203,669,735	)		(388,132,566	)
Sale of investment securities, available-for-sale				155,220,528			143,841,541
Paydowns of investment securities				112,659,710			146,225,458
Purchase of bank owned life insurance				(5,000,000	)		—
Cash paid for merger				(6,841,584	)		—
Cash acquired from merger				13,719,290			—
Increase in premises and equipment, net				(870,140	)		(1,100,877	)
Increase in other equity securities				(681,900	)		(1,684,654	)

		Net cash used in investing activities		(52,562,213	)		(131,973,826	)

Cash flows from financing activities:
Net increase in deposits				80,546,746			107,662,241
Increase (decrease) in advances from FHLB - short term				(23,500,000	)		21,500,000
Increase in other borrowings				5,682,320			—
Proceeds from issuance of common stock				8,190			208,219
Dividends on preferred and common stock				(1,560,703	)		(1,091,089	)

		Net cash provided by financing activities		61,176,553			128,279,371

		Net increase in cash and cash equivalents		10,213,315			3,493,712
Cash and cash equivalents, beginning of period				28,458,557			24,516,252

Cash and cash equivalents, end of period			$	38,671,872		$	28,009,964

SUPPLEMENTAL DATA
	Cash payments for interest on deposits and borrowings, net of cash payments on interest rate swaps		$	(261,653	)	$	5,644,813
	Cash payments for income taxes		$	5,530,000		$	3,125,000

Southern Financial purchased all the capital stock of Metro-County Bank of Virginia. In conjunction with the acquisition, liabilities were assumed as follows:

Fair value of assets acquired			$	98,774,454
Capital stock issued				10,246,110
Cash paid				6,841,584

Liabilities assumed			$	81,686,760

The accompanying notes are an integral part of these consolidated financial statements

SOUTHERN FINANCIAL BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q, and, therefore, do not include all information or footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments which are, in the opinion of management, necessary for a fair presentation have been included. All adjustments are of a normal recurring nature. The results of operations for the three and nine-month periods ended September 30, 2002 are not necessarily indicative of the results of the full year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in Southern Financial Bancorp, Inc.’s (“Southern Financial”) Annual Report and Form 10-K for the year ended December 31, 2001.

NOTE 2 – INVESTMENT SECURITIES

The following table sets forth the investment securities portfolio as of the dates indicated:

	September 30, 2002				December 31, 2001

	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value

Available-for-sale securities:
Mortgage-backed securities	$	100,021,787	$	101,079,156	$	41,493,040	$	42,336,121
Collateralized mortgage obligations		108,525,746		110,193,407		235,061,327		238,074,675
Obligations of counties and municipalities		—		—		860,660		858,701
Corporate obligations		19,834,533		18,914,276		20,552,828		19,737,462
U.S. Treasury and agency securities		2,265,125		2,287,362		495,400		515,572
Federal Home Loan Bank stock		3,750,000		3,750,000		3,375,000		3,375,000
Federal Reserve Bank stock		1,536,850		1,536,850		1,229,950		1,229,950
Other equity securities		494,943		494,943		484,079		484,079

Total classified as investment securities		236,428,984		238,255,994		303,552,284		306,611,560
Corporate obligations classified as loans		44,431,328		45,301,572		36,592,310		37,213,355

	$	280,860,312	$	283,557,566	$	340,144,594	$	343,824,915

In December 2000, investment securities classified as held-to-maturity were transferred to the available-for-sale classification in order to provide more flexibility in managing the interest-rate risk in the investment security portfolio. Because of the transfer, Southern Financial will be unable to classify investment securities as held-to-maturity in the foreseeable future.

NOTE 3 – DERIVATIVE FINANCIAL INSTRUMENTS

As part of our interest rate risk management, we make extensive use of interest rate swaps. Some of them are accounted for as cash flow hedges and some are accounted for as fair value hedges in accordance with SFAS 133. Cash flow hedges are used to hedge variable interest rate assets or liabilities and fair value hedges are used to hedge fixed rate assets or liabilities.

We use interest rate swaps that are accounted for as cash flow hedges to hedge the interest rate risk associated with pools of certificates of deposit (CD’s) which reprice with changes in market interest rates. Under the terms of these interest rate swaps, we are the fixed rate payer and the floating rate receiver. The floating rate on the interest rate swaps is tied to three-month LIBOR, which approximates the issuance rate on the pool of CD’s. The combination of the swaps and the issuance of the pool of CD’s operates to produce long-term rate deposits. Changes in the fair value of cash flow hedges are accounted for in other comprehensive income.

We also use interest rate swaps that are accounted for as fair value hedges to hedge the issuance of individual fixed rate CD’s. Under the terms of these interest rate swaps, we are the fixed rate receiver and the floating rate payer. The floating rate on the interest rate swaps is generally tied to three-month LIBOR. The combination of the swaps and the issuance of individual CD’s operates to produce long-term floating rate deposits. The terms of the CD’s and the interest rate swaps mirror each other and were committed simultaneously. Changes in the fair value of the fair value hedges are accounted for in the income statement, as are changes in the fair value of the certificates of deposit.

