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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2001
[ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from ____________ to ____________
Commission file number 000-33227
SOUTHERN COMMUNITY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 56-2270620
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4701 Country Club Road
Winston-Salem, North Carolina 27104
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (336) 768-8500
Securities Registered Pursuant to Section 12(b) of the Exchange Act:
None
Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, No Par Value
7.25% Convertible Junior Subordinated Debentures
Guarantee with respect to 7.25% Convertible Trust Preferred Securities
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 [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's Common Stock at March 1, 2002,
held by those persons deemed by the registrant to be non-affiliates, was
approximately $53.3 million.
As of March 1, 2002, (the most recent practicable date), the registrant had
outstanding 8,354,990 shares of Common Stock, no par value.
Page 1
Documents Incorporated By Reference
Document Where Incorporated
-------- ------------------
1. Proxy Statement for the Annual Meeting of Shareholders to be held April Part III
25, 2002 to be mailed to shareholders within 120 days of December 31,
2001.
Form 10-K Table of Contents
Index PAGE
- ----- ----
PART I
Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 13
Item 3. Legal.................................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders...................................... 14
PART II
Item 5. Market for Common Stock Equity and Related Stockholder Matters........................... 14
Item 6. Selected Financial Data.................................................................. 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................... 41
Item 8. Financial Statements..................................................................... 41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 63
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 63
Item 11. Executive Compensation................................................................... 63
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 63
Item 13. Certain Relationships and Related Transactions........................................... 63
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 63
Page 2
PART I
ITEM 1. BUSINESS
Who We Are
Southern Community Financial Corporation ("company") is the holding
company for Southern Community Bank and Trust ("bank"). The bank commenced
operations on November 18, 1996 and effective October 1, 2001 became a
wholly-owned subsidiary of the newly formed holding company. We are based in
Winston-Salem, North Carolina which is located in the north central region of
the state, an area also known as the Piedmont Triad. The Piedmont Triad area
includes the cities of Winston-Salem, Greensboro and High Point.
At December 31, 2001, we had total assets of $481.2 million, net loans
of $354.9 million, deposits of $392.9 million, and shareholders' equity of $42.5
million. We had net income of $2.1 million and $2.4 million and diluted earnings
per share of $.24 and $.30 for the years ended December 31, 2001 and 2000,
respectively. We had net income of $1.5 million and diluted earnings per share
of $.19 for the year ended December 31, 1999.
We have been, and intend to remain, a community-focused financial
institution offering a full range of financial services to individuals,
businesses and nonprofit organizations in the communities we serve. Our banking
services include checking and savings accounts; commercial, installment,
mortgage, and personal loans; safe deposit boxes; and other associated services
to satisfy the needs of our customers. In addition, to more fully serve the
specialized needs of certain commercial and retail customers, the bank has
established four subsidiaries as described below.
In our five years of existence we have accomplished the following:
- Assembled a management team with knowledge of our local
markets and over 100 years of banking experience;
- Registered 14 consecutive quarters of profitability after
becoming profitable in our seventh quarter of operation;
- Established seven banking offices including four in
Winston-Salem and one each in Clemmons, Kernersville and
Yadkinville;
- Focused on growing internally reaching total assets of $481.2
million as of December 31, 2001 without any acquisitions;
- Created four subsidiaries of the bank, each managed by
professionals with substantial previous experience in their
discipline:
- Southern Credit Services, Inc., which is engaged in
the business of accounts receivable financing;
- Southern Investment Services, Inc., which provides
investment brokerage services;
- Southeastern Acceptance Corporation, a consumer
finance agency with offices in Winston-Salem and Mt.
Airy, North Carolina; and
- VCS Management, LLC, the managing general partner of
Venture Capital Solutions, L.P., a small business
investment company in which the bank is an investor,
with offices in Winston-Salem, North Carolina and
Atlanta, Georgia.
- Received regulatory approval during August, 2001 for trust
powers and expect to soon begin offering trust services
including investment management, administration and advisory
services primarily for individuals, partnerships and
corporations;
- Increased our equity to $42.5 million as a result of our
initial public offering which raised $12 million, two
secondary stock offerings in February 1998 and January 2001,
raising $18.7 million and $4.9 million respectively, and the
retention of earnings;
- Listed our common stock on the Nasdaq National Market System
on January 2, 2002; o Created a capital trust, Southern
Community Capital Trust I, that issued 1,725,000 cumulative
convertible trust preferred securities in February 2002
generating gross proceeds of $17.3 million; and
- Implemented a strong credit culture. As of December 31, 2001,
our non-performing assets totaled $1.2 million or 0.26% of
total assets and our allowance for loan losses was $5.4
million or 1.50% of total loans and 604% of non-performing
loans.
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The website for the bank is www.smallenoughtocare.com. The bank is a
member of the Federal Reserve System and the Federal Deposit Insurance
Corporation insures its deposits up to applicable limits. The address of our
principal executive office is 4701 Country Club Road, Winston-Salem, North
Carolina 27104 and our telephone number is (336) 768-8500. Our common stock is
currently traded on the Nasdaq National Market System under the symbol "SCMF".
OUR MARKET AREA
We consider our primary market area to be the Piedmont Triad area of
North Carolina including Winston-Salem and the cities of Clemmons, Kernersville
(all in Forsyth County) and Yadkinville (Yadkin County), North Carolina, and to
a lesser extent, adjoining counties. We opened the Clemmons and Kernersville
branches during 2000. We plan to open an additional branch in Winston-Salem
during 2002. We expect our presence in the Piedmont Triad market area to
increase in the future, however presently, Forsyth and Yadkin Counties represent
our primary market area.
The Piedmont Triad is a 12 county region located in the north central
Piedmont of North Carolina and is named for the three largest cities in the
region, Winston-Salem, Greensboro and High Point. The region has one fifth of
the state's population and one fifth of its labor force. Manufacturing (26%) and
services (24%) are the two largest employment sectors. In 1999, the Piedmont
Triad region generated approximately $1.1 billion in new and expanded industry
investment and 7,265 new jobs.
Forsyth and Yadkin Counties are part of the largest Metropolitan
Statistical Area located entirely in North Carolina. The MSA is also one of the
top 50 in the country in both total population and number of households. Forsyth
County had an estimated population of 306,067 in 2000 and Yadkin County was
estimated at 36,348 in 2000. Winston-Salem is the largest city in Forsyth County
and the fourth largest city in North Carolina with an estimated population of
over 173,000. Forsyth County is the economic hub of northwest North Carolina.
The median family income in 1999 was over $45,000, over 14% higher than the
national figure and over 17% higher than the state figure. Forsyth County has a
very balanced and diversified economy. Approximately 99% of the work force is
employed in nonagricultural wage and salary positions. The major employment
sectors in 1999 were trade (23%), services (29%), manufacturing (21%), finance,
communications and utilities (13%), government (9%) and construction (4%).
There has been significant consolidation of banking institutions in
this market area. One of the two largest regional commercial banks in North
Carolina with its headquarters in Winston-Salem, with assets in excess of ten
billion dollars, recently merged with a financial institution in another city in
North Carolina. Another community bank, headquartered in Kernersville, also
recently announced a proposal to be acquired by a financial institution in
another county. We expect this consolidation to offer significant opportunities
for growth in our market area.
The bank serves our market area through seven full service banking
offices, including four branches located in Winston-Salem. Our television and
radio advertising has extended into this market area for several years,
providing the bank name recognition in the Piedmont Triad area. The bank's
customers may access various banking services through eight ATMs owned by the
bank and ATMs owned by others, through debit cards, and through the bank's
automated telephone and internet electronic banking products. These products
allow the bank's customers to apply for loans, access account information and
conduct various transactions from their telephones and computers.
BUSINESS STRATEGY
We established our bank with the objective of becoming a vital,
long-term player in our markets with a reputation for quality customer service
provided by a financially sound organization. Our business strategy is to
operate as an institution that is well capitalized, strong in asset quality,
profitable, independent, customer-oriented and connected to our community.
A commitment to customer service is at the foundation of our approach.
Our commitment is to put our customers first and we believe it differentiates us
from our competitors. Making good quality, profitable loans, which result in a
long-standing relationship with our borrowers, will continue to be a cornerstone
of our strategy.
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We intend to leverage the core relationships we build by providing a variety of
services to our customers. With that focus, we target:
- Small and medium sized businesses, and the owners and managers
of these entities;
- Professional and middle managers of locally based companies;
- Residential real estate developers; and
- Individual consumers.
We intend to grow our franchise through new and existing relationships
developed by our management team, by taking advantage of the opportunity to
acquire new relationships resulting from recent significant consolidation among
banks in our markets, including Wachovia Corporation's merger with First Union
Corporation, and by expanding to contiguous areas through de novo entry and
potentially through acquisitions which make strategic and economic sense.
We also intend to continue to diversify our revenue in order to
generate non-interest income. These efforts have included the formation of our
investment brokerage subsidiary, our mortgage loan department, and our small
business investment company manager (which generates management fees in addition
to interest income on its investments) and the creation of our trust department.
For the year ended December 31, 2001 our non-interest income represented 20.3%
of our total revenue. We believe that the profitability of these added
businesses and services, not just revenue generated, is critical to our success.
Key aspects of our strategy and mission include:
- To provide community-oriented banking services by
delivering a broad range of financial services to our
customers through responsive service and
communication;
- To form a partnership with our customers whereby our
decision making and product offerings are geared
toward their best long-term interests;
- To be recognized in our community as long-term
players with employees, stockholders and board
members committed to that effort; and
- To be progressive in our adoption of new technology
so that we can provide our customers access to
products and services that meet their needs for
convenience and efficiency.
Our belief is that this way of doing business will build a profitable
corporation and shareholder value. We want to consistently reward our
shareholders for their investment and trust in us.
SUBSIDIARIES
The bank operates four subsidiaries that provide financial services in
addition to those offered directly by the bank. The company formed another
subsidiary to issue trust preferred securities. Each subsidiary is described
below.
Southern Credit Services, Inc. was established in July 1997 and is
engaged in the business of accounts receivable financing. It either lends money
using the accounts receivable as collateral or purchases the accounts receivable
at a discount. Its office is located at our main headquarters building in
Winston-Salem. Southern Credit has 6 employees and total assets of $16 million
as of December 31, 2001. For the year ended December 31, 2001, its revenues were
$1.8 million, which represented 5.1% of total consolidated revenue.
Southern Investment Services, Inc. was established March 1999 and,
through an unaffiliated broker dealer, provides customers of the bank with
securities products and services. Through this arrangement, Southern Investment
Services earns revenues through commission sharing with the unaffiliated broker
dealer. Southern Investment Services employs one licensed securities
representative and for the year ended December 31, 2001 generated net fee income
of $193,000 or .6% of total consolidated revenue.
Southeastern Acceptance Corporation was established in December 1999 as
a consumer finance agency. Southeastern Acceptance offers a full line of
automobile and personal loans through its two offices in Winston-Salem and Mt.
Airy as well as through relationships with automobile dealers in its markets.
Southeastern
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Acceptance has 9 employees and $8.3 million of loans outstanding as of December
31, 2001 and for year ended December 31, 2001, its revenues were $1.6 million,
which represented 4.7% of total consolidated revenue.
VCS Management, LLC was formed in March 2000 as the managing general
partner of Venture Capital Solutions, L.P., a small business investment company
licensed by the Small Business Administration. Southern Community Bank and Trust
has $1.7 million invested in the partnership, which has a total of $9.2 million
of committed capital from various private investors including the bank. The
partnership can also borrow funds on a non-recourse basis from the Small
Business Administration to increase its capital available for investment. The
partnership makes investments in the form of subordinated debt and earns revenue
through interest received on its investments and potentially through gains
realized from warrants that it receives in conjunction with its debt
investments. The bank shares in any earnings of the partnership through its
investment in the partnership. VCS Management earns management fees for managing
the investment activities of the partnership. For year ended December 31, 2001
VCS Management earned $564,000 of fee income, representing 1.6% of total
consolidated revenue.
In February of 2002, Southern Community Capital Trust I (the "Trust"),
a newly formed subsidiary of the company, issued 1,725,000 Cumulative
Convertible Trust Preferred Securities (the "Securities"), generating total
proceeds of $17.3 million. The Securities pay distributions at an annual rate of
7.25% and mature on March 31, 2032. The Securities will pay distributions
quarterly beginning on March 31, 2002. The company has fully and unconditionally
guaranteed the obligations of the Trust. The Securities can be converted at any
time into common stock at a price of $8.67 (the "Conversion Price") or 1.153
shares of the company's common stock for each convertible preferred security.
The Securities issued by the Trust are redeemable in whole or in part at any
time after April 1, 2007. The Securities are also redeemable in whole at any
time prior to March 31, 2007 as long as the trading price of our common stock
has been at least 125% of the Conversion Price for a period of twenty
consecutive trading days ending within five days of the notice of redemption.
The proceeds from the Securities were utilized to purchase convertible junior
subordinated debentures from us under the same terms and conditions as the
Securities. We have the right to defer payment of interest on the debentures at
any time and from time to time for a period not exceeding five years, provided
that no deferral period extend beyond the stated maturities of the debentures.
Such deferral of interest payments by the company will result in a deferral of
distribution payments on the related Securities. Should we defer the payment of
interest on the debentures, the company will be precluded from the payment of
cash dividends to shareholders. Subject to certain limitations, the Securities
qualify as Tier 1 capital of the company for regulatory capital purposes. The
principal use of the net proceeds from the sale of the convertible debentures is
to infuse capital into our bank subsidiary, Southern Community Bank and Trust,
to fund its operations and continued expansion, the operations and continued
expansion of the bank's subsidiaries, and to maintain the bank's status as "well
capitalized" under regulatory guidelines.
COMPETITION
The activities we and the bank engage in are highly competitive.
Commercial banking in North Carolina is extremely competitive due to state laws
which permit state-wide branching. Consequently, many commercial banks have
branches located in several communities. One of the largest regional commercial
banks in North Carolina, with assets in excess of ten billion dollars, and one
savings institution have their headquarters in Winston-Salem. Another community
bank is headquartered in Kernersville. As of June 2001, there were 104 branches
in Forsyth County operated by twelve commercial banks and one savings
institution. Approximately $10.0 billion in deposits are located in Forsyth
County. Yadkin County has eight banks with eleven branches and approximately
$375.0 million in deposits. Deposits of the bank on that date were $299.5
million in Forsyth County and $70.1 million in Yadkin County. Therefore, in its
market area, the bank has significant competition for deposits and loans from
other depository institutions.
Other financial institutions such as savings and loan associations,
credit unions, consumer finance companies, insurance companies, brokerage
companies and other financial institutions with varying degrees of regulatory
restrictions compete vigorously for a share of the financial services market.
Brokerage companies continue to become more competitive in the financial
services arena and pose an ever increasing challenge to banks. Legislative
changes also greatly affect the level of competition we face. During 1998
federal legislation allowed credit unions to expand their membership criteria
and compete more intensely for traditional bank business. Additionally, the
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 expanded the
types of activities in which a bank holding company can engage. Currently, we
must compete against some institutions
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located in the Piedmont Triad area which have capital resources and legal loan
limits substantially in excess of those available to us and the bank. We expect
competition to continue to be significant.
EMPLOYEES
At December 31, 2001, the bank employed 121 full time equivalent
persons (including our executive officers). None of the employees are
represented by any unions or similar groups, and we have not experienced any
type of strike or labor dispute. We consider our relationship with our employees
to be good. Southern Community Financial Corporation has no employees of its
own.
SUPERVISION AND REGULATION
Banking is a complex, highly regulated industry. The primary goals of
the bank regulatory scheme are to maintain a safe and sound banking system and
to facilitate the conduct of sound monetary policy. In furtherance of these
goals, Congress has created several largely autonomous regulatory agencies and
enacted numerous laws that govern banks, bank holding companies and the banking
industry. The descriptions of and references to the statutes and regulations
below are brief summaries and do not purport to be complete. The descriptions
are qualified in their entirety by reference to the specific statutes and
regulations discussed.
SOUTHERN COMMUNITY FINANCIAL CORPORATION
Southern Community Financial Corporation is a bank holding company that
has elected to be treated as a financial holding company. As a bank holding
company under the Bank Holding Company Act of 1956, as amended, we are
registered with and subject to regulation by the Federal Reserve. We are
required to file annual and other reports with, and furnish information to, the
Federal Reserve. The Federal Reserve conducts periodic examinations of us and
may examine any of our subsidiaries, including the bank.
The Bank Holding Company Act provides that a bank holding company must
obtain the prior approval of the Federal Reserve for the acquisition of more
than five percent of the voting stock or substantially all the assets of any
bank or bank holding company. In addition, the Bank Holding Company Act
restricts the extension of credit to any bank holding company by its subsidiary
bank. The Bank Holding Company Act also provides that, with certain exceptions,
a bank holding company may not engage in any activities other than those of
banking or managing or controlling banks and other authorized subsidiaries or
own or control more than five percent of the voting shares of any company that
is not a bank. The Federal Reserve has deemed limited activities to be closely
related to banking and therefore permissible for a bank holding company.
However, with the passage of the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999, which became effective on March 11, 2000, the types
of activities in which a bank holding company may engage were significantly
expanded. Subject to various limitations, the Modernization Act generally
permits a bank holding company to elect to become a "financial holding company."
A financial holding company may affiliate with securities firms and insurance
companies and engage in other activities that are "financial in nature." Among
the activities that are deemed "financial in nature" are, in addition to
traditional lending activities, securities underwriting, dealing in or making a
market in securities, sponsoring mutual funds and investment companies,
insurance underwriting and agency activities, certain merchant banking
activities as well as activities that the Federal Reserve considers to be
closely related to banking.
A bank holding company may become a financial holding company under the
Modernization Act if each of its subsidiary banks is "well capitalized" under
the Federal Deposit Insurance Corporation Improvement Act prompt corrective
action provisions, is well managed and has at least a satisfactory rating under
the Community Reinvestment Act. In addition, the bank holding company must file
a declaration with the Federal Reserve that the bank holding company wishes to
become a financial holding company. A bank holding company that falls out of
compliance with these requirements may be required to cease engaging in some of
its activities. Southern Community Financial Corporation has elected, and been
authorized by the Federal Reserve, to become a financial holding company.
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Under the Modernization Act, the Federal Reserve serves as the primary
"umbrella" regulator of financial holding companies, with supervisory authority
over each parent company and limited authority over its subsidiaries. Expanded
financial activities of financial holding companies generally will be regulated
according to the type of such financial activity: banking activities by banking
regulators, securities activities by securities regulators and insurance
activities by insurance regulators. The Modernization Act also imposes
additional restrictions and heightened disclosure requirements regarding private
information collected by financial institutions. We cannot predict the full
sweep of this legislation.
Enforcement Authority. We will be required to obtain the approval of
the Federal Reserve prior to engaging in or, with certain exceptions, acquiring
control of more than 5% of the voting shares of a company engaged in, any new
activity. Prior to granting such approval, the Federal Reserve must weigh the
expected benefits of any such new activity to the public (such as greater
convenience, increased competition, or gains in efficiency) against the risk of
possible adverse effects of such activity (such as undue concentration of
resources, decreased or unfair competition, conflicts of interest, or unsound
banking practices). The Federal Reserve has cease-and-desist powers over bank
holding companies and their nonbanking subsidiaries where their actions would
constitute a serious threat to the safety, soundness or stability of a
subsidiary bank. The Federal Reserve also has authority to regulate debt
obligations (other than commercial paper) issued by bank holding companies. This
authority includes the power to impose interest ceilings and reserve
requirements on such debt obligations. A bank holding company and its
subsidiaries are also prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
Interstate Acquisitions. Federal banking law generally provides that a
bank holding company may acquire or establish banks in any state of the United
States, subject to certain aging and deposit concentration limits. In addition,
North Carolina banking laws permit a bank holding company which owns stock of a
bank located outside North Carolina to acquire a bank or bank holding company
located in North Carolina. This type of acquisition may occur only if the North
Carolina bank to be directly or indirectly controlled by the out-of-state bank
holding company has existed and continuously operated as a bank for a period of
at least five years. In any event, federal banking law will not permit a bank
holding company to own or control banks in North Carolina if the acquisition
would exceed 20% of the total deposits of all federally-insured deposits in
North Carolina.
Capital Adequacy. The Federal Reserve has promulgated capital adequacy
regulations for all bank holding companies with assets in excess of $150
million. The Federal Reserve's capital adequacy regulations are based upon a
risk based capital determination, whereby a bank holding company's capital
adequacy is determined in light of the risk, both on- and off-balance sheet,
contained in the company's assets. Different categories of assets are assigned
risk weightings and are counted at a percentage of their book value.
The regulations divide capital between Tier 1 capital (core capital)
and Tier 2 capital. For a bank holding company, Tier 1 capital consists
primarily of common stock, related surplus, noncumulative perpetual preferred
stock, minority interests in consolidated subsidiaries and a limited amount of
qualifying cumulative preferred securities. Goodwill and certain other
intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an
amount equal to the allowance for loan and lease losses up to a maximum of 1.25%
of risk weighted assets, limited other types of preferred stock not included in
Tier 1 capital, hybrid capital instruments and term subordinated debt.
Investments in and loans to unconsolidated banking and finance subsidiaries that
constitute capital of those subsidiaries are excluded from capital. The sum of
Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1
component must comprise at least 50% of qualifying total capital.
Every bank holding company has to achieve and maintain a minimum Tier 1
capital ratio of at least 4.0% and a minimum total capital ratio of at least
8.0%. In addition, banks and bank holding companies are required to maintain a
minimum leverage ratio of Tier 1 capital to average total consolidated assets
(leverage capital ratio) of at least 3.0% for the most highly-rated, financially
sound banks and bank holding companies and a minimum leverage ratio of at least
4.0% for all other banks. The Federal Deposit Insurance Corporation and the
Federal Reserve define Tier 1 capital for banks in the same manner for both the
leverage ratio and the risk-based capital ratio. However, the Federal Reserve
defines Tier 1 capital for bank holding companies in a slightly different
manner. As of December 31, 2001, our Tier 1 leverage capital ratio and total
capital were 9.21% and 11.53%, respectively.
The guidelines also provide that banking organizations experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory level, without
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significant reliance on intangible assets. The guidelines also indicate that the
Federal Reserve will continue to consider a "Tangible Tier 1 Leverage Ratio" in
evaluating proposals for expansion or new activities. The Tangible Tier 1
Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted
from Tier 1 capital, to quarterly average total assets. As of December 31, 2001,
the Federal Reserve had not advised us of any specific minimum Tangible Tier 1
Leverage Ratio applicable to us.
Source of Strength for Subsidiaries. Bank holding companies are
required to serve as a source of financial strength for their depository
institution subsidiaries, and, if their depository institution subsidiaries
become undercapitalized, bank holding companies may be required to guarantee the
subsidiaries' compliance with capital restoration plans filed with their bank
regulators, subject to certain limits.
Dividends. As a bank holding company that does not, as an entity,
currently engage in separate business activities of a material nature, our
ability to pay cash dividends depends upon the cash dividends we receive from
our subsidiary bank. Our only source of income is dividends paid by the bank. We
must pay all of our operating expenses from funds we receive from the bank.
Therefore, shareholders may receive dividends from us only to the extent that
funds are available after payment of our operating expenses. In addition, the
Federal Reserve generally prohibits bank holding companies from paying dividends
except out of operating earnings, and the prospective rate of earnings retention
appears consistent with the bank holding company's capital needs, asset quality
and overall financial condition. We expect that, for the foreseeable future, any
dividends paid by the bank to us will likely be limited to amounts needed to pay
any separate expenses of Southern Community Financial Corporation and/or to make
required payments on our debt obligations, including the convertible debentures
which fund the interest payments on the convertible preferred securities, issued
by our trust subsidiary.
Change of Control. State and federal banking law restrict the amount of
voting stock of the bank that a person may acquire without the prior approval of
banking regulators. The Bank Holding Company Act requires that a bank holding
company obtain the approval of the Federal Reserve before it may merge with a
bank holding company, acquire a subsidiary bank, acquire substantially all of
the assets of any bank, or before it may acquire ownership or control of any
voting shares of any bank or bank holding company if, after such acquisition, it
would own or control, directly or indirectly, more than 5% of the voting shares
of that bank or bank holding company. The overall effect of such laws is to make
it more difficult to acquire us by tender offer or similar means than it might
be to acquire control of another type of corporation. Consequently, our
shareholders may be less likely to benefit from rapid increases in stock prices
that often result from tender offers or similar efforts to acquire control of
other types of companies.
THE BANK
The bank is subject to various requirements and restrictions under the
laws of the United States and the State of North Carolina. As a North Carolina
bank, our subsidiary bank is subject to regulation, supervision and regular
examination by the North Carolina Banking Commission. As a member of the Federal
Reserve, the bank is subject to regulation, supervision and regular examination
by the Federal Reserve. The North Carolina Banking Commission and the Federal
Reserve have the power to enforce compliance with applicable banking statutes
and regulations. These requirements and restrictions include requirements to
maintain reserves against deposits, restrictions on the nature and amount of
loans that may be made and the interest that may be charged thereon and
restrictions relating to investments and other activities of the bank.
Transactions with Affiliates. The bank may not engage in specified
transactions (including, for example, loans) with its affiliates unless the
terms and conditions of those transactions are substantially the same or at
least as favorable to the bank as those prevailing at the time for comparable
transactions with or involving other nonaffiliated entities. In the absence of
comparable transactions, any transaction between the bank and its affiliates
must be on terms and under circumstances, including credit standards, that in
good faith would be offered or would apply to nonaffiliated companies. In
addition, transactions referred to as "covered transactions" between the bank
and its affiliates may not exceed 10% of the bank's capital and surplus per
affiliate and an aggregate of 20% of its capital and surplus for covered
transactions with all affiliates. Certain transactions with affiliates, such as
loans, also must be secured by collateral of specific types and amounts. The
bank also is prohibited from purchasing low quality assets from an affiliate.
Every company under common control with the bank, including us and Southern
Community Capital Trust I, is deemed to be an affiliate of the bank.
Page 9
Loans to Insiders. Federal law also constrains the types and amounts of
loans that the bank may make to its executive officers, directors and principal
shareholders. Among other things, these loans are limited in amount, must be
approved by the bank's board of directors in advance, and must be on terms and
conditions as favorable to the bank as those available to an unrelated person.
Regulation of Lending Activities. Loans made by the bank are also
subject to numerous federal and state laws and regulations, including the
Truth-In-Lending Act, Federal Consumer Credit Protection Act, the Equal Credit
Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate
mortgage disclosure requirements. Remedies to the borrower or consumer and
penalties to the bank are provided if the bank fails to comply with these laws
and regulations. The scope and requirements of these laws and regulations have
expanded significantly in recent years.
Branch Banking. All banks located in North Carolina are authorized to
branch statewide. Accordingly, a bank located anywhere in North Carolina has the
ability, subject to regulatory approval, to establish branch facilities near any
of our facilities and within our market area. If other banks were to establish
branch facilities near our facilities, it is uncertain whether these branch
facilities would have a material adverse effect on our business.
In 1994 Congress adopted the Reigle-Neal Interstate Banking and
Branching Efficiency Act of 1994. That statute provides for nationwide
interstate banking and branching, subject to certain aging and deposit
concentration limits that may be imposed under applicable state laws. Current
North Carolina law permits interstate branching only through acquisition of a
financial institution that is at least five years old, and after the
acquisition, the resulting institution and its affiliates cannot hold more than
20% of the total deposits in the state. Furthermore, the Reigle-Neal Act and
applicable North Carolina statutes permit regulatory authorities to approve de
novo branching in North Carolina by institutions located in states that would
permit North Carolina institutions to branch on a de novo basis into those
states. Federal regulations under the Riegle-Neal Act prohibit an out-of-state
bank from using the new interstate branching authority primarily for the purpose
of deposit production. These regulations include guidelines to insure that
interstate branches operated by an out-of-state bank in a host state are
reasonably helping to meet the credit needs of the communities served by the
out-of-state bank.
Governmental Monetary Policies. The commercial banking business is
affected not only by general economic conditions but also by the monetary
policies of the Federal Reserve. Changes in the discount rate on member bank
borrowings, control of borrowings, open market transactions in United States
government securities, the imposition of and changes in reserve requirements
against member banks and deposits and assets of foreign bank branches, and the
imposition of and changes in reserve requirements against certain borrowings by
banks and their affiliates are some of the monetary policies available to the
Federal Reserve. Those monetary policies influence to a significant extent the
overall growth of all bank loans, investments and deposits and the interest
rates charged on loans or paid on time and savings deposits in order to mitigate
recessionary and inflationary pressures. These techniques are used in varying
combinations to influence overall growth and distribution of bank loans,
investments, and deposits, and their use may also affect interest rates charged
on loans or paid for deposits.
The monetary policies of the Federal Reserve Board have had a
significant effect on the operating results of commercial banks in the past and
are expected to continue to do so in the future. In view of changing conditions
in the national economy and money markets, as well as the effect of actions by
monetary and fiscal authorities, no prediction can be made as to possible future
changes in interest rates, deposit levels, loan demand or the business and
earnings of the bank.
Dividends. All dividends paid by the bank are paid to us, the sole
shareholder of the bank. The general dividend policy of the bank is to pay
dividends at levels consistent with maintaining liquidity and preserving our
applicable capital ratios and servicing obligations. The dividend policy of the
bank is subject to the discretion of the board of directors of the bank and will
depend upon such factors as future earnings, financial condition, cash needs,
capital adequacy, compliance with applicable statutory and regulatory
requirements and general business conditions.
The ability of the bank to pay dividends is restricted under applicable
law and regulations. Under North Carolina banking law, dividends must be paid
out of retained earnings and no cash dividends may be paid if the bank's surplus
is less than 50% of its paid-in capital. Also, under federal banking law, no
cash dividend may be paid if the bank is undercapitalized or insolvent or if
payment of the cash dividend would render the bank
Page 10
undercapitalized or insolvent, and no cash dividend may be paid by the bank if
it is in default of any deposit insurance assessment due to the Federal Deposit
Insurance Corporation.
The exact amount of future dividends on the stock of the bank will be a
function of the profitability of the bank in general and applicable tax rates in
effect from year to year. The bank's ability to pay dividends in the future will
directly depend on the its future profitability, which cannot be accurately
estimated or assured. We expect that, for the foreseeable future, profits
resulting from the bank's operations will be retained by the bank as additional
capital to support its operations and growth other than dividends paid by the
bank to us as needed to pay any separate expenses of Southern Community
Financial Corporation and/or to make required payments on our debt obligations,
including the convertible debentures which fund the interest payments on the
convertible preferred securities, issued by our trust subsidiary.
Capital Adequacy. The capital adequacy regulations which apply to state
banks, such as the bank, are similar to the Federal Reserve requirements
promulgated with respect to bank holding companies discussed above.
Changes in Management. Any depository institution that has been
chartered less than two years, is not in compliance with the minimum capital
requirements of its primary federal banking regulator, or is otherwise in a
troubled condition must notify its primary federal banking regulator of the
proposed addition of any person to the board of directors or the employment of
any person as a senior executive officer of the institution at least 30 days
before such addition or employment becomes effective. During this 30-day period,
the applicable federal banking regulatory agency may disapprove of the addition
of such director or employment of such officer. The bank is not subject to any
such requirements.
Enforcement Authority. The federal banking laws also contain civil and
criminal penalties available for use by the appropriate regulatory agency
against certain "institution-affiliated parties" primarily including management,
employees and agents of a financial institution, as well as independent
contractors such as attorneys and accountants and others who participate in the
conduct of the financial institution's affairs and who caused or are likely to
cause more than minimum financial loss to or a significant adverse affect on the
institution, who knowingly or recklessly violate a law or regulation, breach a
fiduciary duty or engage in unsafe or unsound practices. These practices can
include the failure of an institution to timely file required reports or the
submission of inaccurate reports. These laws authorize the appropriate banking
agency to issue cease and desist orders that may, among other things, require
affirmative action to correct any harm resulting from a violation or practice,
including restitution, reimbursement, indemnification or guarantees against
loss. A financial institution may also be ordered to restrict its growth,
dispose of certain assets or take other action as determined by the primary
federal banking agency to be appropriate.
Prompt Corrective Action. Banks are subject to restrictions on their
activities depending on their level of capital. Federal "prompt corrective
action" regulations divide banks into five different categories, depending on
their level of capital. Under these regulations, a bank is deemed to be "well
capitalized" if it has a total risk-based capital ratio of 10% or more, a core
capital ratio of six percent or more and a leverage ratio of five percent or
more, and if the bank is not subject to an order or capital directive to meet
and maintain a certain capital level. Under these regulations, a bank is deemed
to be "adequately capitalized" if it has a total risk-based capital ratio of
eight percent or more, a core capital ratio of four percent or more and a
leverage ratio of four percent or more (unless it receives the highest composite
rating at its most recent examination and is not experiencing or anticipating
significant growth, in which instance it must maintain a leverage ratio of three
percent or more). Under these regulations, a bank is deemed to be
"undercapitalized" if it has a total risk-based capital ratio of less than eight
percent, a core capital ratio of less than four percent or a leverage ratio of
less than three percent. Under these regulations, a bank is deemed to be
"significantly undercapitalized" if it has a risk-based capital ratio of less
than six percent, a core capital ratio of less than three percent and a leverage
ratio of less than three percent. Under such regulations, a bank is deemed to be
"critically undercapitalized" if it has a leverage ratio of less than or equal
to two percent. In addition, the applicable federal banking agency has the
ability to downgrade a bank's classification (but not to "critically
undercapitalized") based on other considerations even if the bank meets the
capital guidelines.
If a state member bank, such as the bank, is classified as
undercapitalized, the bank is required to submit a capital restoration plan to
the Federal Reserve. An undercapitalized bank is prohibited from increasing its
assets, engaging in a new line of business, acquiring any interest in any
company or insured depository institution, or opening or acquiring a new branch
office, except under certain circumstances, including the acceptance by the
Federal Reserve of a capital restoration plan for the bank.
Page 11
If a state member bank is classified as undercapitalized, the Federal
Reserve may take certain actions to correct the capital position of the bank. If
a state member bank is classified as significantly undercapitalized, the Federal
Reserve would be required to take one or more prompt corrective actions. These
actions would include, among other things, requiring sales of new securities to
bolster capital, changes in management, limits on interest rates paid,
prohibitions on transactions with affiliates, termination of certain risky
activities and restrictions on compensation paid to executive officers. If a
bank is classified as critically undercapitalized, the bank must be placed into
conservatorship or receivership within 90 days, unless the Federal Deposit
Insurance Corporation determines otherwise.
The capital classification of a bank affects the frequency of
examinations of the bank and impacts the ability of the bank to engage in
certain activities and affects the deposit insurance premiums paid by the bank.
The Federal Reserve is required to conduct a full-scope, on-site examination of
every member bank at least once every twelve months.
Banks also may be restricted in their ability to accept brokered
deposits, depending on their capital classification. "Well capitalized" banks
are permitted to accept brokered deposits, but all banks that are not well
capitalized are not permitted to accept such deposits. The Federal Reserve may,
on a case-by-case basis, permit member banks that are adequately capitalized to
accept brokered deposits if the Federal Reserve determines that acceptance of
such deposits would not constitute an unsafe or unsound banking practice with
respect to the bank.
Deposit Insurance. The bank's deposits are insured up to $100,000 per
insured account by the Bank Insurance Fund of the Federal Deposit Insurance
Corporation. The bank's deposit insurance assessments may increase depending
upon the risk category and subcategory, if any, to which the bank is assigned.
The Federal Deposit Insurance Corporation assesses insurance premiums on a
bank's deposits at a variable rate depending on the probability that the deposit
insurance fund will incur a loss with respect to the bank. The Federal Deposit
Insurance Corporation determines the deposit insurance assessment rates on the
basis of the bank's capital classification and supervisory evaluations. Each of
these categories has three subcategories, resulting in nine assessment risk
classifications. The three subcategories with respect to capital are "well
capitalized," "adequately capitalized" and "less than adequately capitalized"
(that would include "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized" banks). The three subcategories with respect to
supervisory concerns are "healthy," "supervisory concern" and "substantial
supervisory concern." A bank is deemed "healthy" if it is financially sound with
only a few minor weaknesses. A bank is deemed subject to "supervisory concern"
if it has weaknesses that, if not corrected, could result in significant
deterioration of the bank and increased risk to the Bank Insurance Fund of the
Federal Deposit Insurance Corporation. A bank is deemed subject to "substantial
supervisory concern" if it poses a substantial probability of loss to the Bank
Insurance Fund. Any increase in insurance assessments could have an adverse
effect on the bank's earnings.
Our management and the bank's management cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
Page 12
ITEM 2. PROPERTIES
We currently operate out of seven banking offices, two consumer finance
offices, and two operations/administrative offices. All banking offices have
ATMs. A summary of our offices is as follows:
Approximate Year
Square Established Owned or
Footage or Acquired Leased
-------------- --------------- --------------
BANKING OFFICES:
WINSTON SALEM, NORTH CAROLINA
4701 Country Club Rd. - Headquarters 5,500 1996 Leased
3151 Peters Creek Parkway 2,400 1998 Leased
225 Hanes Mill Rd. 2,800 2001 Owned
536 South Stratford Rd. 1,600 1998 Leased
YADKINVILLE, NORTH CAROLINA
532 East Main Street 6,000 1998 Owned
CLEMMONS, NORTH CAROLINA
2755 Lewisville Clemmons Rd. 2,000 2000 Leased
KERNERSVILLE, NORTH CAROLINA
104 Harmon Lane 1,300 2000 Leased
CONSUMER FINANCE OFFICES:
WINSTON SALEM, NORTH CAROLINA
1209 Silas Creek Parkway 2,400 2000 Leased
MT. AIRY, NORTH CAROLINA
1201 West Lebanon Street 1,300 2000 Leased
OPERATIONS AND ADMINISTRATIVE OFFICES:
WINSTON SALEM, NORTH CAROLINA
4625 Country Club Rd. 3,200 1998 Owned
1600 Hanes Mall Blvd. 10,500 2000 Owned
In addition to the above locations, we have two off site ATMs located
at 3484 Robinhood Road, Winston-Salem and at 4575 Yadkinville Road, Pfafftown,
North Carolina. We have also committed to the construction or development of a
new headquarters, a new branch office and an office that will house our
mortgage, trust and brokerage operations. The new headquarters will be a 27,000
square foot facility to be built at a construction cost to us of approximately
$2.8 million on land that we acquired for $400,000, and will be located at 4605
Country Club Road, Winston-Salem, North Carolina. The new branch will be a 7,700
square foot facility to be built at a construction cost to us of approximately
$950,000 on land that we acquired for $500,000, and will be located at 1207
South Main Street, Kernersville, North Carolina. This new branch in Kernersville
will replace our temporary facility there. We moved our mortgage, trust and
brokerage operations in January 2002 to a leased facility located at 112
Cambridge Park, Winston-Salem, North Carolina.