During the quarter ended September 30, 2002, we entered into interest rate swap agreements totaling $53 million in connection with the issuance of like amounts of our certificates of deposit. These interest rate swap agreements are accounted for as fair value hedges. During the quarter ended September 30, 2002, three interest rate swaps with a notional amount of $30 million were terminated with no resulting gain or loss.

During the nine months ended September 30, 2002, we entered into interest rate swap agreements totaling $230.5 million in connection with the issuance of like amounts of our certificates of deposit. These interest rate swap agreements are accounted for as fair value hedges. During the nine months ended September 30, 2002, seven interest rate swaps with a notional amount of $70 million were terminated with no resulting gain or loss. Total interest rate swaps outstanding as of September 30, 2002 had a notional amount of $320.5 million and an estimated fair value of $5.2 million. Interest rate swaps accounted for as cash flow hedges had a notional amount of $20 million and an estimated fair value of ($1.4) million. Interest rate swaps accounted for as fair value hedges had a notional amount of $300.5 million and an estimated fair value of $6.6 million. These estimated fair value amounts are offset by equal fair value amounts of the CD’s that are being hedged.

During the quarter ended September 30, 2001, we entered into interest rate swap agreements totaling $45 million in connection with the issuance of like amounts of our certificates of deposit. These interest rate swap agreements are accounted for as fair value hedges. During the quarter ended September 30, 2001, three interest rate swaps with a notional amount of $30 million were terminated with no resulting gain or loss.

During the nine months ended September 30, 2001, we entered into interest rate swap agreements totaling $85 million in connection with the issuance of like amounts of our certificates of deposit. These interest rate swap agreements are accounted for as fair value hedges. During the nine months ended September 30, 2001, four interest rate swaps with a notional amount of $40 million were terminated with no resulting gain or loss. Total interest rate swaps outstanding as of September 30, 2001 had a notional amount of $135 million and an estimated fair value of $235 thousand. Interest rate swaps accounted for as cash flow hedges had a notional amount of $20 million and an estimated fair value of $(914) thousand. Interest rate swaps accounted for as fair value hedges had a notional amount of $115 million and an estimated fair value of $1.1 million.

NOTE 4 - LOANS RECEIVABLE

Loans receivable consist of the following:

		September 30, 2002		December 31, 2001

Construction and land development
	Residential	$	43,838,241	$	27,460,819
	Commercial		43,435,257		16,849,821
Mortgage
	Residential		98,076,613		61,740,743
	Multifamily Residential		9,855,705		—
	Commercial		240,054,613		171,851,222
Commercial and Industrial			159,166,840		133,258,498
Consumer			13,414,737		9,271,808

Total loans receivable			607,842,006		420,432,911
Less:
	Deferred loan fees, net		2,624,584		2,105,362
	Allowance for loan losses		10,264,558		7,354,289

Loans receivable, net		$	594,952,864	$	410,973,260

Corporate obligations in the amount of $25.8 million are classified as residential mortgage loans and $19.5 million are classified as commercial and industrial loans in the table above as of September 30, 2002. Corporate obligations in the amount of $37.2 million are classified as commercial and industrial loans as of December 31, 2001.

The following sets forth information regarding the allowance for loan losses:

	Nine Months Ended 9/30/02			Nine Months Ended 9/30/01

Allowance at beginning of period	$	7,354,289		$	4,921,342
Acquired from Metro County Bank		1,350,194			—
Provision for losses charged to income		4,010,000			2,420,000
Charge-offs		(3,132,733	)		(1,651,931	)
Recoveries		682,808			279,341

Allowance at end of period	$	10,264,558		$	5,968,752

The following table sets forth information regarding past due and nonperforming assets as of the periods indicated:

			At September 30, 2002			At December 31, 2001

Accruing Loans 90 Days or More Delinquent			$	—		$	—

Nonperforming Loans
	Mortgage-residential			—			343,285
	Mortgage-commercial			874,114			1,129,290
	Commercial and industrial (1)			1,412,791			—

		Subtotal		2,286,905			1,472,575

Real Estate Owned				—			—

Total Nonperforming Assets			$	2,286,905		$	1,472,575

Nonperforming Assets to Total Assets (2)				0.24	%		0.19	%

(1)	Includes $826,886 of loans guaranteed by the Small Business Admininstration (SBA) at September 30, 2002.

(2)	The nonperforming asset ratio is 0.15% at September 30, 2002 excluding $826,886 of loans guaranteed by the SBA.

NOTE 5 – EARNINGS PER SHARE

The following table shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potential dilutive common stock:

			For the three months ended

			September 30, 2002							September 30, 2001

			Amount			Shares		Per Share Amount		Amount			Shares		Per Share Amount

Net income			$	2,675,205						$	2,277,351
Preferred dividends				(2,797	)						(2,963	)

	Basic earnings per share		$	2,672,408			4,482,585	$	0.60	$	2,274,388			3,330,518	$	0.68

Effect of dilutive securities:
		Stock options					216,551							142,975
		Convertible preferred stock					22,923							24,173

	Diluted earnings per share		$	2,675,205			4,722,059	$	0.57	$	2,277,351			3,497,666	$	0.65

			For the nine months ended

			September 30, 2002							September 30, 2001

			Net Income			Shares		Per Share Amount		Net Income			Shares		Per Share Amount

Net income			$	7,511,251						$	6,032,812
Preferred dividends				(8,722	)						(8,888	)

	Basic earnings per share		$	7,502,529			4,352,442	$	1.72	$	6,023,924			3,321,036	$	1.82

Effect of dilutive securities:
		Stock options					188,660							96,924
		Convertible preferred stock					23,756							24,173

	Diluted earnings per share		$	7,511,251			4,564,858	$	1.65	$	6,032,812			3,442,133	$	1.75

NOTE 6 – INTANGIBLE ASSETS

Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (SFAS 142) was issued in June 2001. It discontinues amortization of intangible assets unless they have finite useful lives, and, instead, requires that they be tested at least annually for impairment by comparing their fair values with their recorded amounts. SFAS No. 142 also requires disclosure of the changes in the carrying amounts of goodwill from period to period, the carrying amounts of intangible assets by major intangible asset class for those subject to and not subject to amortization, and the estimated intangible asset amortization expense for the next five years. We adopted SFAS No. 142 as of January 1, 2002, and therefore, discontinued the amortization of goodwill on January 1, 2002. We have evaluated impairment of goodwill under SFAS No. 142 as of June 30, 2002, and we have determined there is no impairment of the goodwill.

Data concerning various intangible assets is presented in the following tables:

	September 30, 2002					December 31, 2001					September 30, 2001

	Gross Carrying Value		Accumulated Amortization			Gross Carrying Value		Accumulated Amortization			Gross Carrying Value		Accumulated Amortization

Amortizable core deposit intangibles	$	3,966,163	$	(347,500	)	$	1,566,163	$	(209,600	)	$	1,566,163	$	(170,300	)
Amortizable other intangibles		361,300		(202,251	)		442,763		(232,162	)		716,334		(133,344	)
Unamortizable goodwill		11,026,059		(145,200	)		1,586,651		(145,200	)		1,586,651		(118,800	)

	Other		Core Deposit Intangibles		Goodwill

Amortization expense:
Three months ended September 30, 2002	$	17,184	$	59,300	$	—
Three months ended September 30, 2001		19,083		39,300		26,800
Nine months ended September 30, 2002		51,552		137,900		—
Nine months ended September 30, 2001		57,249		135,500		77,600

	Other		Core Deposit Intangibles		Goodwill

Estimated amortization expense:
Three months ended December 31, 2002	$	17,179	$	99,300	$	—
Year ended December 31,
2003	$	20,400	$	397,200	$	—
2004		20,400		397,200		—
2005		20,400		397,200		—
2006		20,400		397,200		—
2007		20,400		397,200		—

	For the three months ended				For the nine months ended

	September 30, 2002		September 30, 2001		September 30, 2002		September 30, 2001

Reported net income	$	2,675,205	$	2,277,351	$	7,511,251	$	6,032,812
Add back - goodwill amortization		—		26,800		—		77,600

Adjusted net income	$	2,675,205	$	2,304,151	$	7,511,251	$	6,110,412

Reported basic earnings per share:	$	0.60	$	0.68	$	1.72	$	1.82
Add back - goodwill amortization per share		—		0.01		—		0.02

Adjusted basic earnings per share	$	0.60	$	0.69	$	1.72	$	1.84

Reported diluted earnings per share:	$	0.57	$	0.65	$	1.65	$	1.75
Add back - goodwill amortization per share		—		0.01		—		0.02

Adjusted diluted earnings per share	$	0.57	$	0.66	$	1.65	$	1.77

NOTE 7 – NEW FINANCIAL ACCOUNTING STANDARDS

SFAS No. 143, “Accounting for Asset Retirement Obligations,” was also issued in June 2001. SFAS No. 143 addresses accounting and reporting for legal obligations and related costs associated with the retirement of long-lived assets. The Statement requires that the fair value of the liability for an asset retirement obligation be recognized in the period incurred if a reasonable estimate of fair value can be made. The estimated retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. We have not determined the impact, if any, SFAS No. 143 will have on the company.

The FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002, which is effective for fiscal years beginning after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64, which required that all gains and losses from extinguishment of debt be aggregated, and if material, classified as an extraordinary item. As a result, gains and losses from debt extinguishment are to be classified as extraordinary only if they meet the criteria set forth in Accounting Principles Board Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 145 also requires that sale-leaseback accounting be used for capital lease modifications with economic effects similar to sale-leaseback transactions. We do not expect implementation to have a significant effect on our results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Restructuring Costs. SFAS No. 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. Under SFAS No. 146, a company will record a liability for a cost associated with an exit or disposal activity when that liability is incurred and can be measured at fair value. SFAS 146 will require a company to disclose information about its exit and disposal activities, the related costs, and changes in those costs in the notes to the interim and annual financial statements that include the period in which an exit activity is initiated and in any subsequent period until the activity is completed. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. Under SFAS No. 146, a company may not restate its previously issued financial statements and the new Statement grandfathers the accounting for liabilities that a company had previously recorded under Emerging Issues Task Force Issue 94-3. We do not currently have any activities that would be accounted for under SFAS No. 146, but the statement will be complied with when and if such activities arise.

NOTE 8 – BUSINESS COMBINATION

On August 14, 2002, Southern Financial acquired all the outstanding common stock of Metro-County Bank of Virginia for 354,711 shares of Southern Financial common stock and cash in the amount of $6,841,584. The merger was accounted for in accordance with SFAS No. 141, Business Combinations, and the results of operations of Metro-County Bank have been included in our consolidated financial statements from August 15, 2002. The excess of the purchase price over the fair value of the net identifiable assets acquired has been recorded as goodwill in the amount of $9,439,408 and core deposit intangible assets in the amount of $2,400,000. The factors considered in the decision to acquire Metro-County Bank included the opportunity for future growth and an expanded geographic presence, as the acquisition of Metro-County’s locations in the greater Richmond area is a natural extension of our geographic area and fits well into our expansion plans. The following table presents pro forma results of operations for the nine months ended September 30, 2002 and September 30, 2001 as though Southern Financial and Metro-County Bank of Virginia had combined at the beginning of the period:

		Three Months Ended September 30,				Nine Months Ended September 30,

		2002		2001		2002		2001

Total revenue		$	14,743,560	$	17,618,398	$	45,473,796	$	50,351,917
Net income			878,703		2,348,351		5,902,848		6,255,812
Earnings per share:
	Basic	$	0.13	$	0.43	$	0.91	$	1.15
	Diluted		0.13		0.41		0.87		1.09

SOUTHERN FINANCIAL BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Financial Condition

Total assets increased to $949.3 million at September 30, 2002, from $785.0 million at December 31, 2001. During the quarter, loan growth continued at a strong pace, increasing by $98.9 million, or 16.8%. Loans acquired from Metro-County Bank totaled $71.0 million. Excluding the loans acquired from Metro-County Bank, loans increased $27.9 million, representing 22.0% increase on an annualized basis, consisting of loans closed totaling $60.3 million and repayments of $32.4 million. During the nine months ended September 30, 2002 loans increased by $186.9 million including a group loan purchase totaling $26.9 million. Investment securities increased only $3.2 million during this third quarter and decreased $68.4 million, or 22.3% since December 31, 2001. During the third quarter, investment securities purchased totaled $74.9 million, which was offset by repayments and sales totaling $69.6 million during the quarter. The growth in other assets during the nine months ended September 30, 2002 included goodwill in the amount of $9.4 million and a core deposit intangible asset in the amount of $2.4 million resulting from the acquisition of Metro-County Bank. Also included in the growth of other assets were the purchase of $5 million in bank-owned life insurance and a $6.7 million investment in a low-income housing partnership that is expected to provide tax credits to us over the next ten years. Deposits and borrowings combined with proceeds from investment security repayments and sales funded the loan growth.

Results of Operations

Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings. Operating results are also affected by the level of our noninterest income, including income or loss from the sale of loans and fees and service charges on deposit accounts, and by the level of our operating expenses, including compensation, premises and equipment and income taxes.

The following table presents, for the periods indicated, average balances of and weighted average yields on interest-earning assets and average balances of and weighted average effective rates paid on interest-bearing liabilities. Calculations have been made utilizing daily average balances, and the effect of the interest rate swaps is reflected in the average rate on deposits. Loan balances do not include non-accrual loans.