All of our properties, including land, buildings and improvements,
furniture, equipment and vehicles, including the land acquisitions described
above, had a net book value at December 31, 2001 of $12.1 million.
Additional banking offices may be opened at later dates if deemed
appropriate by the Board of Directors and if regulatory approval can then be
obtained. The Board of Directors may acquire property in which a director,
directly or indirectly, has an interest. In such event, the acquisition of such
facilities shall be approved by a majority of the Board of Directors, excluding
any individual who may have such an interest in the property.
Page 13
ITEM 3. LEGAL
We are party to legal proceedings arising in the normal conduct of
business. Our management believes that this litigation is not material to our
financial position or results of our operations or the operations of the bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our security holders
during the fourth quarter of our fiscal year ended December 31, 2001.
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
Our common stock was quoted on the OTC Bulletin Board under the symbol
"SCMF" until January 2, 2002 when it was accepted for listing on the Nasdaq
National Market System. The following table sets forth the high and low sales
prices per share of our common stock, based on published financial sources, for
the last two years. All information has been adjusted for stock splits and stock
dividends effected during the periods presented.
PRICE
-----
YEAR QUARTERLY PERIOD HIGH LOW
------- ---------------- ------ ------
2000 First quarter.................................... $ 9.52 $ 7.79
Second quarter................................... 9.09 6.49
Third quarter.................................... 9.09 6.49
Fourth quarter................................... 8.69 6.49
2001 First quarter.................................... 8.57 7.02
Second quarter................................... 7.86 6.91
Third quarter.................................... 7.62 6.48
Fourth quarter................................... 8.65 5.00
At December 31, 2001, there were approximately 5,500 holders of record
of our common stock.
Holders of our common stock will be entitled to receive any cash
dividends the Board of Directors may declare. The declaration and payment of
future dividends to holders of our common stock will be at the discretion of our
Board of Directors and will depend upon our earnings and financial condition,
regulatory conditions and considerations and such other factors as our Board of
Directors may deem relevant. We expect that, for the foreseeable future, profits
resulting from the bank's operations will be retained by the bank as additional
capital to support its operations and growth other than dividends paid by the
bank to us as needed to pay any separate expenses of Southern Community
Financial Corporation and/or to make required payments on our debt obligations,
including the convertible debentures which will fund the interest payments on
the convertible preferred securities, issued by our trust subsidiary.
As a holding company, Southern Community Financial Corporation is
ultimately dependent upon its bank subsidiary to provide funding for its
operating expenses, debt service and dividends. Various banking laws applicable
to our bank subsidiary limit the payment of dividends, management fees and other
distributions by the bank to us and may therefore limit our ability to make
dividend payments. Under North Carolina banking law, dividends must be paid out
of retained earnings and no cash dividends may be paid if the bank's surplus is
less than 50% of its paid-in capital. Under federal banking law, no cash
dividend may paid if the bank is undercapitalized or insolvent or if payment of
the cash dividend would render the bank undercapitalized or insolvent, or if it
is in default of any deposit insurance assessment due to the Federal Deposit
Insurance Corporation.
Page 14
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
Effective October 1, 2001, the Southern Community Bank and Trust became
a wholly owned subsidiary of Southern Community Financial Corporation. Southern
Community Financial Corporation has no assets other than those of the bank.
Therefore, the financial statements of the bank prior to October 1, 2001 are the
historical financial statements of Southern Community Financial Corporation. The
information set forth below does not purport to be complete and should be read
in conjunction with the company's consolidated financial statements appearing
elsewhere in this annual report.
For the Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
OPERATING DATA:
Interest income $ 31,366 $ 26,831 $ 16,562 $ 10,103 $ 3,309
Interest expense 18,034 14,944 8,481 4,907 1,477
---------- ---------- ---------- ---------- ----------
Net interest income 13,332 11,887 8,081 5,196 1,832
Provision for loan losses 2,320 1,480 1,135 1,200 650
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 11,012 10,407 6,946 3,996 1,182
Non-interest income 3,403 2,198 775 339 74
Non-interest expense 11,162 8,723 5,892 3,810 1,868
---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes 3,252 3,882 1,829 525 (612)
Provision for income taxes 1,147 1,466 293 -- --
---------- ---------- ---------- ---------- ----------
Net income (loss) $ 2,105 $ 2,416 $ 1,536 $ 525 $ (612)
========== ========== ========== ========== ==========
PER SHARE DATA: (7)
Net income (loss)
Basic $ .25 $ .31 $ .20 $ .08 $ (.17)
Diluted .24 .30 .19 .07 (.17)
Cash dividends .00 .00 .00 .00 .00
Book value 5.08 4.63 4.13 3.94 2.97
Weighted average shares
Basic 8,293,027 7,711,955 7,655,147 6,854,172 3,532,780
Diluted 8,612,963 8,047,853 8,133,612 7,020,162 3,532,780
BALANCE SHEET DATA:
Total assets $ 481,220 $ 384,027 $ 254,172 $ 174,474 $ 68,597
Loans receivable 360,288 282,161 200,312 127,095 47,937
Allowance for loan losses 5,400 4,283 3,013 1,905 725
Deposits 392,851 338,753 218,953 143,850 57,788
Short-term borrowings 19,980 6,000 2,500 -- --
Long-term debt 25,000 -- -- -- --
Stockholders' equity 42,451 36,950 31,766 29,926 10,480
CAPITAL RATIOS: (5)
Total risk-based capital 11.53% 13.03% 16.40% 23.22% 22.23%
Tier 1 risk-based capital 10.28% 11.78% 15.15% 21.97% 20.98%
Leverage ratio 9.21% 11.16% 14.26% 21.57% 18.48%
Equity to assets ratio 8.82% 9.62% 12.50% 17.15% 15.28%
Page 15
For the Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
SELECTED PERFORMANCE RATIOS:
Return on average assets .50% .77% .71% .41% (1.45)%
Return on average equity 5.13% 7.27% 5.00% 2.03% (5.70)%
Net interest spread (2) 2.82% 3.22% 3.02% 2.93% 2.92%
Net interest margin (1) 3.36% 4.01% 3.90% 4.20% 4.52%
Non-interest income as a
percentage of total
revenue (6) 20.33% 15.61% 8.75% 6.12% 3.88%
Non-interest income as a
percentage of average
assets .80% .70% .36% .26% .18%
Non-interest expense to
average assets 2.63% 2.79% 2.71% 2.97% 4.45%
Efficiency ratio (3) 66.70% 61.93% 66.53% 68.83% 98.01%
Dividend payout ratio .00% .00% .00% .00% .00%
ASSET QUALITY RATIOS:
Nonperforming loans to
period-end loans .25% .10% .00% .01% .00%
Allowance for loan losses
to period-end loans 1.50% 1.52% 1.50% 1.50% 1.51%
Allowance for loan losses
to nonperforming loans 604% 1,552% NM 12,700% NM
Nonperforming assets
to total assets (4) .26% .07% .00% .01% .00%
Net loan charge-offs
to average loans outstanding .38% .09% .02% .02% .00%
OTHER DATA:
Number of banking offices 7 7 5 4 1
Number of full time
equivalent employees 121 104 70 46 24
(1) Net interest margin is net interest income divided by average interest
earning assets.
(2) Net interest spread is the difference between the average yield on
interest earning assets and the average cost of interest bearing
liabilities.
(3) Efficiency ratio is non-interest expense divided by the sum of net
interest income and non-interest income.
(4) Nonperforming assets consists of nonaccrual loans, restructured loans,
and Real Estate owned, where applicable.
(5) Capital ratios are for the bank.
(6) Total revenue consists of net interest income and non-interest income.
(7) All per share data has been restated to reflect the dilutive effect of
a stock split effected in the form of a 25% stock dividend in 1997, a
stock split effected in the form of a 10% stock dividend in 1998, a
two-for-one stock split in 1999, a stock split effected in the form of
a 10% stock dividend in 2000, and a 5% stock dividend in 2001.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following presents management's discussion and analysis of our
financial condition and results of operations and should be read in conjunction
with the financial statements and related notes included elsewhere in this
annual report. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ significantly from
those anticipated in these forward-looking statements as a result of various
factors. All share data has been adjusted to give retroactive effect to stock
splits and stock dividends. The following discussion is intended to assist in
understanding the financial condition and results of operations of the company.
Page 16
OVERVIEW
Our founders recognized an opportunity to fulfill the financial service
needs of individuals and organizations left underserved by consolidation within
the financial services industry. To fill a part of this void, we began in 1995
the process by which Southern Community Financial Corporation was created,
finally beginning operations on November 18, 1996 in the banking office that
still serves as our headquarters. From inception, we have strived to serve the
financial needs of small to medium-sized businesses, individuals, residential
homebuilders and others in and around Winston-Salem and the Piedmont Triad area
of North Carolina. We offer a broad array of banking and other financial
products - products similar to those offered by our larger competitors, but with
an emphasis on superior customer service. We believe that our emphasis on
quality customer service is the single most important factor among many that
have fueled our growth to $481 million in total assets in just over five years
of operations.
We began operations in November 1996 with $11 million in capital, a
single branch facility and thirteen employees. Through December 31, 2001,
Southern Community Financial Corporation has grown to a total of seven
full-service banking offices with $393 million in customer deposit accounts. In
support of this growth, we have generated $24 million of additional capital
through sales of common stock in 1998, 2000 and 2001. We have also formed four
subsidiaries offering a diversity of financial services that augment our
traditional banking products and services. These subsidiaries, and the services
each provides, include Southeastern Acceptance Corporation (Consumer Finance),
Southern Credit Services (Asset Based Commercial Finance), Southern Investment
Services (which, through an unaffiliated broker-dealer, provides customers of
the bank with securities products and services and earns revenues through
sharing of commissions) and VCS Management, LLC (Manager of a Small Business
Investment Company). More recently we have created a Trust Department that we
expect will begin operating in the first quarter of 2002. In October of 2001, we
formed Southern Community Financial Corporation , a financial holding company,
to become the parent company of Southern Community Bank and Trust. Our immediate
plans for expansion include the construction of both a new headquarters facility
on property adjacent to our current headquarters in Winston-Salem and a new full
service branch office in Kernersville.
Real estate secured loans, including construction loans and loans
secured by existing commercial and residential properties, comprise the majority
of our loan portfolio, with the balance of our loans consisting of commercial
and industrial loans and loans to individuals. Through associations with various
mortgage lending companies, we originate residential and commercial long-term
mortgages, at both fixed and variable rates, earning fees for loans originated.
It has been our strategy to recruit skilled banking professionals who are well
trained and highly knowledgeable about our market area, enabling us to develop
and maintain a loan portfolio of sound credit quality.
We recognize that our growth may expose us to increased operational and
market risk, primarily with respect to managing overhead, funding costs and
credit quality. We have developed critical functions such as Training, Audit,
and Credit Administration to assist in managing and monitoring these and other
risks. We are committed to creating a solid and diversified financial services
organization with a focus on customer service. It is our firm belief that this
foundation will continue building our loyal customer base while attracting new
clients and providing opportunities for future growth. As bank consolidations
continue to take place in our marketplace, Southern Community Financial
Corporation is positioned to continue to benefit from their effects.
Additionally, we expect to benefit from the recent merger of First Union and
Wachovia, both of which have a significant presence in our marketplace.
FINANCIAL CONDITION AT DECEMBER 31, 2001 AND 2000
During the year ended December 31, 2001, our total assets increased by
$97.2 million, or 25.3%, to $481.2 million. Consistent with prior years, strong
loan demand has provided the primary impetus for this overall asset growth. At
December 31, 2001, loans totaled $360.3 million, an increase of $78.1 million or
27.7% during the year. This growth was spread among our mortgage, construction
and commercial loans. Our commercial mortgage loans and non-mortgage commercial
loans increased by $29.9 million and $17.5 million, respectively, and
collectively provided 60.8% of our overall loan growth. We also generated growth
of $21.1 million and $8.8 million, respectively, in residential mortgage loans
and construction loans.
Our total liquid assets, defined as cash and due from banks, federal
funds sold and investment securities, increased by $15.5 million during the
year, to $107 million at December 31, 2001 versus $91.5 million at the beginning
of the year. Liquid assets represented 22.2% of total assets at December 31,
2001 as compared to 23.8% at the beginning of the year. Because of the
significant rate cuts enacted by the Federal Reserve Board, we have chosen to
invest more heavily in investments held to maturity, which we increased by $14.3
million to $34.5 million at December 31, 2001. The higher yields on these
investments help to somewhat mitigate the effect of the overall declining trend
in interest rates.
Page 17
Customer deposits continue to be our primary funding source. While our
deposits are primarily generated through our growing branch network, we do
utilize some out-of-market and brokered deposits to support our funding base. At
December 31, 2001, deposits totaled $392.9 million, an increase of $54.1 million
or 16.0% from year-end 2000. During the fourth quarter of 2000 we opened two
branches, which has contributed to our deposit growth. However, loan growth this
year has outpaced our growth in deposits. We have utilized borrowings from the
Federal Home Loan Bank of Atlanta (FHLB) to fill this funding gap. We will use
FHLB advances and other funding sources as necessary to support balance sheet
management and growth. However, we believe that as our branch network grows and
matures, the volume of core deposits will become a relatively larger portion of
our funding mix, which should contribute to a reduction in our overall funding
cost.
Our capital position remains strong, with all of our regulatory capital
ratios at levels that make us "well capitalized" under federal bank regulatory
capital guidelines. At December 31, 2001, our stockholders' equity totaled $42.5
million, an increase of $5.5 million from the December 31, 2000 balance. This
increase includes net income of $2.1 million earned during the year, proceeds of
$2.8 million received in February 2001 from the sale of 344,000 shares of our
common stock and $493,000 that resulted from an increase in the fair value of
our available-for-sale investments.
FINANCIAL CONDITION AT DECEMBER 31, 2000 AND 1999
Throughout 2000 we continued to aggressively follow our business plan
objectives of serving the banking needs of small to medium-sized businesses,
individuals, residential homebuilders and others in our market area. In doing so
we generated consistent strong growth and profitability during the year. Our
total assets increased by $129.9 million, or 51.1%, to $384.0 million at the
year-end 2000. We opened two new branches in 2000, and otherwise focused our
efforts at increasing our deposit base, with the result that we generated growth
in deposits of $119.8 million to $338.8 million, an increase of 54.7% over the
year-end 1999 deposit total of $219.0 million.
Loan growth continued to be strong in 2000, with total loans increasing
by $81.9 million, or 40.9%, to $282.2 million at December 31, 2000 from $200.3
million at December 31, 1999. This loan growth was well spread across our
portfolio, as each major category of loans grew in excess of 28%. Our credit
quality continued to be strong as well, with non-performing loans at year-end
and net loan charge-offs for the year below .10% of total year-end loans and
average loans for the year, respectively. Because our deposit growth
substantially exceeded our loan growth in 2000, we were able to significantly
increase our liquidity position during the year. Our total liquid investments,
which consists of federal funds sold and investment securities, grew from $36.7
million to $80.3 million, with available for sale and held to maturity
investment securities totaling $39.0 million and $20.2 million, respectively,
and federal funds sold of $21.0 million, at December 31, 2000.
Our total stockholders' equity increased by $5.2 million in 2000
principally as a result of net income for the year of $2.4 million and proceeds
of $2.2 million from the sale of common stock through a public offering and the
exercise of options. We also recorded an increase in accumulated other
comprehensive income of $578,000 arising from appreciation in the market value
of our available for sale investment securities during the year. At December 31,
2000, all of our regulatory capital ratios were at levels deemed "well
capitalized" under federal bank regulatory capital guidelines.
NET INTEREST INCOME
Like most financial institutions, the primary component of our earnings
is net interest income. Net interest income is the difference between interest
income, principally from loans and investments, and interest expense,
principally on customer deposits and borrowings. Changes in net interest income
result from changes in volume and changes in interest rates earned and paid. By
volume, we mean the average dollar level of interest-earning assets and
interest-bearing liabilities. Spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities, and margin refers to net interest income divided
by average interest-earning assets. Spread and margin are influenced by the
level and relative mix of interest-earning assets and interest-bearing
liabilities, as well as by levels of noninterest-bearing liabilities. During the
years ended December 31, 2001, 2000 and 1999, our average interest-earning
assets were $397.0 million, $296.6 million, and $207.1 million, respectively.
During these same years, our net interest margins were 3.36%, 4.01%, and 3.90%,
respectively.
Page 18
Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the years 1999 through 2001, information with regard to average
balances of assets and liabilities, as well as the total dollar amounts of
interest income from interest-earning assets and interest expense on
interest-bearing liabilities, resultant yields or costs, net interest income,
net interest spread, net interest margin and ratio of average interest-earning
assets to average interest-bearing liabilities. Average loans include
nonaccruing loans, the effect of which is to lower the average rate shown.
For the Years Ended December 31,
----------------------------------------------------------------------------------------
2001 2000 1999
----------------------------- ---------------------------- -----------------------------
Interest Interest Interest
Average earned/ Average Average earned/ Average Average earned/ Average
balance paid yield/cost balance paid yield/cost balance paid yield/cost
-------- ------ ---------- -------- ------- ---------- ---------- -------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans $318,696 $ 26,292 8.25% $240,888 $23,351 9.69% $160,718 $14,026 8.73%
Investment securities
available for sale 36,439 2,320 6.37% 26,821 1,733 6.46% 16,102 944 5.86%
Investment securities
held to maturity 32,261 2,201 6.82% 14,897 849 5.70% 14,189 802 5.65%
Other 9,620 553 5.75% 14,012 898 6.41% 16,109 790 4.90%
-------- -------- -------- -------- -------- -------
Total interest-earning assets 397,016 31,366 7.90% 296,618 26,831 9.05% 207,118 16,562 8.00%
-------- ---- -------- ---- ------- ----
Other assets 27,158 16,119 10,282
-------- -------- ---------
Total assets $424,174 $312,737 $217,400
======== ======== =========
Interest-bearing liabilities:
Deposits:
NOW and money market $ 80,695 2,135 2.65% $ 52,144 2,079 3.99% $ 43,044 1,470 3.42%
Time deposits greater
than $100,000 96,542 5,795 6.00% 68,553 4,282 6.25% 47,405 2,864 6.04%
Other time deposits 155,979 9,063 5.81% 130,752 8,229 6.29% 79,621 4,139 5.20%
Borrowings 21,810 1,041 4.77% 5,086 354 6.96% 125 8 6.40%
-------- -------- -------- -------- -------- -------
Total interest-bearing
liabilities 355,026 18,034 5.08% 256,535 14,944 5.83% 170,195 8,481 4.98%
-------- ---- -------- ---- ------- ----
Demand deposits 25,749 20,932 15,548
Other liabilities 2,351 2,042 902
Stockholders' equity 41,048 33,228 30,755
-------- -------- ---------
Total liabilities and
stockholders' equity $424,174 $312,737 $ 217,400
======== ======== =========
Net interest income and
net interest spread $ 13,332 2.82% $ 11,887 3.22% $ 8,081 3.02%
======== ==== ======== ==== ======= ====
Net interest margin 3.36% 4.01% 3.90%
==== ==== ====
Ratio of average interest-earning
assets to average interest-bearing
liabilities 111.83% 115.62% 121.69%
======== ======== =========
Page 19
RATE/VOLUME ANALYSIS
The following table analyzes the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume), and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated equally to both the changes attributable
to volume and the changes attributable to rate.