								Nine Months Ended September 30,

								2002							2001

								Average Outstanding Balance		Interest Earned/ Paid		Average Yield/Rate			Average Outstanding Balance		Interest Earned/ Paid		Average Yield/Rate

								($ in thousands)
Assets:
		Interest-earning assets:
				Loans				$	485,245	$	26,089		7.17	%	$	344,365	$	23,195		8.98	%
				Securities					267,101		11,588		5.78			296,572		16,366		7.36
			Investments						7,344		78		1.42			5,546		181		4.35

							Total interest-earning assets		759,690		37,755		6.63	%		646,483		39,742		8.20	%
			Less allowance for loan losses						8,489							5,428

					Total interest-earning assets, net of allowance				751,201							641,055
	Noninterest-earning assets:
			Bank owned life insurance						20,457							15,532
			Other noninterest-earning assets						40,673							44,392

						Total assets		$	812,331						$	700,979

Liabilities and Stockholders’ Equity:
	Interest-bearing liabilities:
			Interest-bearing demand deposits					$	37,608	$	320		1.13	%	$	31,068	$	288		1.24	%
			Savings and money market accounts						98,746		1,174		1.59			81,746		2,031		3.31
			Time deposits						452,561		9,295		2.74			361,591		14,490		5.34
			Other borrowings						59,379		1,350		3.03			86,989		3,182		4.88
			Company-obligated mandatorily redeemable 11.0% preferred securities of Southern Financial Capital Trust I						5,000		429		11.44			5,000		429		11.44
			Company-obligated mandatorily redeemable 10.60% preferred securities of Southern Financial Statutory Trust I						8,000		645		10.74			8,000		644		10.74

	Total interest-bearing liabilities								661,294		13,213		2.66	%		574,394		21,064		4.89	%
	Noninterest-bearing liabilities:
			Demand deposits						70,685							63,395
			Other liabilities						12,825							19,869

						Total liabilities			744,804							657,658
	Stockholders’ equity								67,527							43,321

			Total liabilities and stockholder’ equity					$	812,331						$	700,979

	Net interest income									$	24,542						$	18,678

	Net interest spread												3.97	%						3.31	%
	Net interest margin												4.31	%						3.85	%

The following table presents information regarding changes in interest income and interest expense for the periods indicated for each major category of interest-earning asset and interest-bearing liability which distinguishes between the changes attributable to changes in volume (changes in volume multiplied by old rate) and changes in rate (changes in rate multiplied by old volume). The dollar amount of changes in interest income and interest expense attributable to changes in rate/volume (change in rate multiplied by change in volume) have been allocated between rate and volume variances based on the percentage relationship of such variances to each other.

			For The Nine Months Ended September 30, 2002 Versus September 30, 2001

			Volume			Rate			Net

			($ in thousands)
Interest income
	Loans receivable		$	8,202		$	(5,308	)	$	2,894
	Investments			(1,420	)		(3,461	)		(4,881	)

		Total interest income		6,782			(8,769	)		(1,987	)

Interest expense
	Interest-bearing deposits			3,229			(9,249	)		(6,020	)
	Borrowings			(1,036	)		(795	)		(1,831	)

		Total interest expense		2,193			(10,044	)		(7,851	)

Net interest income				4,589			1,275			5,864

Our net income was $2.7 million ($.57 diluted earnings per share) for the quarter ended September 30, 2002, an increase in net income of 17.5% over the $2.2 million ($.65 diluted earnings per share) earned for the quarter ended September 30, 2001. The decline in the diluted earnings per share was impacted by increased shares from the secondary common stock offering in October of 2001 as well as the Metro-County merger. The increase in net income was primarily due to growth in loans receivable and increased fee income and a lower loan loss provision offset by a decrease in net gains on sales of investment securities and an increase in other expenses. Net income excluding net gains and losses on investment securities and non-recurring items for the quarters ended September 30, 2002 and 2001 was $2.8 million ($.58 diluted earnings per share) and $2.0 million ($.57 diluted earnings per share), respectively, an increase of 37.7%.

Net income for the nine months ended September 30, 2002 and 2001 was $7.5 million ($1.65 diluted earnings per share) and $6.0 million ($1.75 diluted earnings per share), respectively, an increase in income of 24.5%. The increase in net income for the nine-month comparative periods resulted primarily from growth in loans receivable offset by a higher loan loss provision and a decrease in net gains on sales of investment securities and non-recurring items and an increase in other expenses. Net income excluding net gains and losses on investment securities and non-recurring items was $7.8 million ($1.71 earnings per diluted share) and $5.0 million ($1.43 earnings per diluted share) for the nine months ended September 30, 2002 and 2001, respectively, an increase of 58.8%.

Net interest income for the quarter was $8.2 million, an increase of 12.6% over the same quarter in the prior year. The increase in net interest income was primarily due to growth in earning assets resulting from loan originations and purchases, and an improved margin. Average earning assets increased 11.0% to $798 million for the quarter ended September 30, 2002 compared with 2001. The net interest margin was 4.09% and 4.03% for the quarters ended September 30, 2002 and 2001, respectively, as the ratio of average investment securities to loans declined to 41.2% compared with the prior year when it was 98.0%. Net interest margin declined compared with the quarter ended June 30, 2002, as our cost of funds remained relatively stable and our yield on earning assets declined to 6.34% from 6.82%. The reduction in the yield on earning assets is primarily the result of increased amortization of premiums on mortgage-related securities due to higher prepayments compared with the previous quarter.

Net interest income for the nine months ended September 30, 2002 was $24.5 million, an increase of 31.4% over the same period last year. The increase in net interest income was primarily due to growth in earning assets resulting from loan originations and purchases, and an improved margin. Average earning assets increased 17.5% to $759.7 million for the nine months ended September 30, 2002 compared with 2001. The net interest margin was 4.31% and 3.85% for the nine-month periods ended September 30, 2002 and 2001, respectively, as the ratio of average investment securities to loans declined to 55.0% compared with the prior year when it was 86.1%. The continued reduction in the cost of funds also contributed to the improved margin. The cost of funds declined to 2.66% from 4.89% for the nine-month periods ended September 30, 2002

and 2001, respectively. The yield on earning assets only declined to 6.63% from 8.20% during the same periods.

Credit quality for the third quarter of 2002 remains sound. The provision for loan losses was $950 thousand for the quarter ended September 30, 2002. In addition, during the quarter ended September 30, 2002, the allowance for loan losses increased $1.4 million due to the acquisition of Metro-County Bank. For the quarters ended September 30, 2002 and 2001, net charge-offs were .47% of average loans, or $659 thousand, compared with .84%, or $756 thousand. The ratios of allowance to loans receivable outstanding at September 30, 2002 and 2001 were both 1.70% compared with 1.76% as of December 31, 2001. At September 30, 2002 and 2001, the ratio of nonperforming assets to total assets was .15% and .21%, respectively. The improvement in these measurements indicates continued sound asset quality as the loan portfolio grows. We continue to monitor the loan portfolio and make charge-offs we deem appropriate, particularly given the uncertainty in the U.S. economy. Due to the uncertainty of risks in the loan portfolio, management’s judgement of the amount of the allowance necessary to absorb loan losses is approximate; however, management believes that the allowance for loan losses at September 30, 2002 is adequate to absorb known and inherent losses in the loan portfolio at that date.

Total other income decreased to $1.3 million from $1.5 million for the quarters ended September 30, 2002 and 2001, respectively. During the third quarters of 2002 and 2001, respectively, we recognized net securities (losses) gains totaling $(103) thousand and $363 thousand. Securities losses for the quarter are comprised of net securities gains totaling $2.0 million offset by $2.1 million of write-downs of interest-only strips included in our investment securities portfolio. Excluding the impact of net gains on investment securities and non-recurring items, other income increased by approximately 32% for the quarters ended September 30, 2002 and 2001, respectively. Areas of increase included account maintenance and electronic banking fees, and fees generated from commercial service products including lockbox fees.

Total other expenses for the quarter were $4.6 million, an increase of 8.5% when compared to the third quarter of 2001 largely due to expenses associated with the Metro-County merger. Other expenses decreased primarily due to costs associated with litigation in the prior year that has since been settled. The efficiency ratio, the ratio of non-interest expenses before amortization of intangibles divided by net interest income and non-interest income less gains on securities and non-recurring items, was 47.6% for the quarter ended September 30, 2002; an improvement compared with 50.4% for the quarter ended September 30, 2001.

Regulatory Capital Requirements

At September 30, 2002 we exceeded all regulatory capital standards.

Liquidity

The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity, and the ability to fund loan commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. Therefore, we must seek funding from additional sources, including brokered certificates of deposit, available-for-sale investment securities, lines of credit from the Federal Home Loan Bank of Atlanta and reverse repurchase agreement borrowings from approved securities dealers. In addition, we use derivative products such as interest rate swaps to enhance our liquidity through the issuance of long-term liabilities to match with our long-term assets. We also enhance our liquidity by monitoring unfunded loan commitments, which reduces unexpected funding requirements.

During the nine months ended September 30, 2002, we funded our financial obligations with deposits, borrowings from the Federal Home Loan Bank of Atlanta, and sales of investment securities. At September 30, 2002, we had $52.0 million of unfunded lines of credit and undisbursed construction loan funds of $41.3 million. Approved loan commitments were $22.9 million at September 30, 2002. It is anticipated that funding requirements for these commitments can be met from the normal sources of funds.

Critical Accounting Policies

Our accounting and reporting policies are in accordance with the accounting principles generally accepted in the United States of America and conform with general practices in the banking industry. The preparation of financial statements in conformity with these principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are based on information available at the date of the financial statements and could differ from actual results. The more critical of the accounting policies involves the determination of the allowance

for loan losses and accounting for derivative financial instruments.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses, which is charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is a current estimate of the known and inherent losses in the present portfolio based upon management’s evaluation of the loan portfolio. Estimates of losses inherent in the portfolio involve the exercise of judgment and the use of assumptions. The evaluations take into consideration such factors as changes in the nature, volume and quality of the loan portfolio, prior loss experience, level of nonperforming loans, current and anticipated general economic conditions and the value and adequacy of collateral. Changes in the estimate of losses may occur due to changing economic conditions and the economic conditions of borrowers.