Year Ended Year Ended
December 31, 2001 vs. 2000 December 31, 2000 vs. 1999
------------------------------------------- ------------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
------------------------------------------- ------------------------------------------
Volume Rate Total Volume Rate Total
----------- ---------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Interest income:
Loans $ $ 6,981 $ (4,040) $ 2,941 $ 7,384 $ 1,941 $ 9,325
Investment securities available
for sale 617 (30) 587 661 128 789
Investment securities held
to maturity 1,087 265 1,352 40 7 47
Other (267) (78) (345) (119) 227 108
----------- ---------- ----------- ---------- ----------- -----------
Total interest income 8,418 (3,883) 4,535 7,966 2,303 10,269
----------- ---------- ----------- ---------- ----------- -----------
Interest expense:
Deposits:
NOW and money market 947 (890) 57 337 272 609
Time deposits greater
than $100,000 1,714 (201) 1,513 1,299 119 1,418
Other time deposits 1,527 (693) 834 2,938 1,152 4,090
Borrowings 981 (294) 687 331 15 346
----------- ---------- ----------- ---------- ----------- -----------
Total interest expense 5,169 (2,078) 3,091 4,905 1,558 6,463
----------- ---------- ----------- ---------- ----------- -----------
Net interest income increase
(decrease) $ 3,249 $ (1,805) $ 1,444 $ 3,061 $ 745 $ 3,806
=========== ========== =========== ========== =========== ===========
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Income. Our net income for 2001 was $2.1 million, a decrease of
$311,000 below net income of $2.4 million earned in 2000. Net income per share
was $.25 basic and $.24 diluted for the year ended December 31, 2001, down from
$.31 basic and $.30 diluted for 2000. We have continued to experience strong
growth, with total assets averaging $424.2 million during the current year as
compared to $312.7 million in 2000, an increase of 35.6%. Our percentage growth
in non-interest income of 54.8% exceeded our rate of asset growth, while our
28.0% increase in non-interest expenses was below our rate of asset growth.
While such trends generally contribute to improved profitability, their positive
effects were more than offset by an increase in our provision for loan losses
coupled with the effects of declining interest rates that caused our interest
rate spread and net yield on average interest earning assets to decline by 40
basis points and 65 basis points, respectively. As a result, our increases of
$1.4 million in net interest income and $1.2 million in non-interest income were
not enough to overcome the combined impact of increases of $840,000 in our
provision for loan losses and $2.4 million in our non-interest expenses. Our
expense growth included the costs of two new branches, additional branch
personnel, as well as personnel costs associated with expansion of our business.
While these expenses represent investments in building our franchise, they are
initially a drag on earnings. Also contributing to the decline in earnings per
share was the increase in shares outstanding as result of our sale of 344,118
shares of common stock early in 2001.
Page 20
Net Interest Income. During 2001, our net interest income increased by
$1.4 million or 12.2% to $13.3 million. Our total interest income benefited from
strong growth in the level of average earning assets, which offset lower asset
yields caused by the dramatic trend of declining interest rates throughout the
period. The rates earned on a significant portion of our loans adjust
immediately when index rates such as our prime rate change. Conversely, most of
our interest-bearing liabilities, including certificates of deposit and
borrowings, have rates fixed until maturity. As a result, interest rate
reductions will generally result in an immediate drop in our interest income on
loans, with a more delayed impact on interest expense because reductions in
interest costs will only occur upon renewals of certificates of deposit or
borrowings. Average total interest-earning assets increased $100.4 million, or
33.8%, during 2001 as compared to 2000, while our average yield dropped by 115
basis points from 9.05% to 7.90%. Our average total interest-bearing liabilities
increased by $98.5 million, or 38.4%, consistent with our increase in
interest-earning assets. However, because our interest costs generally do not
react as quickly to rate changes, our average cost of interest-bearing
liabilities decreased by only 75 basis points from 5.83% to 5.08%, resulting in
the compression in interest margins described above. For the year ended December
31, 2001, our net interest spread was 2.82% and our net interest margin was
3.36%. For the year ended December 31, 2000, our net interest spread was 3.22%
and our net interest margin was 4.01%.
Provision for Loan Losses. We recorded a $2.3 million provision for
loan losses for the year ended December 31, 2001, representing an increase of
$840,000 over the $1.5 million provision we made for the year ended December 31,
2000. Provisions for loan losses are charged to income to bring our allowance
for loan losses to a level deemed appropriate by management based on the factors
discussed under "Analysis of Allowance for Loan Losses." We have continued to
increase the level of our allowance for loan losses principally as a result of
the continued growth in our loan portfolio. Total loans receivable increased by
$78.1 million during 2001, and by $81.8 million during 2000. Our higher
provision for loan losses for the current year was made largely in response to
an increase in net loan charge-offs, which totaled $1.2 million during 2001, up
from $210,000 during the year ended December 31, 2000. On an annualized basis,
our percentage of net loan charge-offs to average loans outstanding was .38% for
the year ended December 31, 2001 as compared with .09% for the year ended
December 31, 2000. For all full fiscal years through 2000, our loan loss
experience was similar to that of other new banks, with net loan charge-offs in
each year of less than .10% of average loans outstanding. The increase in our
net charge-offs reflects the relatively higher charge-offs associated with our
consumer finance subsidiary, as well as the maturation of our loan portfolio.
During 2001, our consumer finance subsidiary had net loan charge-offs of
$290,000, which is consistent with our budgeted level for that line of business.
On a stand-alone basis, the rate of net loan charge-offs to average loans
outstanding in our bank was .29%, which we believe reflects the maturation and
seasoning of our loan portfolio. Nonperforming loans totaled $894,000 or .25% of
total loans at December 31, 2001, up from $276,000 or .10% of total loans at
December 31, 2000. The allowance for loan losses at December 31, 2001 of $5.4
million represents 1.50% of total loans and 604% of nonperforming loans. The
allowance for loan losses at December 31, 2000 of $4.3 million equaled 1.52% of
total loans outstanding at that date.
Non-Interest Income. For the year ended December 31, 2001, non-interest
income increased $1.2 million or 54.8% to $3.4 million from $2.2 million for the
prior year. This favorable increase resulted from factors that include an
increase of $284,000, or 47.7% to $879,000, in service charges and fees on
deposit accounts as a result of deposit growth, an increase of $459,000, or
83.5% to $1.0 million, in income from the origination of residential mortgage
loans sold into the secondary market and income of $383,000 realized from an
interest rate floor contract.
Non-Interest Expense. We strive to maintain non-interest expenses at
levels that we believe are appropriate given the nature of our operations and
the investments in personnel and facilities that have been necessary to generate
our growth. From 1998 forward, we have consistently maintained our ratio of
non-interest expenses to average total assets below 3%. Because of our growth
and the costs associated with building our franchise, we have consistently seen
increases in every major component of our non-interest expenses. For the year
ended December 31, 2001, our non-interest expense increased $2.4 million, or
28.0%. Salary and employee benefit expense increased $934,000, or 20.4%, and
reflects the addition of personnel in our two new branches as well as additions
of personnel to expand our lines of business, and, to a lesser degree, normal
salary increases. Occupancy and equipment expense increased $611,000, or 42.0%,
reflecting the expenses associated with our two newest branches and our
operations center, all of which were opened in the fourth quarter of 2000. Other
non-interest expenses increased $894,000, or 33.2%, reflecting the increased
volume of business activity, principally increases in lending and growth in
deposit accounts. For the year ended December 31, 2001, on an annualized basis,
our ratio of non-interest expenses to average total assets improved to 2.63% as
compared with 2.79% for 2000.
Provision for Income Taxes. Our provision for income taxes, as a
percentage of income before income taxes, was 35.3% and 37.8%, respectively, for
the years ended December 31, 2001 and 2000. The decline in the effective rate
for the current period principally results from a higher level of investment in
federally issued debt instruments that are not subject to state income taxes.
Page 21
YEARS ENDED DECEMBER 31, 2000 AND 1999
Net Income. We generated net income of $2.4 million during 2000
compared to $1.5 million in 1999, a 57% increase. As a result, diluted net per
share increased to $0.30 per share compared to $0.19 per share in 1999, an
increase of 58%. Operating results were considerably impacted by increases in
all categories of revenue and expenses as we experienced significant growth
during the year. In addition, we diversified and enhanced our earnings stream by
adding consumer finance and small business investment company activities.
Net Interest Income. Net interest income for 2000 was $11.9 million
compared to $8.1 for 1999. The increase was largely driven by asset growth and
to a lesser degree by a widening of our net interest margin. Total assets
increased $129.9 million, or 51%, during the year. The yield on average
interest-earning assets and the rate on average interest-bearing liabilities
increased in 2000 over 1999 as interest rates rose during this time period.
Since our interest-bearing assets, mostly loans, repriced more quickly than our
interest-bearing liabilities, the Federal Open Market Committee's decision to
raise the federal funds target rate during 2000 had a direct benefit on the
bank's net interest spread and net interest margin. Our net interest spread and
net interest margin increased to 3.22% and 4.01% in 2000, respectively from
3.02% and 3.90% in 1999.
Provision for Loan Losses. We recorded a $1.5 million provision for
loan losses in 2000, representing an increase of $345,000 over the $1.1 million
provision we made in 1999. Provisions for loan losses are charged to income to
bring our allowance for loan losses to a level deemed appropriate by management
based on the factors discussed under "Analysis of Allowance for Loan Losses." In
each year the provision for loan losses was made principally in response to
growth in loans, as total loans outstanding increased by $80.2 million in 2000
and by $73.2 million in 1999. The loan loss provision for 2000 was further
impacted by a higher level of net loan charge-offs, which totaled $210,000 for
the year as compared to only $27,000 during 1999. At December 31, the allowance
for loan losses was $4.3 million for 2000 and $3.0 million for 1999,
representing 1.52% and 1.50%, respectively, of loans outstanding. At December
31, 2000, the bank had $276,000 in nonaccrual loans. The bank had no
nonperforming loans at December 31, 1999.
Non-Interest Income. Non-interest income of $2.2 million in 2000 was
significantly greater than the $775,000 in 1999. The bank experienced a
significant increase in service charges and fees on deposit accounts, by and
large due to growth in the number and activity of deposit accounts. In addition,
the bank generated higher levels of mortgage loan origination fees and stock
brokerage fees. In 2000 the bank also earned $515,000 in fees as the managing
general partner of Venture Capital Solutions, L.P., a small business investment
company licensed by the SBA. The bank had no gains or losses on investment
security transactions in either year.
Non-Interest Expense. Non-interest expense increased in 2000 to $8.7
million, or 48%, from $5.9 million in 1999. The increase in non-interest expense
in 2000 compared to 1999 is principally due to growth of the bank. Salaries and
employee benefits expense increased to $4.6 million, or 67%, from $2.7 million
and reflect continued growth in our business as we added personnel. A key
element of other non-interest expense has been advertising and promotion, which
in 2000 was $578,000 and in 1999 was $434,000. Data processing and other
outsourced services are another major expense, constituting $624,000 in 2000 and
$537,000 in 1999. In 2000, the bank opened two additional branches, which
contributed to the increase in occupancy and equipment expense, which increased
to $1.5 million, or 39%, from $1.0 million the prior year.
Provision for Income Taxes. The bank had an effective income tax rate
of 37.8% in 2000 and 16.0% in 1999, as the bank's earnings became fully taxable
for 2000. The effective rate for 1999 was different from fully taxable rates
predominantly because of recognition deferred tax assets generated in periods
before the bank achieved profitability.
LIQUIDITY AND CAPITAL RESOURCES
Market and public confidence in our financial strength and in the
strength of financial institutions in general will largely determine our access
to appropriate levels of liquidity. This confidence is significantly dependent
on our ability to maintain sound asset quality and appropriate levels of capital
resources.
The term "liquidity" refers to our ability to generate adequate amounts
of cash to meet our needs for funding loan originations, deposit withdrawals,
maturities of borrowings and operating expenses. Management measures our
liquidity position by giving consideration to both on- and off-balance sheet
sources of, and demands for, funds on a daily and weekly basis.
Page 22
Sources of liquidity include cash and cash equivalents, net of federal
requirements to maintain reserves against deposit liabilities, investment
securities eligible for pledging to secure borrowings from correspondent banks
pursuant to securities sold under repurchase agreements, investments available
for sale, loan repayments, loan sales, deposits, and borrowings from the Federal
Home Loan Bank and from correspondent banks under overnight federal funds credit
lines. In addition to interest rate-sensitive deposits, the company's primary
demand for liquidity is anticipated fundings under credit commitments to
customers.
Because of our continued growth, we have maintained a relatively high
level of liquidity in the form of interest-bearing bank deposits, federal funds
sold, and investment securities. These aggregated $88.1 million at December 31,
2001, compared to $80.3 million and $36.7 million at December 31, 2000 and 1999,
respectively. We achieved strong deposit growth in 2000, with a $119.8 million
increase in total customer deposit accounts generating liquidity in excess of
the amount required to fund our $81.8 million increase in total loans for that
year. This provided for the significant increase in liquid assets in 2000, and
we have maintained this higher level of liquidity during the current fiscal
year. Supplementing customer deposits as a source of funding, we have available
lines of credit from various correspondent banks to purchase federal funds on a
short-term basis of approximately $26.0 million. We also have the ability to
borrow up to $45.7 million, as of December 31, 2001, from the Federal Home Loan
Bank of Atlanta, with $35.0 million outstanding as of that date. At December 31,
2000 we had FHLB borrowings outstanding of $6.0 million. Our loan growth during
2001 has exceeded our growth in customer deposits, and we have taken advantage
of favorable interest rates offered by the FHLB to provide funding for that
higher loan growth. We also had a repurchase agreement with an outstanding
balance of $10.0 million at December 31, 2001. Securities sold under agreements
to repurchase generally mature within ninety days from the transaction date and
are collateralized by U.S. Government Agency obligations. We have repurchase
lines of credit aggregating $37.0 million from various institutions. The
repurchases must be adequately collateralized. At December 31, 2001, our
outstanding commitments to extend credit consisted of loan commitments of $26.5
million and amounts available under home equity credit lines, other credit lines
and standby letters of credit of $27.3 million, $38.1 million and $3.8 million,
respectively. We believe that our combined aggregate liquidity position from all
of these sources is sufficient to meet the funding requirements of loan demand
and deposit maturities and withdrawals in the near term.
Throughout our five-year history, our loan demand has exceeded our
growth in core deposits. We have therefore relied heavily on certificates of
deposits as a source of funds. While the majority of these funds are from our
local market area, the bank has utilized brokered and out-of-market certificates
of deposits to diversify and supplement our deposit base. Certificates of
deposits represented 66% of our total deposits at December 31, 2001, down from
72% at December 31, 2000. Certificates of deposit of $100,000 or more
represented 28.4% of our total deposits at December 31, 2001 and 22% at December
31, 2000. A portion of these deposits are controlled by members of our Board of
Directors and Advisory Board members, or otherwise comes from customers
considered to have long-standing relationships with our management. Based upon
the nature of these relationships, management does not believe we are subject to
significant liquidity risk related to these deposits. Certificates of deposit of
$100,000 or more, exclusive of these relationships, constituted 25% of our total
deposits at December 31, 2001. Large certificates of deposits are generally
considered rate sensitive. However, we believe a portion of our large
certificates of deposits are relationship-oriented, and while will need to pay
competitive rates to retain these deposits at their maturities, there are other
subjective factors that will determine their continued retention.
CAPITAL RATIOS
At December 31, 2001, our capital to asset ratio was 8.8%, and all of
our capital ratios exceeded the minimums established for a well-capitalized bank
by regulatory measures. Our Tier 1 risk-based capital ratio at December 31, 2001
was 10.28%.
The bank is subject to minimum capital requirements. See "Supervision
and Regulation." As the following table indicates, at December 31, 2001, we
exceeded our regulatory capital requirements.
At December 31, 2001
--------------------------------------------------------
Actual Minimum Well-Capitalized
Ratio Requirement Requirement
---------------- ---------------- ----------------
Total risk-based capital ratio................... 11.53% 8.00% 10.00%
Tier 1 risk-based capital ratio.................. 10.28% 4.00% 6.00%
Leverage ratio................................... 9.21% 4.00% 5.00%
Page 23
In February of 2002, Southern Community Capital Trust I (the "Trust"),
a newly formed subsidiary of the company, issued 1,725,000 Cumulative
Convertible Trust Preferred Securities (the "Securities"), generating total
proceeds of $17.3 million. The Securities pay distributions at an annual rate of
7.25% and mature on March 31, 2032. The Securities will pay distributions
quarterly beginning on March 31, 2002. The company has fully and unconditionally
guaranteed the obligations of the Trust. The Securities can be converted at any
time into common stock at a price of $8.67 (the "Conversion Price") or 1.153
shares of the company's common stock for each convertible preferred security.
The Securities issued by the Trust are redeemable in whole or in part at any
time after April 1, 2007. The Securities are also redeemable in whole at any
time prior to March 31, 2007 as long as the trading price of our common stock
has been at least 125% of the Conversion Price for a period of twenty
consecutive trading days ending within five days of the notice of redemption.
The proceeds from the Securities were utilized to purchase convertible junior
subordinated debentures from us under the same terms and conditions as the
Securities. The company has the right to defer payment of interest on the
debentures at any time and from time to time for a period not exceeding five
years, provided that no deferral period extend beyond the stated maturities of
the debentures. Such deferral of interest payments by the company will result in
a deferral of distribution payments on the related Securities. Should the
company defer the payment of interest on the debentures, the company will be
precluded from the payment of cash dividends to shareholders. Subject to certain
limitations, the Securities qualify as Tier 1 capital of the company for
regulatory capital purposes. The principal use of the net proceeds from the sale
of the convertible debentures is to infuse capital to our bank subsidiary,
Southern Community Bank and Trust, to fund its operations and continued
expansion, the operations and continued expansion of the bank's subsidiaries,
and to maintain the bank's status as "well capitalized" under regulatory
guidelines.
ASSET/LIABILITY MANAGEMENT
Our results of operations depend substantially on net interest income.
Like most financial institutions, our interest income and cost of funds are
affected by general economic conditions and by competition in the market place.
The purpose of asset/liability management is to provide stable net interest
income growth by protecting earnings from undue interest rate risk, which arises
from volatile interest rates and changes in the balance sheet mix, and by
managing the risk/return relationships between liquidity, interest rate risk,
market risk and capital adequacy. We adhere to a Board approved asset/liability
management policy that provides guidelines for controlling exposure to interest
rate risk by utilizing the following ratios and trend analysis: liquidity,
equity, volatile liability dependence, and portfolio maturities. Our policy is
to control the exposure of earnings to changing interest rates by generally
endeavoring to maintain a position within a narrow range around an "earnings
neutral position," which is defined as the mix of assets and liabilities that
generate a net interest margin that is least affected by interest rate changes.
When suitable lending opportunities are not sufficient to utilize
available funds, we have generally invested such funds in securities, primarily
U.S. Treasury securities, securities issued by governmental agencies,
mortgage-backed securities and corporate obligations. The securities portfolio
contributes to profitability and plays an important part in our overall interest
rate management. However, management of the securities portfolio alone cannot
balance overall interest rate risk. The securities portfolio must be used in
combination with other asset/liability techniques to actively manage the balance
sheet. The primary objectives in the overall management of the securities
portfolio are safety, liquidity, yield, asset/liability management (interest
rate risk), and investing in securities that can be pledged for public deposits
or for borrowings.
In reviewing the needs of our bank with regard to proper management of
its asset/liability program, we estimate future needs, taking into consideration
historical periods of high loan demand and low deposit balances, estimated loan
and deposit increases (due to increased demand through marketing), and
forecasted interest rate changes. We use a number of measures to monitor and
manage interest rate risk, including income simulations and interest sensitivity
or "gap" analyses. An income simulation model is the primary tool used to assess
the direction and magnitude of changes in net interest income resulting from
changes in interest rates. Key assumptions in the model include prepayment
speeds on mortgage-related assets, cash flows and maturities of other investment
securities, loan and deposit volumes and pricing. These assumptions are
inherently uncertain and, as a result, the model cannot precisely estimate net
interest income or precisely predict the impact of higher or lower interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude and frequency of interest rate changes and changes in
market conditions and management strategies, among other factors. Based on the
results of the income simulation model as of December 31, 2001, we would expect
an increase in net interest income of $1.3 million if interest rates increase
from current rates by 200 basis points over the next twelve months and a
decrease in net interest income of $1.1 million if interest rates decrease from
current rates by 200 basis points over the next twelve months.
Page 24
The analysis of interest rate gap (the difference between the amount of
interest-earning assets and interest-bearing liabilities repricing during a
given period of time) is another standard tool we use to measure exposure to
interest rate risk. We believe that because interest rate gap analysis does not
address all factors that can affect earnings performance, it should be used in
conjunction with other methods of evaluating interest rate risk.
Our balance sheet was asset-sensitive at December 31, 2001 in the
three-month horizon and liability-sensitive in the one-year period. An
asset-sensitive position means that there are more assets than liabilities
subject to repricing in that period as market rates change, and conversely with
a liability-sensitive position. As a result, in a falling rate environment, our
earnings position could deteriorate initially followed by improvement, with the
opposite expectation in a rising rate environment, depending on the correlation
of rate changes in these categories.
The following table presents information about the periods in which the
interest-sensitive assets and liabilities at December 31, 2001 will either
mature or be subject to repricing in accordance with market rates, and the
resulting interest-sensitivity gaps. This table shows the sensitivity of the
balance sheet at one point in time and is not necessarily indicative of what the
sensitivity will be on other dates. Included in interest-bearing liabilities
subject to rate changes within 90 days is 100% of the money market and NOW
deposits. These types of deposits historically have not repriced coincidentally
with or in the same proportion as general market indicators. As simplifying
assumptions concerning repricing behavior, all money market and NOW deposits are
assumed to reprice immediately and fixed rate loans and mortgage-backed
securities are assumed to reprice at their contractual maturity.
At December 31, 2001
------------------------------------------------------------------------------
Over 3 Total
3 Months Months to Within Over 12
or Less 12 Months 12 Months Months Total
------------ ------------ ------------ ------------ ------------
(Dollars in thousands)
Interest-earning assets
Loans $ 205,035 $ 17,743 $ 222,778 $ 137,510 $ 360,288
Investment securities available for sale 1,006 2,044 3,050 27,628 30,678
Investment securities held to maturity - 500 500 34,029 34,529
Federal funds sold 22,926 - 22,926 - 22,926
------------- ------------ ------------- ------------ -------------
Total interest-earning assets $ 228,967 $ 20,287 $ 249,254 $ 199,167 $ 448,421
============= ============ ============= ============ =============
Interest-bearing liabilities
Deposits:
Money market and NOW deposits $ 95,904 $ - $ 95,904 $ - $ 95,904
Time deposits greater than $100,000 24,501 67,258 91,759 19,782 111,541
Other time deposits 25,448 105,643 131,091 18,113 149,204
Borrowings 9,980 10,000 19,980 25,000 44,980
------------- ------------ ------------- ------------ -------------
Total interest-bearing liabilities $ 155,833 $ 182,901 $ 338,734 $ 62,895 $ 401,629
============= ============ ============= ============ =============
Interest sensitivity gap per period $ 73,134 $ (162,614) $ (89,480) $ 136,272 $ 46,792
Cumulative gap $ 73,134 $ (89,480) $ (89,480) $ 46,792 $ 46,792
Cumulative ratio of interest-sensitive
assets to interest-sensitive liabilities 146.93% 73.58% 73.58% 111.65% 111.65%
Page 25
MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market price and interest rates. This risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods. Our market risk arises primarily from interest rate risk
inherent in our lending and deposit-taking activities. The structure of our loan
and deposit portfolios is such that a significant decline in interest rates may
adversely impact net market values and net interest income. We do not maintain a
trading account nor are we subject to currency exchange risk or commodity price
risk. Interest rate risk is monitored as part of the bank's asset/liability
management function, which is discussed in "Asset/Liability Management" above.
The following table presents information about the contractual maturities,
average interest rates and estimated fair values of our financial instruments
that are considered market risk sensitive at December 31, 2001.
Expected Maturities of Market Sensitive Instruments Held
at December 31, 2001 Occurring in the Indicated Year
-------------------------------------------------------------------------------
Average
Beyond Interest Estimated
2002 2003 2004 2005 2006 Five Years Total Rate Fair Value
--------- --------- -------- --------- --------- ---------- --------- -------- -----------
(Dollars in thousands)
FINANCIAL ASSETS
Federal funds sold $ 22,926 $ - $ - $ - $ - $ - $ 22,926 1.72% $ 22,926
Debt securities 37,483 11,821 2,695 5,669 - 7,539 65,207 6.41% 65,903
Loans (1):
Fixed rate 23,244 11,317 22,378 28,009 28,953 46,473 160,374 7.03% 160,824
Variable rate 90,521 12,729 9,447 9,873 26,741 50,603 199,914 5.20% 200,464
--------- --------- -------- --------- --------- --------- --------- ---------
Total $ 174,174 $ 35,867 $ 34,520 $ 43,551 $ 55,694 $ 104,615 $ 448,421 5.85% $ 450,117
========= ========= ======== ========= ========= ========= ========= =========
FINANCIAL LIABILITIES
Money market and NOW
deposits $ 47,953 $ 19,180 $ 14,385 $ 9,590 $ 4,796 $ - $ 95,904 1.45% $ 96,021
Time deposits 222,851 15,492 9,565 303 12,434 100 260,745 4.64% 261,059
Borrowings 19,980 10,000 10,000 - 5,000 - 44,980 4.14% 45,065
--------- --------- -------- --------- --------- --------- --------- ---------
Total $ 290,784 $ 44,672 $ 33,950 $ 9,893 $ 22,230 $ 100 $ 401,629 3.74% $ 402,145
========= ========= ======== ========= ========= ========= ========= =========
(1) Nonaccrual loans are included in the balance of loans. The allowance
for loan losses is excluded.
Page 26
QUARTERLY FINANCIAL INFORMATION
The following table sets forth, for the periods indicated, certain of our
consolidated quarterly financial information. This information is derived from
our unaudited financial statements, which include, in the opinion of management,
all normal recurring adjustments which management considers necessary for a fair
presentation of the results for such periods. This information should be read in
conjunction with our Financial Statements included elsewhere in this report. The
results for any quarter are not necessarily indicative of results for any future
period.
Year Ended December 31, 2001 Year Ended December 31, 2000
-------------------------------------------- -------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
--------- --------- ------- -------- --------- -------- -------- --------
(In thousands, except per share data)
Interest income $ 7,399 $ 8,080 $ 7,820 $ 8,067 $ 7,982 $ 7,333 $ 6,310 $ 5,206
Interest expense 3,875 4,564 4,751 4,844 4,695 4,191 3,378 2,680
--------- --------- ------- -------- ------- ------- ------- -------
Net interest income 3,524 3,516 3,069 3,223 3,287 3,142 2,932 2,526
Provision for loan losses 820 625 440 435 350 370 540 220
--------- --------- ------- -------- ------- ------- ------- -------
Net interest income
after provision for
loan losses 2,704 2,891 2,629 2,788 2,937 2,772 2,392 2,306
Non-interest income 785 784 1,001 832 648 570 600 380
Non-interest expense 2,858 2,890 2,738 2,676 2,542 2,281 2,080 1,820
--------- --------- ------- -------- ------- ------- ------- -------
Income before income
taxes 631 785 892 944 1,043 1,061 912 866
Income taxes 228 278 285 356 394 401 345 326
--------- --------- ------- -------- ------- ------- ------- -------
Net income $ 403 $ 507 $ 607 $ 588 $ 649 $ 660 $ 567 $ 540
========= ========= ======= ======== ======= ======= ======= =======
Per share data (1):
Net income:
Basic $ .05 $ .06 $ .07 $ .07 $ .08 $ .09 $ .07 $ .07
Diluted .05 .06 .07 .07 .08 .08 .07 .07
Common stock price:
High $ 8.65 $ 7.62 $ 7.86 $ 8.57 $ 8.69 $ 9.09 $ 9.09 $ 9.52
Low 5.00 5.52 6.90 7.02 6.49 6.49 6.49 7.79
(1) Per share data has been adjusted to reflect the dilutive effect of a stock
split effected in the form of a 10% stock dividend in 2000 and a 5% stock
dividend in 2001.
Page 27
LENDING ACTIVITIES
General. We provide to our customers residential, commercial and
construction loans secured by real estate, as well as a full range of short- to
medium-term commercial and industrial, Small Business Administration guaranteed
and personal loans, both secured and unsecured. We have implemented loan
policies and procedures that establish the basic guidelines governing our
lending operations. Generally, those guidelines address the types of loans that
we seek, our target markets, underwriting and collateral requirements, terms,
interest rate and yield considerations and compliance with laws and regulations.
All loans or credit lines are subject to approval procedures and amount
limitations. These limitations apply to the borrower's total outstanding
indebtedness to us, including the indebtedness of any guarantor. The policies
are reviewed and approved at least annually by our Board of Directors. We
supplement our supervision of the loan underwriting and approval process with
periodic loan audits by internal loan examiners and outside professionals
experienced in loan review work. We have focused our lending activities on the
types of loans that we believe will be most in demand by our target customers,
as presented in the loan portfolio composition tables below:
At December 31,
--------------------------------------------------------------------------
2001 2000 1999
----------------------- ----------------------- -----------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
---------- ---------- ----------- ---------- ---------- -----------
(Dollars in thousands)
Residential mortgage loans $ 105,357 29.2% $ 84,280 29.9% $ 65,399 32.6%
Commercial mortgage loans 89,354 24.8% 59,410 21.0% 38,293 19.1%
Construction loans 61,558 17.1% 52,800 18.7% 32,427 16.2%
Commercial and industrial loans 77,820 21.6% 60,280 21.4% 44,563 22.3%
Loans to individuals 26,199 7.3% 25,391 9.0% 19,630 9.8%
---------- ---------- ----------- ---------- ---------- -----------
Subtotal 360,288 100.0% 282,161 100.0% 200,312 100.0%
========== ========== ===========
Less: Allowance for loan losses (5,400) (4,283) (3,013)
---------- ----------- ----------
Net loans $ 354,888 $ 277,878 $ 197,299
========== =========== ==========
At December 31,
---------------------------------------------------
1998 1997
-------------------------- -----------------------
Percent Percent
Amount of Total Amount of Total
------------- ----------- ---------- ----------
(Dollars in thousands)
Residential mortgage loans $ 41,261 32.5% $ 16,498 34.4%
Commercial mortgage loans 26,077 20.5% 9,081 19.0%
Construction loans 16,569 13.0% 5,765 12.0%
Commercial and industrial loans 30,208 23.8% 11,800 24.6%
Loans to individuals 12,980 10.2% 4,793 10.0%
------------- ----------- ---------- ----------
Subtotal 127,095 100.0% 47,937 100.0%
=========== ==========
Less: Allowance for loan losses (1,905) (725)
------------- ----------
Net loans $ 125,190 $ 47,212
============= ==========
Page 28
The following table presents at December 31, 2001 (i) the aggregate
maturities of loans in the named categories of our loan portfolio and (ii) the
aggregate amounts of such loans, by variable and fixed rates, that mature after
one year:
December 31, 2001
-----------------------------------------------------------------
Within 1 Year 1-5 Years After 5 Years Total
------------- ------------- ------------- -------------
(Dollars in thousands)
Commercial and industrial
and commercial mortgage $ 56,103 $ 72,891 $ 38,180 $ 167,174
Real estate - construction 40,311 18,480 2,767(*) 61,558
------------- ------------- ------------- -------------
Total $ 96,414 $ 91,371 $ 40,947 $ 228,732
============= ============= ============= =============
Fixed rate loans $ 77,859
Variable rate loans 54,459
-------------
$ 132,318
=============
(*) Consists principally of real estate construction loans for which
permanent financing is to be provided upon completion of the construction phase.
Real Estate Loans. Real estate loans represent our greatest
concentration of loans, and are divided into three categories: residential
mortgage, commercial mortgage, and construction loans. We make real estate loans
for purchasing, constructing and refinancing one to four family residential,
five or more family residential and commercial properties. We also make loans
secured by real estate to commercial and individual borrowers who use the loan
proceeds for other purposes. Our real estate loans totaled $256.3 million at
December 31, 2001, representing 71.1% of our total loans outstanding. Our loan
policy requires appraisal prior to funding a real estate loan and also outlines
the policy for requirements for appraisals on renewals.
We pursue an aggressive policy of evaluation and monitoring on any real
estate loan that becomes troubled, including reappraisal when appropriate. We
recognize and reserve for potential exposures as soon as we identify them.
However, the pace of absorption of real properties is affected both by each
property's individual nature and characteristics, the status of the real estate
market at the time, general economic conditions and other factors that could
adversely affect our volume of non-performing real estate loans and our ability
to dispose of foreclosed properties without loss.
Residential Mortgage Loans. Many of the fixed rate one to four family
owner occupied residential mortgage loans that we make are originated for the
account of third parties. We provide our customers access to long-term
conventional real estate loans through the origination of Federal National
Mortgage Association-conforming loans for the account of third parties. Such
loans are closed by the third party and therefore are not shown in our financial
statements. We receive a fee for each such loan originated, with such fees
aggregating $1.0 million for the year ended December 31, 2001 and $550,000 for
the year ended December 31, 2000. We anticipate that we will continue to be an
active originator of residential loans for the account of third parties.
Residential loans are generated through our in-house staff as well as
the bank's existing customer base, referrals from real estate agents and
builders, and local marketing efforts. Our lending efforts include the
origination of loans secured by first mortgages on one to four family residences
and on home equity credit lines. Our residential mortgage loans totaled $105.4
million at December 31, 2001, and included $51.0 million in one-to-four family
permanent mortgage loans, $41.6 million in outstanding advances under home
equity credit lines, and $12.8 million of other loans secured by residential
real estate. Of our residential mortgage loans, 54% have variable rates of
interest while 46% have fixed interest rates. Substantially all of our
residential mortgage loans are secured by properties located within our market
area, although we will make loans secured by properties outside our market area
to qualifying existing customers. We believe that the amount of risk associated
with this group of loans is
Page 29
mitigated in part due to the type of loans involved. Historically, the amount of
losses suffered on this type of loan has been significantly less than those
loans collateralized by other types of properties.
Our one to four family residential loans generally have maturities
ranging from 1 to 30 years. These loans are either fully amortizing with monthly
payments sufficient to repay the total amount of the loan or amortizing with a
balloon feature, typically due in fifteen years or less. We review information
concerning the income, financial condition, employment history and credit
history when evaluating the creditworthiness of an applicant for a residential
mortgage loan.
Commercial Mortgage Loans. Our commercial mortgage loans totaled $89.4
million at December 31, 2001. These loans are secured principally by commercial
buildings for office, retail, manufacturing, storage and warehouse space
properties. Generally in underwriting commercial mortgage loans, we require the
personal guaranty of borrowers and a demonstrated cash flow capability
sufficient to service the debt. Loans secured by commercial real estate may be
in greater amount and involve a greater degree of risk than one to four family
residential mortgage loans, and payments on such loans are often dependent on
successful operation or management of the properties and the underlying
business. We make commercial mortgage loans at both fixed and variable rates for
terms generally up to 15 years. Of our commercial mortgage loans, 36% have
variable rates of interest while 64% have fixed interest rates.
Construction Loans. We originate one to four family residential
construction loans for the construction of custom homes (where the home buyer is
the borrower), and we provide construction financing to builders. We have a
staff of lending professionals and assistants who service only our construction
loan portfolio. We generally receive a pre-arranged permanent financing
commitment from an outside banking entity prior to financing the construction of
pre-sold homes. We lend to builders who have demonstrated a favorable record of
performance and profitable operations and who are building in our market area.
We also make commercial real estate construction loans, as noted in the
preceding paragraph. We endeavor to limit our construction lending risk through
adherence to established underwriting procedures. Also, we generally require
documentation of all draw requests and utilize loan officers to inspect the
project prior to paying any draw requests from the builder. With few exceptions,
the bank requires personal guarantees and secondary sources of repayment on
construction loans. Construction loans aggregated $61.6 million at December 31,
2001.
Commercial Loans. Commercial business lending is a primary focus of our
lending activities. At December 31, 2001, our commercial loan portfolio equaled
$77.8 million or 21.6% of total loans. Commercial loans include both secured and
unsecured loans for working capital, expansion, and other business purposes.
Short-term working capital loans generally are secured by accounts receivable,
inventory and/or equipment. The bank also makes term commercial loans secured by
equipment and real estate. Lending decisions are based on an evaluation of the
financial strength, management and credit history of the borrower, and the
quality of the collateral securing the loan. With few exceptions, the bank
requires personal guarantees and secondary sources of repayment.
Commercial loans generally provide greater yields and re-price more
frequently than other types of loans, such as real estate loans. More frequent
re-pricing means that yields on our commercial loans adjust with changes in
interest rates.
Loans to Individuals. Loans to individuals include automobile loans,
boat and recreational vehicle financing, and miscellaneous secured and unsecured
personal loans. Consumer loans generally can carry significantly greater risks
than other loans, even if secured, if the collateral consists of rapidly
depreciating assets such as automobiles and equipment. Repossessed collateral
securing a defaulted consumer loan may not provide an adequate source of
repayment of the loan. We attempt to manage the risks inherent in consumer
lending by following established credit guidelines and underwriting practices
designed to minimize risk of loss.