A loan is considered impaired when, based on all current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the agreement, including all scheduled principal and interest payments. Such impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate or, as a practical expedient, impairment may be measured based on the loan’s observable market price, or if, the loan is collateral – dependent, the fair value of the collateral. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. Loans for which foreclosure is probable continue to be accounted for as loans.

Each impaired loan is evaluated individually to determine the income recognition policy. Generally, payments received are applied in accordance with the contractual terms of the note or as a reduction of principal.

Derivative Financial Instruments

As part of our interest rate risk management, we use interest rate swaps that are accounted for as both cash flow and fair value hedges in accordance with Statement of Financial Accounting Standards No. 133. Cash flow hedges are used to hedge variable interest rate assets or liabilities and fair value hedges are used to hedge fixed rate assets or liabilities. At the inception of the hedge, the risk management objective and strategy, the hedged risk, the derivative instrument, the hedged item and how hedge effectiveness will be assessed initially and on an ongoing basis are documented. At inception of the hedge and on an ongoing basis, the hedge must be deemed to be highly effective in hedging the hedged risk in order to qualify for hedge accounting. Effectiveness is measured by comparing the change in LIBOR (which the interest rate swap is priced from) to the change in the rate underlying the hedged asset or liability. If high correlation is not achieved, the hedging designation is discontinued with the change in the fair value of the interest rate swap recorded as other income or expense. In the event that any derivative that meets the requirements for hedge accounting or hedged item is terminated or sold, the gain or loss on the derivative will be amortized over the remaining life of the item hedged. Interest to be received or paid on the interest rate swaps is accrued monthly.

We use interest rate swaps that are accounted for as cash flow hedges to hedge the issuance of pools of certificates of deposit (CD’s) which reprice with changes in market interest rates. Under the terms of these interest rate swaps, we are the fixed rate payer and the floating rate receiver. The floating rate on the interest rate swaps is tied to three-month LIBOR, which approximates the issuance rate on the pool of CD’s. The combination of the swaps and the issuance of the pool of CD’s operates to produce long-term fixed rate deposits. The fair value of the interest rate swap is recorded in other assets in the consolidated balance sheets with changes in the fair value included in other comprehensive income. To the extent that the hedge is not completely effective, the ineffective portion is charged or credited to other income or expense in the consolidated statements of income. The amounts recorded in other comprehensive income are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the CD’s affect earnings.

We also use interest rate swaps that are accounted for as fair value hedges to hedge the issuance of individual fixed rate CD’s. Under the terms of these interest rate swaps, we are the fixed rate receiver and the floating rate payer. The floating rate on the interest rate swaps is generally tied to three-month LIBOR, which approximates the issuance rate on the individual CD’s. The combination of the swaps and the issuance of the individual CD’s operates to produce long-term floating rate deposits. The terms of the CD’s and the interest rate swaps mirror each other and were committed to simultaneously. Both the interest rate swap (included in other assets in the consolidated balance sheets) and the CD’s are recorded at fair value, with changes in fair value included in the statements of income as interest expense.

We incorporate all items from the consolidated balance sheet as well as off-balance sheet items such as derivative items used to hedge balance sheet items in an overall assessment of its interest rate risk. All on-balance sheet items and off-balance sheet items are incorporated in a report that is generated quarterly by the Federal Home Loan Bank of Atlanta that

assesses the interest rate risk in different interest rate environments. The report shows how the market value of our portfolio value of equity changes when interest rates rise or fall 1%, 2%, and 3%. The report also shows the change in net interest income in the same interest rate change scenarios.

Special Note Regarding Forward-looking Information

Certain statements under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report and the documents incorporated herein by reference constitute “forward-looking statements” within the meaning of the United States Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of Southern Financial, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions in Southern Financial’s market area, inflation, fluctuations in interest rates, changes in government regulations and competition, which will, among other things, impact demand for loans and banking services; the ability of Southern Financial to implement its business strategy; and changes in, or the failure to comply with, government regulations.

Forward-looking statements are intended to apply only at the time they are made. Moreover, whether or not stated in connection with a forward-looking statement, Southern Financial undertakes no obligation to correct or update a forward-looking statement should Southern Financial later become aware that it is not likely to be achieved. If Southern Financial were to update or correct a forward-looking statement, investors and others should not conclude that Southern Financial would make additional updates or corrections thereafter.

Item 3 – Quantitative and Qualitative Disclosure about Market Risk

We are engaged primarily in the business of investing funds obtained from deposits and borrowings into interest-bearing loans and investments. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between the interest income on loans and investments and the interest expense on deposits and borrowing. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-bearing assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. We have employed asset/liability management policies that attempt to manage our interest-earning assets and interest-bearing liabilities, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of credit or investment risk.