Loan Approvals. Our loan policies and procedures establish the basic
guidelines governing our lending operations. Generally, the guidelines address
the type of loans that we seek, our target markets, underwriting and collateral
requirements, terms, interest rate and yield considerations and compliance with
laws and regulations. All loans or credit lines are subject to approval
procedures and amount limitations. These limitations apply to the borrower's
total outstanding indebtedness to us, including the indebtedness of any
guarantor. The policies are
Page 30
reviewed and approved at least annually. We supplement our supervision of the
loan underwriting and approval process with periodic loan audits by independent,
outside professionals experienced in loan review work.
Individual lending authorities are established by the Board of
Directors as periodically requested by Management. All individual lending
authorities are reviewed and approved at least annually by the Board of
Directors.
The Board Loan Committee consists of the CEO, President, Managing SVP
of Commercial Lending, VP in charge of Credit Administration, and four outside
Directors as appointed by the Board of Directors. This Committee meets on a
monthly basis to review for approval, all loan requests in excess of $2 million.
As of December 31, 2001, the legal lending limit for the bank was approximately
$7.1 million.
COMMITMENTS AND CONTINGENT LIABILITIES
In the ordinary course of business, we enter into various types of
transactions that include commitments to extend credit that are not included in
loans receivable as presented on our consolidated balance sheets. We apply the
same credit standards to these commitments as we use in all of our lending
activities, and we include these commitments in our lending risk evaluations.
Our exposure to credit loss under commitments to extend credit is represented by
the amount of these commitments. See "Notes to Financial Statements."
ASSET QUALITY
We consider asset quality to be of primary importance. We employ a
formal internal loan review process to ensure adherence to the Lending Policy as
approved by the Board of Directors. It is the responsibility of each lending
officer to assign an appropriate risk grade to every loan originated. Credit
Administration, through the loan review process, validates the accuracy of the
initial risk grade assessment. In addition, as a given loan's credit quality
improves or deteriorates, it is Credit Administration's responsibility to change
the borrowers risk grade accordingly. The function of determining the allowance
for loan losses is fundamentally driven by the risk grade system. As part of the
loan review function, we use a third party professional to review the
underwriting documentation and risk grading analysis. In determining the
allowance for loan losses and any resulting provision to be charged against
earnings, particular emphasis is placed on the results of the loan review
process. We also give consideration to historical loan loss experience, the
value and adequacy of collateral, economic conditions in our market area and
other factors. For loans determined to be impaired, the allowance is based on
discounted cash flows using the loan's initial effective interest rate or the
fair value of the collateral for certain collateral dependent loans. This
evaluation is inherently subjective as it requires material estimates, including
the amounts and timing of future cash flows expected to be received on impaired
loans that may be susceptible to significant change. The allowance for loan
losses represents management's estimate of the appropriate level of reserve to
provide for probable losses inherent in the loan portfolio.
Our policy in regard to past due loans normally requires a prompt
charge-off to the allowance for loan losses following timely collection efforts
and a thorough review. Further efforts are then pursued through various means
available. Loans carried in a non-accrual status are generally collateralized
and the possibility of future losses is considered in the determination of the
allowance for loan losses.
Page 31
NONPERFORMING ASSETS
The table sets forth, for the period indicated, information about our
nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual
loans plus restructured loans), and total nonperforming assets.
At December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Nonaccrual loans $ 894 $ 276 $ - $ 15 $ -
Restructured loans - - - - -
---------- ---------- ---------- ---------- ----------
Total nonperforming loans 894 276 - 15 -
Real estate owned 347 4 - - -
---------- ---------- ---------- ---------- ----------
Total nonperforming assets $ 1,241 $ 280 $ - $ 15 $ -
========== ========== ========== ========== ==========
Accruing loans past due
90 days or more $ - $ 15 $ 7 $ - $ 2
Allowance for loan losses 5,400 4,283 3,013 1,905 725
Nonperforming loans to
period end loans .25% .10% .00% .01% .00%
Allowance for loan losses
to period end loans 1.50% 1.52% 1.50% 1.50% 1.51%
Allowance for loan losses
to nonperforming loans 604% 1,552% NM 12,700% NM
Nonperforming assets to
total assets .26% .07% .00% .01% .00%
Our financial statements are prepared on the accrual basis of
accounting, including the recognition of interest income on loans, unless we
place a loan on nonaccrual basis. We account for loans on a nonaccrual basis
when we have serious doubts about the collectibility of principal or interest.
Generally, our policy is to place a loan on nonaccrual status when the loan
becomes past due 90 days. We also place loans on nonaccrual status in cases
where we are uncertain whether the borrower can satisfy the contractual terms of
the loan agreement. Amounts received on nonaccrual loans generally are applied
first to principal and then to interest only after all principal has been
collected. Restructured loans are those for which concessions, including the
reduction of interest rates below a rate otherwise available to that borrower or
the deferral of interest or principal, have been granted due to the borrower's
weakened financial condition. We record interest on restructured loans at the
restructured rates, as collected, when we anticipate that no loss of original
principal will occur. Potential problem loans are loans which are currently
performing and are not included in nonaccrual or restructured loans above, but
about which we have serious doubts as to the borrower's ability to comply with
present repayment terms. These loans are likely to be included later in
nonaccrual, past due or restructured loans, so they are considered by our
management in assessing the adequacy of our allowance for loan losses. At
December 31, 2001, we had identified no loans as potential problem loans.
At December 31, 2001, we had $894,000 of nonaccrual loans. The largest
nonaccrual balance to any one borrower was $303,000, with the average balance
for the 21 nonaccrual loans being $42,500. Interest on nonaccrual loans foregone
was approximately $60,000 for the year ended December 31, 2001 and $4,000 for
the year ended December 31, 2000.
Real estate owned consists of foreclosed, repossessed and idled
properties. At December 31, 2001 real estate owned totaled $347,000 or .07% of
total assets, and consisted of a residential property with a carrying value of
$268,000 and a commercial property with a carrying value of $79,000. We have
reviewed a recent appraisal of this property and believe that its fair value,
less estimated costs to sell, exceeds its carrying value.
Page 32
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
Our allowance for loan losses is established through charges to
earnings in the form of a provision for loan losses. We increase our allowance
for loan losses by provisions charged to operations and by recoveries of amounts
previously charged off, and we reduce our allowance by loans charged off. We
evaluate the adequacy of the allowance at least quarterly. In addition, on a
quarterly basis our Board of Directors reviews our loan portfolio, conducts an
evaluation of our credit quality and reviews our computation of the loan loss
provision, recommending changes as may be required. In evaluating the adequacy
of the allowance, we consider the growth, composition and industry
diversification of the portfolio, historical loan loss experience, current
delinquency levels, adverse situations that may affect a borrower's ability to
repay, estimated value of any underlying collateral, prevailing economic
conditions and other relevant factors deriving from our limited history of
operations. Because we have a limited history of our own, we also consider the
loss experience and allowance levels of other similar banks and the historical
experience encountered by our management and senior lending officers prior to
joining us. In addition, regulatory agencies, as an integral part of their
examination process, periodically review our allowance for loan losses and may
require us to make additions for estimated losses based upon judgments different
from those of our management.
We use our risk grading program, as described under "ASSET QUALITY," to
facilitate our evaluation of probable inherent loan losses and the adequacy of
the allowance for loan losses. In this program, risk grades are initially
assigned by loan officers, reviewed by Credit Administration, and tested by our
internal auditor and by an independent professional. The testing program
includes an evaluation of a sample of new loans, large loans, loans that are
identified as having potential credit weaknesses, loans past due 90 days or
more, and nonaccrual loans. We strive to maintain our loan portfolio in
accordance with conservative loan underwriting policies that result in loans
specifically tailored to the needs of our market area. Every effort is made to
identify and minimize the credit risks associated with such lending strategies.
We have no foreign loans and we do not engage in lease financing or highly
leveraged transactions.
We follow a loan review program designed to evaluate the credit risk in
our loan portfolio. Through this loan review process, we maintain an internally
classified watch list that helps management assess the overall quality of the
loan portfolio and the adequacy of the allowance for loan losses. In
establishing the appropriate classification for specific assets, management
considers, among other factors, the estimated value of the underlying
collateral, the borrower's ability to repay, the borrower's payment history and
the current delinquent status. As a result of this process, certain loans are
categorized as substandard, doubtful or loss and reserves are allocated based on
management's judgment and historical experience.
Loans classified as "substandard" are those loans with clear and
defined weaknesses such as unfavorable financial ratios, uncertain repayment
sources or poor financial condition that may jeopardize the liquidation of the
debt. They are characterized by the distinct possibility that we will sustain
some losses if the deficiencies are not corrected. A reserve of 20% is generally
allocated to these loans. Loans classified as "doubtful" are those loans that
have characteristics similar to substandard loans but with an increased risk
that collection or liquidation in full is highly questionable and improbable. A
reserve of 50% is generally allocated to loans classified as doubtful. Loans
classified as "loss" are considered uncollectible and of such little value that
their continuance as bankable assets is not warranted. This classification does
not mean that the loan has absolutely no recovery or salvage value but rather it
is not practical or desirable to defer writing off this asset even though
partial recovery may be achieved in the future. As a practical matter, when
loans are identified as loss they are charged off against the allowance for loan
losses. In addition to the above classification categories, we also categorize
loans based upon risk grade and loan type, assigning an allowance allocation
based upon each category.
Growth in loans outstanding has, throughout our history, been the
primary reason for increases in our allowance for loan losses and the resultant
provisions for loan losses necessary to provide for those increases. This growth
has been spread among our major loan categories, with the concentrations of
major loan categories being relatively consistent in recent years. Between
December 31, 1997 and December 31, 2001, the range of each major category of
loans as a percentage of total loans outstanding is as follows: residential
mortgage loans - 29.2% to 34.4%; commercial mortgage loans - 19.0% to 24.8%;
construction loans - 12.0% to 18.7%; commercial and industrial loans - 21.4% to
24.6%; and loans to individuals - 7.3% to 10.2%. For all full fiscal years
through 2000, our loan loss experience was similar to that of other new banks,
with net loan charge-offs in each year of less than .10% of average loans
outstanding. Our percentage of net loan charge-offs to average loans outstanding
was .38% for the
Page 33
year ended December 31, 2001. The higher level of net loan charge-offs during
2001 was a significant factor contributing to the increased provision for loan
losses compared to 2000. Our allowance for loan losses at December 31, 2001 of
$5.4 million represents 1.50% of total loans and 604% of nonperforming loans.
The allowance for loan losses represents management's estimate of an
amount adequate to provide for known and inherent losses in the loan portfolio
in the normal course of business. We make specific allowances that are allocated
to certain individual loans and pools of loans based on risk characteristics, as
discussed below. In addition to the allocated portion of the allowance for loan
losses, we maintain an unallocated portion that is not assigned to any specific
category of loans. This unallocated portion is intended to reserve for the
inherent risk in the portfolio and the intrinsic inaccuracies associated with
the estimation of the allowance for loan losses and its allocation to specific
loan categories. While management believes that it uses the best information
available to establish the allowance for loan losses, future adjustments to the
allowance may be necessary and results of operations could be adversely affected
if circumstances differ substantially from the assumptions used in making the
determinations. Furthermore, while we believe we have established the allowance
for loan losses in conformity with generally accepted accounting principles,
there can be no assurance that regulators, in reviewing our portfolio, will not
require an increase in our allowance for loan losses. In addition, because
future events affecting borrowers and collateral cannot be predicted with
certainty, there can be no assurance that the existing allowance for loan losses
is adequate or that increases will not be necessary should the quality of any
loans deteriorate as a result of the factors discussed herein. Any material
increase in the allowance for loan losses may adversely affect our financial
condition and results of operations.
The following table describes the allocation of the allowance for loan
losses among various categories of loans and certain other information for the
dates indicated. The allocation is made for analytical purposes only and is not
necessarily indicative of the categories in which future losses may occur.
At December 31,
--------------------------------------------------------------------------
2001 2000 1999
----------------------- ----------------------- -----------------------
% of Total % of Total % of Total
Amount Loans (1) Amount Loans (1) Amount Loans (1)
---------- ---------- ----------- ------------- ------------- ---------
(Dollars in thousands)
Residential mortgage loans $ 550 29.2% $ 350 29.9% $ 125 32.6%
Commercial mortgage loans 825 24.8% 525 21.0% 425 19.1%
Construction loans 1,000 17.1% 900 18.7% 750 16.2%
Commercial and
industrial loans 1,100 21.6% 900 21.4% 725 22.3%
Loans to individuals 925 7.3% 650 9.0% 225 9.8%
Unallocated 1,000 -% 958 -% 763 -%
---------- --------- ----------- --------- ---------- -------
Total $ 5,400 100.0% $ 4,283 100.0% $ 3,013 100.0%
========== ========= =========== ========= ========== =======
At December 31,
------------------------------------------------
1998 1997
----------------------- ----------------------
% of Total % of Total
Amount Loans (1) Amount Loans (1)
---------- ---------- -------- ----------
(Dollars in thousands)
Residential mortgage loans $ 125 32.5% $ 50 34.4%
Commercial mortgage loans 375 20.5% 70 19.0%
Construction loans 250 13.0% 100 12.0%
Commercial and
industrial loans 450 23.8% 160 24.6%
Loans to individuals 225 10.2% 100 10.0%
Unallocated 480 -% 245 -%
---------- --------- --------- ---------
Total $ 1,905 100.0% $ 725 100.0%
========== ========= ========= =========
(1) Represents total of all outstanding loans in each category as a percent of
total loans outstanding.
Page 34
The following table presents for the periods indicated information
regarding changes in our allowance for loan losses:
At or for the Years Ended December 31,
-----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Balance at beginning of period $ 4,283 $ 3,013 $ 1,905 $ 725 $ 75
---------- ---------- ---------- ---------- ----------
Charge-offs:
Residential mortgage loans 115 - 28 - -
Commercial mortgage loans 53 - - - -
Construction loans - - - 20 -
Commercial and industrial loans 416 122 5 - -
Loans to individuals 663 90 14 2 -
---------- ---------- ---------- ---------- ----------
Total charge-offs 1,247 212 47 22 -
---------- ---------- ---------- ---------- ----------
Recoveries:
Construction loans - - 20 - -
Commercial and industrial loans 29 1 - - -
Loans to individuals 15 1 - 2 -
---------- ---------- ---------- ---------- ----------
Total recoveries 44 2 20 2 -
---------- ---------- ---------- ---------- ----------
Net charge-offs (1,203) (210) (27) (20) -
Provision for loan losses 2,320 1,480 1,135 1,200 650
---------- ---------- ---------- ---------- ----------
Balance at end of period $ 5,400 $ 4,283 $ 3,013 $ 1,905 $ 725
========== ========== ========== ========== ==========
Total loans outstanding $ 360,288 $ 282,161 $ 200,312 $ 127,095 $ 47,937
Average loans outstanding $ 318,696 $ 240,888 $ 160,718 $ 89,442 $ 26,593
Allowance for loan losses to
loans outstanding 1.50% 1.52% 1.50% 1.50% 1.51%
Ratio of net loan charge-offs to
average loans outstanding .38% .09% .02% .02% .00%
INVESTMENT ACTIVITIES
Our investment portfolio plays a primary role in management of
liquidity and interest rate sensitivity and, therefore, is managed in the
context of the overall balance sheet. The securities portfolio generates a
substantial percentage of our interest income and serves as a necessary source
of liquidity. We account for investment securities as follows:
- Held to Maturity. Debt securities for which we have the positive
intent and ability to hold until maturity are classified as held to maturity and
are carried at their remaining unpaid principal balance, net of unamortized
premiums or unaccreted discounts. Premiums are amortized and discounts are
accreted using a method that approximates the level interest yield method over
the estimated remaining term of the underlying security.
- Available for Sale. Debt and equity securities that will be held for
indefinite periods of time, including securities that we may sell in response to
changes in market interest or prepayment rates, needs for liquidity and changes
in the availability of and the yield of alternative investments are classified
as available for sale. We carry these investments at market value, which we
generally determine using published quotes as of the close of business.
Unrealized gains and losses
Page 35
are excluded from our earnings and are reported, net of applicable income tax,
as a component of accumulated other comprehensive income or loss in
stockholders' equity until realized.
Management attempts to deploy investable funds into instruments that
are expected to increase the overall return of the portfolio given the current
assessment of economic and financial conditions, while maintaining acceptable
levels of capital, and interest rate and liquidity risk.
The following table summarizes the amortized costs, gross unrealized
gains and losses and the resulting market value of securities at the dates
indicated:
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------- ------------- ------------- -------------
(Dollars in thousands)
DECEMBER 31, 2001
Securities available for sale:
U.S. Government agencies $ 22,172 $ 1,162 $ - $ 23,334
Mortgage-backed 4,271 147 - 4,418
Other 2,926 - - 2,926
------------- ------------- ------------- -------------
$ 29,369 $ 1,309 $ - $ 30,678
============= ============= ============= =============
Securities held to maturity:
U.S. Government agencies $ 33,500 $ 664 $ 2 $ 34,162
Mortgage-backed 1,029 34 - 1,063
------------- ------------- ------------- -------------
$ 34,529 $ 698 $ 2 $ 35,225
============= ============= ============= =============
DECEMBER 31, 2000
Securities available for sale:
U.S. Government agencies $ 31,663 $ 480 $ 50 $ 32,093
Mortgage-backed 5,970 83 6 6,047
Other 865 - - 865
------------- ------------- ------------- -------------
$ 38,498 $ 563 $ 56 $ 39,005
============= ============= ============= =============
Securities held to maturity:
U.S. Government agencies $ 18,535 $ 196 $ 34 $ 18,697
Mortgage-backed 1,709 19 6 1,722
------------- ------------- ------------- -------------
$ 20,244 $ 215 $ 40 $ 20,419
============= ============= ============= =============
Page 36
The following table presents the carrying values, fair values,
intervals of maturities or repricings, and weighted average yields of our
investment portfolio at December 31, 2001:
Weighted
Amortized Fair Average/
Cost Value Yield
-------------- --------------- --------------
(Amounts in thousands)
Securities available for sale:
U.S. Government agencies
Due within one year $ 3,000 $ 3,050 5.30%
Due after one but within five years 7,490 7,840 6.84%
Due after five but within ten years 11,682 12,445 7.08%
-------------- ---------------
22,172 23,335 6.77%
-------------- ---------------
Mortgage-backed
Due after one but within five years 265 287 5.57%
Due after five but within ten years 4,006 4,131 6.52%
-------------- ---------------
4,271 4,418 6.46%
-------------- ---------------
Other
Due after ten years 2,926 2,926 4.77%
-------------- ---------------
Total securities available for sale
Due within one year 3,000 3,050 5.30%
Due after one but within five years 7,755 8,127 6.80%
Due after five but within ten years 15,688 16,576 6.94%
Due after ten years 2,926 2,926 4.77%
-------------- ---------------
$ 29,369 $ 30,679 6.53%
============== ===============
Securities held to maturity:
U. S. Government agencies
Due within one year $ 500 $ 504 5.03%
Due after one but within five years 8,000 8,316 6.72%
Due after five but within ten years 3,000 3,176 6.83%
Due after ten years 22,000 22,166 6.99%
-------------- ---------------
33,500 34,162 6.88%
-------------- ---------------
Mortgage-backed
Due after one but within five years 546 574 5.69%
Due after five but within ten years 483 489 7.25%
-------------- ---------------
1,029 1,063 6.42%
-------------- ---------------
Total securities held to maturity
Due within one year 500 504 5.03%
Due after one but within five years 8,546 8,890 6.65%
Due after five but within ten years 3,483 3,665 6.89%
Due after ten years 22,000 22,166 6.99%
-------------- ---------------
$ 34,529 $ 35,225 6.87%
============== ===============
At December 31, 2001, there were no securities of any issuer (other
than governmental agencies) that exceeded 10% of the bank's stockholder's
equity.
A derivative is a financial instrument that derives its cash flows, and
therefore its value, by reference to an underlying instrument, index or
reference rate. These instruments primarily consist of interest rate swaps,
caps, floors, financial forward and futures contracts and options written or
purchased. Derivative contracts are written in amounts referred to as notional
amounts. Notional amounts only provide the basis for calculating payments
between counterparties and do not represent amounts to be exchanged between
parties and are not a measure of financial risks. Credit risk arises when
amounts receivable from a counterparty exceed amounts payable. Throughout most
of our history, until recently, we have not used derivative instruments to
manage interest rate sensitivity and net interest income, although our policies
provide for their use and we continually evaluate their appropriateness. We
control our risk of loss on derivative contracts by subjecting counterparties to
credit reviews and
Page 37
approvals similar to those used in making loans and other extensions of credit.
Late in 2000, in anticipation of declining interest rates, we bought an interest
rate floor contract with a notional amount of $20 million, which we subsequently
sold in 2001. We recognized income aggregating $383,000 on this floor contract
in 2001, including the gain realized upon its disposal, in non-interest income.
We currently hold no derivative instruments, although we may use them in the
future in situations where we believe their use to be appropriate.
SOURCES OF FUNDS
Deposit Activities
We provide a range of deposit services, including non-interest bearing
checking accounts, interest bearing checking and savings accounts, money market
accounts and certificates of deposit. These accounts generally earn interest at
rates established by management based on competitive market factors and our
desire to increase or decrease certain types or maturities of deposits. We have,
on a limited basis, used brokered deposits and out of market deposits as funding
sources. As of December 31, 2001, we have $22.0 million of brokered deposits and
$39.0 million of out of market deposits. However, we strive to establish
customer relations to attract core deposits in non-interest bearing
transactional accounts and thus to reduce our costs of funds.
The following table sets forth for the periods indicated the average
balances outstanding and average interest rates for each or our major categories
of deposits.
For the Years Ended December 31,
--------------------------------------------------------------------
2001 2000 1999
------------------- --------------------- ----------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
---------- -------- ----------- -------- -------- ---------
(Dollars in thousands)
Interest bearing NOW and money market accounts $ 80,695 2.65% $ 52,144 3.99% $ 43,044 3.42%
Time deposits greater than $100,000 96,542 6.00% 68,553 6.25% 47,405 6.04%
Other time deposits 155,979 5.81% 130,752 6.29% 79,621 5.20%
-------- -------- --------
Total interest-bearing deposits 333,216 5.10% 251,449 5.80% 170,070 4.98%
Demand and other noninterest-bearing deposits 25,749 20,932 15,548
-------- -------- --------
Total average deposits $358,965 4.73% $272,381 5.36% $185,618 4.57%
======== ======== ========
The following table presents the amounts and maturities of our
certificates of deposit with balances of $100,000 or more at December 31, 2001:
At December 31, 2001
--------------------
(In thousands)
Remaining maturity:
Less than three months $ 24,501
Three to twelve months 67,258
Over twelve months 19,782
------------
Total $ 111,541
============
Page 38
Borrowings
As an additional source of funding, we use advances from the Federal
Home Loan Bank of Atlanta. As set forth in the following table, outstanding
advances at December 31, 2001 totaled $35.0 million, and are secured by loans
with a carrying amount of $27.7 million, which approximates market value, and
investment securities with a market value of $22.4 million. Available additional
borrowings, based on the collateral value of these assets, was $15.1 million at
December 31, 2001.
Interest
Maturity Rate Amount
--------------------- ------------- ------------
(In thousands)
July 11, 2002 4.15% $ 10,000
June 6, 2003 4.84% 10,000
June 1, 2004 5.35% 10,000
September 19, 2011 4.43% 5,000
------------
$ 35,000
============
In addition to the Federal Home Loan Bank advances, we also had a
repurchase agreement with an outstanding balance of $10.0 million at December
31, 2001. Securities sold under agreements to repurchase generally mature within
ninety days from the transaction date and are collateralized by U.S. Government
Agency obligations. The bank has repurchase lines of credit aggregating $37.0
million from various institutions. The repurchases must be adequately
collateralized.
In addition, we may purchase federal funds through unsecured federal
funds lines of credit with various banks aggregating $26.0 million. These lines
are intended for short-term borrowings and are subject to restrictions limiting
the frequency and term of advances. These lines of credit are payable on demand
and bear interest based upon the daily federal funds rate. We had no borrowings
outstanding under these lines as of December 31, 2001.
In February of 2002, Southern Community Capital Trust I (the "Trust"),
a newly formed subsidiary of the company, issued 1,725,000 Cumulative
Convertible Trust Preferred Securities (the "Securities"), generating total
proceeds of $17.3 million. The Securities pay distributions at an annual rate of
7.25% and mature on March 31, 2032. The Securities will pay distributions
quarterly beginning on March 31, 2002. The company has fully and unconditionally
guaranteed the obligations of the Trust. The Securities can be converted at any
time into common stock at a price of $8.67 (the "Conversion Price") or 1.153
shares of the company's common stock for each convertible preferred security.
The Securities issued by the Trust are redeemable in whole or in part at any
time after April 1, 2007. The Securities are also redeemable in whole at any
time prior to March 31, 2007 as long as the trading price of our common stock
has been at least 125% of the Conversion Price for a period of twenty
consecutive trading days ending within five days of the notice of redemption.
The proceeds from the Securities were utilized to purchase convertible junior
subordinated debentures from us under the same terms and conditions as the
Securities. The company has the right to defer payment of interest on the
debentures at any time and from time to time for a period not exceeding five
years, provided that no deferral period extend beyond the stated maturities of
the debentures. Such deferral of interest payments by the company will result in
a deferral of distribution payments on the related Securities. Should the
company defer the payment of interest on the debentures, the company will be
precluded from the payment of cash dividends to shareholders. Subject to certain
limitations, the Securities qualify as Tier 1 capital of the company for
regulatory capital purposes. The principal use of the net proceeds from the sale
of the convertible debentures is to infuse capital to our bank subsidiary,
Southern Community Bank and Trust, to fund its operations and continued
expansion, the operations and continued expansion of the bank's subsidiaries,
and to maintain the bank's status as "well capitalized" under regulatory
guidelines.
IMPACT OF INFLATION AND CHANGING PRICES
A commercial bank has an asset and liability structure that is
distinctly different from that of a company with substantial investments in
plant and inventory because the major portion of its assets are monetary in
nature. As a result, a bank's performance may be significantly influenced by
changes in interest rates. Although the banking industry is more affected by
changes in interest rates than by inflation in the prices of goods and services,
inflation is a factor that may influence interest rates. However, the frequency
and magnitude of interest rate fluctuations do not necessarily coincide with
changes in the general inflation rate. Inflation does affect operating expenses
in that personnel expenses and the cost of supplies and outside services tend to
increase more during periods of high inflation.
Page 39
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and
Hedging Activities. This Statement established accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. The adoption of this statement did not affect the company's
financial statements.
In September 2000, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities. SFAS No. 140 is a replacement of SFAS No.
125, although SFAS No. 140 carried forward most of the provisions of SFAS No.
125 without change. SFAS No. 140 is effective for transfers occurring after
March 31, 2001 and for disclosures relating to securitizations, retained
interests, and collateral received and pledged in repurchase agreements for
fiscal years ending after December 15, 2000. The new statement eliminates the
prior requirement to record collateral received under certain securities
financing transactions and requires reclassification in the balance sheet of
assets pledged under certain conditions. The adoption of SFAS No. 140 on January
1, 2001 did not have a significant impact on the company's financial statements.
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001. SFAS No. 141 also specifies the criteria that
intangible assets acquired in a purchase method business combination must meet
to be recognized and reported apart from goodwill. SFAS No. 142 is effective for
the company beginning on January 1, 2002 and will require that all goodwill and
intangible assets with indefinite useful lives (including such assets acquired
prior to January 1, 2002) no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets - see
below. The adoption of SFAS No. 142 on January 1, 2002 will not affect the
company's financial statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires that obligations associated with
the retirement of tangible long-lived assets be recorded as a liability when
those obligations are incurred, with the amount of liability initially measured
at fair value. SFAS No. 143 will be effective for financial statements for
fiscal years beginning after June 15, 2002, though early adoption is encouraged.
The application of this statement is not expected to have a material impact on
the company's financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This standard provides guidance for differentiating between long-lived assets to
be held and used, long-lived assets to be disposed of other than by sale and
long-lived assets to be disposed of by sale. SFAS No. 144 supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of. SFAS No. 144 also supersedes APB 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. This statement is effective for fiscal years beginning
after December 15, 2001. Adoption of SFAS No. 144 on January 1, 2002 will not
have a significant effect on the company's financial statements.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this annual report, which are not historical
facts, are forward-looking statements, as that term is defined in the Private
Securities Litigation Reform Act of 1995. Amounts herein could vary as a result
of market and other factors. Such forward-looking statements are subject to
risks and uncertainties which could cause actual results to differ materially
from those currently anticipated due to a number of factors, which include, but
are not limited to, factors discussed in documents filed by the company with the
Securities and Exchange Commission and the bank with the Federal Reserve Bank
from time to time. Such forward-looking statements may be identified by the use
of such words as "believe," "expect," "anticipate," "should," "planned,"
"estimated," and "potential." Examples of forward-looking statements include,
but are not limited to, estimates with respect to the financial condition,
expected or anticipated revenue, results of operations and business of the
company that are subject to various factors which could cause actual results to
differ materially from these estimates. These factors include, but are not
limited to, general economic conditions, changes in interest rates, deposit
flows, loan
Page 40
demand, real estate values, and competition; changes in accounting principles,
policies, or guidelines; changes in legislation or regulation; and other
economic, competitive, governmental, regulatory, and technological factors
affecting the company's operations, pricing, products and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "MARKET RISK" under Item 6.
ITEM 8. FINANCIAL STATEMENTS
The information required by this item is filed herewith.
Page 41
[DIXON ODOM PLLC LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
To the Stockholders and the Board of Directors
Southern Community Financial Corporation and Subsidiaries
Winston-Salem, North Carolina
We have audited the accompanying consolidated balance sheets of Southern
Community Financial Corporation and Subsidiaries as of December 31, 2001 and
2000, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 2001. These financial statements are the
responsibility of the bank's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated 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
audits provide 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 Southern Community
Financial Corporation and Subsidiaries at December 31, 2001 and 2000 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Dixon Odom PLLC
Sanford, North Carolina
January 18, 2002 except for Note 16,
as to which the date is February 19, 2002
Page 42
SOUTHERN COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
ASSETS 2001 2000
---------- ----------
(Amounts in thousands,
except share data)
Cash and due from banks $ 18,878 $ 11,197
Federal funds sold 22,926 21,045
Investment securities (Note 3)
Available for sale, at fair value 30,678 39,005
Held to maturity, at amortized cost 34,529 20,244
Loans (Note 4) 360,288 282,161
Allowance for loan losses (Note 5) (5,400) (4,283)
---------- ----------
Net Loans 354,888 277,878
Premises and equipment (Note 6) 12,111 9,704
Other assets 7,210 4,954
---------- ----------
Total Assets $ 481,220 $ 384,027
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Demand $ 36,202 $ 26,645
Money market and NOW 95,904 66,740
Time (Note 7) 260,745 245,368
---------- ----------
Total Deposits 392,851 338,753
Short-term borrowings (Note 8) 19,980 6,000
Long-term debt (Note 8) 25,000 --
Other liabilities 938 2,324
---------- ----------
Total Liabilities 438,769 347,077
---------- ----------
Stockholders' Equity (Notes 9 and 13)
Common stock, no par value, 30,000,000 shares authorized;
8,354,990 shares issued and outstanding in 2001 40,285 --
Common stock, $2.50 par value, 20,000,000 shares authorized;
7,595,979 shares issued and outstanding in 2000 -- 18,990
Additional paid-in capital -- 15,766
Retained earnings 1,362 1,883
Accumulated other comprehensive income 804 311
---------- ----------
Total Stockholders' Equity 42,451 36,950
---------- ----------
Commitments (Notes 10 and 14)
Total Liabilities and
Stockholders' Equity $ 481,220 $ 384,027
========== ==========
See accompanying notes.
Page 43
SOUTHERN COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
----------- ----------- -----------
(Amounts in thousands, except
share and per share data)
Interest Income
Loans $ 26,292 $ 23,351 $ 14,026
Investment securities available for sale 2,320 1,733 944
Investment securities held to maturity 2,201 849 802
Federal funds sold and interest-bearing deposits with banks 553 898 790
----------- ----------- -----------
Total Interest Income 31,366 26,831 16,562
----------- ----------- -----------
Interest Expense
Money market and NOW deposits 2,135 2,079 1,470
Time deposits 14,858 12,511 7,003
Federal funds purchased and borrowings 1,041 354 8
----------- ----------- -----------
Total Interest Expense 18,034 14,944 8,481
----------- ----------- -----------
Net Interest Income 13,332 11,887 8,081
Provision for Loan Losses (Note 5) 2,320 1,480 1,135
----------- ----------- -----------
Net Interest Income After
Provision for Loan Losses 11,012 10,407 6,946
----------- ----------- -----------
Non-Interest Income (Note 12) 3,402 2,198 775
----------- ----------- -----------
Non-Interest Expense
Salaries and employee benefits 5,510 4,576 2,736
Occupancy and equipment 2,067 1,456 1,048
Other (Note 12) 3,585 2,691 2,108
----------- ----------- -----------
Total Non-Interest Expense 11,162 8,723 5,892
----------- ----------- -----------
Income Before Income Taxes 3,252 3,882 1,829
Income Tax Expense (Note 11) 1,147 1,466 293
----------- ----------- -----------
Net Income $ 2,105 $ 2,416 $ 1,536
=========== =========== ===========
Net Income Per Share
Basic $ .25 $ .31 $ .20
Diluted .24 .30 .19
Weighted Average Shares Outstanding
Basic 8,293,027 7,711,955 7,655,147
Diluted 8,612,963 8,047,853 8,133,612
See accompanying notes.
Page 44
SOUTHERN COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
Accumulated
Common Stock Additional Retained Other Total
---------------------- Paid-in Earnings Comprehensive Stockholders'
Shares Amount Capital (Deficit) Income (Loss) Equity
---------- -------- ---------- -------- ------------- -------------
(Amounts in thousands, except share data)
Balance at December 31, 1998 3,291,732 $ 16,459 $ 13,842 $ (397) $ 22 $ 29,926
Comprehensive income
Net income -- -- -- 1,536 -- 1,536
Other comprehensive income, net of
tax
Net decrease in fair value of securities
available for sale, net of tax benefit of
$179 -- -- -- -- (289) (289)
---------
Total comprehensive income 1,247
---------
Common stock issued pursuant to:
Sale of common stock 1,140 5 21 -- -- 26
Two-for-one stock split 3,305,689 -- -- -- -- --
Stock options exercised 58,801 179 153 -- -- 332
Current income tax benefit -- -- 235 -- -- 235
---------- -------- --------- -------- ------ ---------
Balance at December 31, 1999 6,657,362 16,643 14,251 1,139 (267) 31,766
Comprehensive income
Net income -- -- -- 2,416 -- 2,416
Other comprehensive income, net of
tax
Net increase in fair value of securities
available for sale, net of tax of $363 -- -- -- -- 578 578
---------
Total comprehensive income 2,994
---------
Common stock issued pursuant to:
Sale of common stock 254,567 636 1,456 -- -- 2,092
10% stock split in the form of a dividend 666,503 1,667 -- (1,672) -- (5)
Stock options exercised 17,547 44 40 -- -- 84
Current income tax benefit -- -- 19 -- -- 19
---------- -------- --------- -------- ------ ---------
Balance at December 31, 2000 7,595,979 18,990 15,766 1,883 311 36,950
Comprehensive income
Net income -- -- -- 2,105 -- 2,105
Other comprehensive income, net of
tax
Net increase in fair value of securities
available for sale, net of tax of $309 -- -- -- -- 493 493
---------
Total comprehensive income 2,598
---------
Formation of holding company -- 17,771 (17,771) -- -- --
Common stock issued pursuant to:
Sale of common stock 344,118 860 1,951 -- -- 2,811
5% stock dividend 396,702 2,618 -- (2,626) -- (8)
Stock options exercised 18,191 46 35 -- -- 81
Current income tax benefit -- -- 19 -- -- 19
---------- -------- --------- -------- ------ ---------
Balance at December 31, 2001 8,354,990 $ 40,285 $ -- $ 1,362 $ 804 $ 42,451
========== ======== ========= ======== ====== =========
See accompanying notes.
Page 45
SOUTHERN COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
2001 2000 1999
---------- ---------- ----------
(Amounts in thousands)
Cash Flows from Operating Activities
Net income $ 2,105 $ 2,416 $ 1,536
---------- ---------- ----------
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,003 628 350
Provision for loan losses 2,320 1,480 1,135
Change in assets and liabilities:
Increase in other assets (256) (2,078) (686)
Increase (decrease) in other liabilities (1,695) 1,371 255
---------- ---------- ----------
Total Adjustments 1,372 1,401 1,054
---------- ---------- ----------
Net Cash Provided by Operating Activities 3,477 3,817 2,590
---------- ---------- ----------
Cash Flows from Investing Activities
(Increase) decrease in federal funds sold (1,881) (20,241) 14,203
Decrease in interest-bearing deposits with banks -- -- 2,000
Purchases of:
Available-for-sale investment securities (2,061) (18,186) (16,318)
Held-to-maturity investment securities (35,000) (9,693) (5,035)
Proceeds from maturities and calls of:
Available-for-sale investment securities 11,190 1,884 4,503
Held-to-maturity investment securities 20,712 3,616 1,782
Net increase in loans (79,330) (82,059) (73,244)
Purchases of premises and equipment (3,407) (5,167) (2,875)
Purchase of other assets (2,000) -- --
---------- ---------- ----------
Net Cash Used by Investing Activities (91,777) (129,846) (74,984)
---------- ---------- ----------
Cash Flows from Financing Activities
Net increase in deposits 54,098 119,800 75,103
Net increase (decrease) in federal funds purchased -- (2,500) 2,500
Net increase in borrowings 38,980 6,000 --
Net proceeds from issuance of common stock 2,911 2,195 593
Cash paid in lieu of fractional shares (8) (5) --
---------- ---------- ----------
Net Cash Provided by Financing Activities 95,981 125,490 78,196
---------- ---------- ----------
Net Increase (Decrease) in Cash and Cash Equivalents 7,681 (539) 5,802
Cash and Cash Equivalents, Beginning of Year 11,197 11,736 5,934
---------- ---------- ----------
Cash and Cash Equivalents, End of Year $ 18,878 $ 11,197 $ 11,736
========== ========== ==========
Supplemental Disclosures of Cash Flow Information
Interest paid $ 18,269 $ 14,498 $ 8,391
Income taxes paid 1,530 2,041 545
Supplemental Schedule of Noncash Investing and Financing Activities
Increase (decrease) in fair value of securities available for sale, net of tax $ 493 $ 578 $ (289)
See accompanying notes.