We actively manage our overall exposure to changes in interest rates. In managing our funding, we first attempt to gauge the direction of interest rates, which will determine how much sensitivity we are willing to take. If rates are decreasing, we seek to fund with liabilities that reprice in the near future. If rates are rising, we attempt to do the opposite. When necessary, we will enter into interest rate swaps, financial options or forward delivery contracts for the purpose of reducing interest rate risk.

Management uses a duration gap of equity approach to manage our interest rate risk and reviews quarterly interest sensitivity reports prepared for us by Risk Analytics Inc. This approach uses a model which generates estimates of the change in our market value of portfolio equity (“MVPE”) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using standard industry assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

With respect to our residential mortgage loan portfolio, it is our policy to retain those mortgage loans which have an adjustable interest rate and to sell most fixed rate mortgage loans originated into the secondary market. In addition, our commercial loans generally have rates that are tied to the prime rate, the one-year Constant Maturity Treasury (“CMT”) rate as reported by the Federal Reserve Board, or the three-year CMT rate. Both of these actions help control our exposure to rising interest rates.

The following table prepared by Risk Analytics, Inc. sets forth an analysis of our interest rate risk as measured by the estimated change in MVPE resulting from instantaneous and sustained parallel shifts in the yield curve (plus or minus 300 basis points, measured in 100 basis point increments) as of September 30, 2002 and December 31, 2001:

Sensitivity of Market Value of Portfolio Equity
As of September 30, 2002
(amounts in thousands)

	Market Value of Portfolio Equity								Market Value of Portfolio Equity as a % of

Change in Interest Rates In Basis Points (Rate Shock)	Amount		$ Change From Base			% Change From Base			Total Assets			Portfolio Equity Book Value

Up 300	$	89,198	$	(29,670	)		(24.96	)%		9.40	%		111.38	%
Up 200		101,250		(17,618	)		(14.82	)		10.67			126.43
Up 100		112,651		(6,217	)		(5.23	)		11.87			140.66
Base		118,868		—			—			12.52			148.43
Down 100		124,339		5,471			4.60			13.10			155.26
Down 200		135,049		16,181			13.61			14.23			168.63
Down 300		153,402		34,534			29.05			16.16			191.55

Sensitivity of Market Value of Portfolio Equity
As of December 31, 2001
(amounts in thousands)

	Market Value of Portfolio Equity								Market Value of Portfolio Equity as a % of

Change in Interest Rates In Basis Points (Rate Shock)	Amount		$ Change From Base			% Change From Base			Total Assets			Portfolio Equity Book Value

Up 300	$	53,137	$	(29,175	)		(35.44	)%		6.77	%		82.14	%
Up 200		65,736		(16,576	)		(20.14	)		8.37			101.62
Up 100		77,441		(4,871	)		(5.92	)		9.87			119.71
Base		82,312		—			—			10.49			127.24
Down 100		83,473		1,161			(1.41	)		10.63			129.04
Down 200		92,335		10,023			12.18			11.76			142.74
Down 300		103,921		21,609			26.25			13.24			160.65

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in MVPE requires the making of certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Accordingly, although the MVPE table provides an indication of our interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on our worth.

Item 4 - Controls and Procedures

Our management, including the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing of this quarterly report, and , based on their evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

SOUTHERN FINANCIAL BANCORP, INC.

Part II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

	The bank and we are involved in legal proceedings arising in the normal course of business from time to time. Management believes that neither we nor the bank are a party to, nor is any of our property the subject of, any material pending or threatened legal proceedings which, if determined adversely, would have a material adverse effect upon our consolidated position, results of operations or cash flows.

Item 2. CHANGES IN SECURITIES

	Not applicable

Item 3. DEFAULTS UPON SENIOR SECURITIES

	Not applicable

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

	Not applicable

Item 5. OTHER INFORMATION

	Not applicable

Item 6. EXHIBITS AND REPORTS ON FORM 8-K

	Exhibits Required 99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002

	Reports on Form 8-K We filed a report on Form 8-K on July 23, 2002 to file as an exhibit a copy of our press release dated July 22, 2002 announcing our earnings for the three months and the six months ended June 30, 2002.

SOUTHERN FINANCIAL BANCORP, INC.

Part III. SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SOUTHERN FINANCIAL BANCORP, INC.

	(Registrant)


Date 11/14/02	/s/ GEORGIA S. DERRICO

	Georgia S. Derrico Chairman and Chief Executive Officer (Duly Authorized Representative)

Date 11/14/02	/s/ WILLIAM H. LAGOS

	William H. Lagos Senior Vice President and Controller Principal Accounting Officer (Duly Authorized Representative)

I, Georgia S. Derrico, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Southern Financial Bancorp, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

November 14, 2002

/s/ GEORGIA S. DERRICO

Georgia S. Derrico Chairman and Chief Executive Officer

I, Patricia A. Ferrick, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Southern Financial Bancorp, Inc.;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

November 14, 2002

/s/ PATRICIA A. FERRICK

Patricia A. Ferrick Chief Financial Officer and Senior Vice President

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