Page 46
SOUTHERN COMMUNITY FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
(1) ORGANIZATION AND OPERATIONS
In October 2001, Southern Community Financial Corporation was formed as a
holding company for Southern Community Bank and Trust. Upon formation, one share
of Southern Community Financial Corporation's no par value common stock was
exchanged for each of the outstanding shares of Southern Community Bank and
Trust's $2.50 par value common stock.
Southern Community Bank and Trust (the "bank") was incorporated November 14,
1996 and began banking operations on November 18, 1996. The bank is engaged in
general commercial and retail banking in the Piedmont area of North Carolina,
principally Forsyth and Yadkin Counties, operating under the banking laws of
North Carolina and the rules and regulations of the Federal Deposit Insurance
Corporation and on February 2, 2001 the bank became a member of the Federal
Reserve System. The bank undergoes periodic examinations by those regulatory
authorities.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Southern Community
Financial Corporation and Southern Community Bank and Trust and its wholly-owned
subsidiaries, Southern Credit Services, Inc., which is engaged in the business
of accounts receivable financing, Southern Investment Services, Inc., which,
through an unaffiliated broker dealer, provides customers of the bank with
securities products and services and earns revenues through sharing of
commissions, Southeastern Acceptance Corporation, a consumer finance company,
and VCS Management, L.L.C., the managing general partner for Venture Capital
Solutions L. P., a Small Business Investment Company. All intercompany
transactions and balances have been eliminated in consolidation. Southern
Community Financial Corporation and its subsidiaries are collectively referred
to herein as the "company."
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change relate to the determination of
the allowance for losses on loans.
CASH EQUIVALENTS
For the purpose of presentation in the statements of cash flows, cash and cash
equivalents are defined as those amounts included in the balance sheet caption
"Cash and due from banks."
INVESTMENT SECURITIES
Available-for-sale securities are carried at fair value and consist of bonds and
notes not classified as trading securities or as held-to-maturity securities.
Unrealized holding gains and losses on available-for-sale securities are
reported as a net amount in accumulated other comprehensive income. Gains and
losses on the sale of available-for-sale securities are determined using the
specific-identification method. Bonds and notes for which the bank has the
positive intent and ability to hold to maturity are reported at cost, adjusted
for premiums and discounts that are recognized in interest income using a method
that approximates the interest method over the period to maturity. Declines in
the fair value of individual held-to-maturity and available-for-sale securities
below their cost that are other than temporary would result in write-downs of
the individual securities to their fair value. Such write-downs would be
included in earnings as realized losses.
Page 47
LOANS
Loans that management has the intent and ability to hold for the foreseeable
future or until maturity are reported at their outstanding principal adjusted
for any charge-offs, the allowance for loan losses, and any deferred fees or
costs on originated loans and unamortized premiums or discounts on purchased
loans. Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the related loan.
The accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses is based upon management's estimate of the amount
needed to maintain the allowance for loan losses at an adequate level. In making
the evaluation of the adequacy of the allowance for loan losses, management
gives consideration to current and anticipated economic conditions, statutory
examinations of the loan portfolio by regulatory agencies, delinquency
information and management's internal review of the loan portfolio. Loans are
considered impaired when it is probable that all amounts due under the
contractual terms of the loan will not be collected. The measurement of impaired
loans that are collateral dependent is generally based on the present value of
expected future cash flows discounted at the historical effective interest rate,
or upon the fair value of the collateral if readily determinable. If the
recorded investment in the loan exceeds the measure of fair value, a valuation
allowance is established as a component of the allowance for loan losses. While
management uses the best information available to make evaluations, future
adjustments to the allowance may be necessary if conditions differ substantially
from the assumptions used in making the evaluations. In addition, regulatory
examiners may require the bank to recognize changes to the allowance for loan
losses based on their judgments about information available to them at the time
of their examination.
BANK PREMISES AND EQUIPMENT
Bank premises and equipment are stated at cost less accumulated depreciation.
Depreciation is calculated on the straight-line method over the estimated useful
lives of the assets which are 30 years for buildings and 3 - 10 years for
furniture and equipment. Leasehold improvements are amortized over the expected
terms of the respective leases or the estimated useful lives of the
improvements, whichever is shorter. Repairs and maintenance costs are charged to
operations as incurred and additions and improvements to premises and equipment
are capitalized. Upon sale or retirement, the cost and related accumulated
depreciation are removed from the accounts and any gains or losses are reflected
in current operations.
FORECLOSED ASSETS
Assets acquired through, or in lieu of, loan foreclosure are held for sale and
are initially recorded at fair value at the date of foreclosure, establishing a
new cost basis. Subsequent to foreclosure, valuations are periodically performed
by management and the assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the tax bases of assets and
liabilities and their carrying amounts for financial reporting purposes.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which the temporary differences are expected to be
recovered or settled. Deferred tax assets are reduced by a valuation allowance
if it is more likely than not that the tax benefits will not be realized.
Page 48
PER SHARE DATA
Basic and diluted net income per share is computed based on the weighted average
number of shares outstanding during each period after retroactively adjusting
for a 5% stock dividend distributed October 15, 2001, a stock split effected in
the form of a 10% stock dividend during 2000 and a two-for-one stock split
during 1999. Diluted net income per share 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 net income of the bank.
Basic and diluted net income per share have been computed based upon net income
as presented in the accompanying statements of operations divided by the
weighted average number of common shares outstanding or assumed to be
outstanding as summarized below:
2001 2000 1999
---------- ---------- ----------
Weighted average number of common shares used in
computing basic net income per share 8,293,027 7,711,955 7,655,147
Effect of dilutive stock options 319,936 335,898 478,465
---------- ---------- ----------
Weighted average number of common shares and dilutive
potential common shares used in computing diluted net
income per share 8,612,963 8,047,853 8,133,612
========== ========== ==========
For the years ended December 31, 2001, 2000 and 1999 there were 174,240, 89,000,
and 12,000 options, respectively that were antidilutive since the exercise price
exceeded the average market price for the year. These common stock equivalents
have been omitted from the calculation of diluted earnings per share for their
respective years.
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2001, the company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities. This Statement established accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. The adoption of this statement did not affect the company's
financial statements.
In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. SFAS No. 140 is a replacement of SFAS No. 125,
although SFAS No. 140 carried forward most of the provisions of SFAS No. 125
without change. SFAS No. 140 is effective for transfers occurring after March
31, 2001 and for disclosures relating to securitizations, retained interests,
and collateral received and pledged in repurchase agreements for fiscal years
ending after December 15, 2000. The new statement eliminates the prior
requirement to record collateral received under certain securities financing
transactions and requires reclassification in the balance sheet of assets
pledged under certain conditions. The adoption of SFAS No. 140 on January 1,
2001 did not have a significant impact on the company's financial statements.
Page 49
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also specifies the criteria that intangible
assets acquired in a purchase method business combination must meet to be
recognized and reported apart from goodwill. SFAS No. 142 is effective for the
company beginning on January 1, 2002 and will require that all goodwill and
intangible assets with indefinite useful lives (including such assets acquired
prior to January 1, 2002) no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets - see
below. The adoption of SFAS No. 142 on January 1, 2002 will not affect the
company's financial statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires that obligations associated with the
retirement of tangible long-lived assets be recorded as a liability when those
obligations are incurred, with the amount of liability initially measured at
fair value. SFAS No. 143 will be effective for financial statements for fiscal
years beginning after June 15, 2002, though early adoption is encouraged. The
application of this statement is not expected to have a material impact on the
company's financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This standard
provides guidance for differentiating between long-lived assets to be held and
used, long-lived assets to be disposed of other than by sale and long-lived
assets to be disposed of by sale. SFAS No. 144 supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of. SFAS No. 144 also supersedes APB 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. This statement is effective for fiscal years beginning after
December 15, 2001. Adoption of SFAS No. 144 on January 1, 2002 will not have a
significant effect on the company's financial statements.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period for
non-owner transactions and is divided into net income and other comprehensive
income. Other comprehensive income includes revenues, expenses, gains, and
losses that are excluded from earnings under current accounting standards. As of
and for the periods presented, the sole component of other comprehensive income
for the company has consisted of the unrealized gains and losses, net of taxes,
in the company's available for sale securities portfolio.
SEGMENT REPORTING
Statement of Financial Accounting Standards No. 131, Disclosures about Segments
of an Enterprise and Related Information requires management to report selected
financial and descriptive information about reportable operating segments. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. Generally, disclosures are required for
segments internally identified to evaluate performance and resource allocation.
In all material respects, the company's operations are entirely within the
commercial banking segment, and the financial statements presented herein
reflect the results of that segment. Also, the company has no foreign operations
or customers.
Page 50
(3) INVESTMENT SECURITIES
The following is a summary of the securities portfolio by major classification
at December 31, 2001 and 2000:
2001
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
(Amounts in thousands)
Securities available for sale:
U. S. Government agencies $ 22,172 $ 1,162 $ -- $ 23,334
Mortgage-backed 4,271 147 -- 4,418
Other 2,926 -- -- 2,926
-------- ------- -------- --------
$ 29,369 $ 1,309 $ -- $ 30,678
======== ======= ======== ========
Securities held to maturity:
U. S. Government agencies $ 33,500 $ 664 $ 2 $ 34,162
Mortgage-backed 1,029 34 -- 1,063
-------- ------- -------- --------
$ 34,529 $ 698 $ 2 $ 35,225
======== ======= ======== ========
2000
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
(Amounts in thousands)
Securities available for sale:
U. S. Government agencies $ 31,663 $ 480 $ 50 $ 32,093
Mortgage-backed 5,970 83 6 6,047
Other 865 -- -- 865
-------- ------- -------- --------
$ 38,498 $ 563 $ 56 $ 39,005
======== ======= ======== ========
Securities held to maturity:
U. S. Government agencies $ 18,535 $ 196 $ 34 $ 18,697
Mortgage-backed 1,709 19 6 1,722
-------- ------- -------- --------
$ 20,244 $ 215 $ 40 $ 20,419
======== ======= ======== ========
The amortized cost and fair values of securities available for sale and held to
maturity at December 31, 2001 by contractual maturity are shown below. Actual
expected maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations.
Securities Available for Sale Securities Held to Maturity
----------------------------- ---------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ------- --------- --------
(Amounts in thousands)
Due within one year $ 3,000 $ 3,050 $ 500 $ 504
Due after one year through five years 7,490 7,840 8,000 8,316
Due after five years through ten years 11,682 12,444 3,000 3,176
Due after ten years 2,926 2,926 22,000 22,166
Mortgage-backed securities 4,271 4,418 1,029 1,063
-------- ------- -------- --------
$ 29,369 $30,678 $ 34,529 $ 35,225
======== ======= ======== ========
Page 51
There were no sales of investment securities available for sale during 2001,
2000 or 1999.
Securities with carrying values of $10.9 million and $5.0 million and fair
values of $11.0 million and $5.0 million at December 31, 2001 and 2000,
respectively, were pledged to secure public deposits as required by law.
Additionally, at December 31, 2001, securities with carrying values of $32.5
million and fair values of $32.5 million were pledged to secure both the
company's borrowing from the FHLB and repurchase agreements.
(4) LOANS
Following is a summary of loans at December 31, 2001 and 2000:
2001 2000
--------- ---------
(Amounts in thousands)
Residential mortgage loans $ 105,357 $ 84,280
Commercial mortgage loans 89,354 59,410
Construction loans 61,558 52,800
Commercial and industrial loans 77,820 60,280
Loans to individuals 26,199 25,391
--------- ---------
Total $ 360,288 $ 282,161
========= =========
Loans are primarily made in the Piedmont area of North Carolina, principally
Forsyth and Yadkin Counties. Real estate loans can be affected by the condition
of the local real estate market. Commercial and installment loans can be
affected by the local economic conditions.
Nonaccrual loans aggregated $894,000 and $276,000 at December 31, 2001 and 2000,
respectively.
The company has granted loans to certain directors and executive officers of the
company and their related interests. Such loans are made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other borrowers and, in management's
opinion, do not involve more than the normal risk of collectibility. All loans
to directors and executive officers or their interests are submitted to the
Board of Directors for approval. A summary of loans to directors and their
interests follows (amounts in thousands):
Loans to directors and officers as a group (10) at December 31, 1998 $ 12,258
Disbursements during year ended December 31, 1999 5,808
Amounts collected during year ended December 31, 1999 (5,490)
---------
Loans to directors and officers as a group (11) at December 31, 1999 12,576
Disbursements during year ended December 31, 2000 6,875
Amounts collected during year ended December 31, 2000 (7,241)
---------
Loans to directors and officers as a group (12) at December 31, 2000 12,210
---------
Disbursements during year ended December 31, 2001 4,282
Amounts collected during year ended December 31, 2001 (6,648)
---------
Loans to directors and officers as a group (12) at December 31, 2001 $ 9,844
=========
Page 52
(4) LOANS (continued)
At December 31, 2001, the company had pre-approved but unused lines of credit
totaling $4.1 million to executive officers, directors and their affiliates.
(5) ALLOWANCE FOR LOAN LOSSES
An analysis of the allowance for loan losses follows:
2001 2000 1999
-------- -------- --------
(Amounts in thousands)
Balance at beginning of period $ 4,283 $ 3,013 $ 1,905
-------- -------- --------
Provision charged to operations 2,320 1,480 1,135
-------- -------- --------
Charge-offs (1,247) (212) (47)
Recoveries 44 2 20
-------- -------- --------
Net charge-offs (1,203) (210) (27)
-------- -------- --------
Balance at end of period $ 5,400 $ 4,283 $ 3,013
======== ======== ========
(6) PREMISES AND EQUIPMENT
Following is a summary of premises and equipment at December 31, 2001 and 2000:
2001 2000
--------- ---------
(Amounts in thousands)
Land $ 2,870 $ 2,870
Buildings and leasehold improvements 7,287 4,861
Furniture and equipment 4,112 3,132
--------- ---------
14,269 10,863
Less accumulated depreciation (2,158) (1,159)
--------- ---------
Total $ 12,111 $ 9,704
========= =========
Depreciation and amortization amounting to $999,907 in 2001, $616,000 in 2000
and $329,000 in 1999 is included in occupancy and equipment expense.
(7) DEPOSITS
Time deposits in denominations of $100,000 or more were approximately $111.5
million and $76.1 million at December 31, 2001 and 2000, respectively. At
December 31, 2001, the scheduled maturities of certificates of deposit are as
follows:
$100,000 Under
and Over $100,000 Total
--------- --------- ---------
(Amounts in thousands)
2002 $ 91,759 $ 131,091 $ 222,850
2003-2004 8,061 16,996 25,057
2005-2006 11,721 1,117 12,838
--------- --------- ---------
Total $ 111,541 $ 149,204 $ 260,745
========= ========= =========
Page 53
(8) BORROWINGS
Advances from the Federal Home Loan Bank of Atlanta consisted of the following
at December 31, 2001 and 2000:
Interest
Maturity rate 2001 2000
- ---------------- -------- ---------- --------
(Amounts in thousands)
May 3, 2001 7.04% $ -- $ 6,000
July 11, 2002 4.15% 10,000 --
June 6, 2003 4.84% 10,000 --
June 1, 2004 5.35% 10,000 --
September 19, 2011 4.43% 5,000 --
--------- --------
$ 35,000 $ 6,000
========= ========
Under collateral agreements with the Federal Home Loan Bank at December 31,
2001, advances are secured both by loans with a carrying value of $27.7 million
and pledged investment securities with a market value of $22.4 million.
In addition to the above advances, the company also has a repurchase agreement
with an outstanding balance of $9,980,000 at December 31, 2001. Securities sold
under agreements to repurchase generally mature within ninety days from the
transaction date and are collateralized by U.S. Government Agency obligations.
The company has repurchase lines of credit of $37.0 million from various
institutions, which must be adequately collateralized.
In addition to the above advances, the company has lines of credit of $26.0
million from various correspondent banks to purchase federal funds sold on a
short-term basis.
Aggregate borrowings at December 31, 2001 amounted to $45.0 million, including
$20.0 million that is due within one year and classified as short-term
borrowings and $25.0 million due after one year that is classified as long-term
debt in the accompanying balance sheet.
(9) EMPLOYEE AND DIRECTOR BENEFIT PLANS
401(K) RETIREMENT PLAN
The company maintains a 401(k) retirement plan that covers all eligible
employees. The company matches 100% of employee contributions, with the
company's contribution limited to 6% of each employee's salary. Matching
contributions are funded when accrued. Matching expenses totaled approximately
$240,000 in 2001, $117,000 in 2000 and $63,000 in 1999.
EMPLOYMENT AGREEMENTS
The company has entered into employment agreements with its chief executive
officer and two other executive officers to ensure a stable and competent
management base. The agreements provide for a three-year term, but the
agreements may annually be extended for an additional year. The agreements
provide for benefits as spelled out in the contracts and cannot be terminated by
the Board of Directors, except for cause, without prejudicing the officers'
rights to receive certain vested benefits, including compensation. In the event
of a change in control of the company, as outlined in the agreements, the
acquirer will be bound to the terms of the contracts.
TERMINATION AGREEMENTS
The company has entered into special termination agreements with substantially
all other employees, who have completed one year of service, which provide for
severance pay benefits in the event of a change in control of the company which
results in the termination of such employee or diminished compensation, duties
or benefits.
Page 54
SUPPLEMENTAL RETIREMENT
The company during 2001 implemented a non-qualifying deferred compensation plan
for certain key executive officers. The company has purchased life insurance
policies on the participating officers in order to provide future funding of
benefit payments. Benefits will accrue based upon the performance of the
underlying life insurance policies both during employment and after retirement.
Such benefits will continue to accrue and be paid throughout each participant's
life assuming satisfactory performance of the funding life insurance policies.
The plan also provides for payment of death or disability benefits in the event
a participating officer becomes permanently disabled or dies prior to attainment
of retirement age. During 2001, a provision of approximately $58,000 was
expensed for future benefits to be provided under this plan.
STOCK OPTION PLANS
During 1997 the company adopted, with stockholder approval, an Incentive Stock
Option Plan (the "ISO Plan") and a Nonstatutory Stock Option Plan (the "NSO
Plan"). Both plans were amended in 2001, with stockholder approval, to increase
the number of shares available for grant. Each plan makes available options to
purchase 833,574 shares of the company's common stock, for an aggregate number
of common shares reserved for options of 1,667,148. The exercise price of all
options granted to date is the fair value of the company's common shares on the
date of grant. All options vest over a five-year period. All unexercised options
expire ten years after the date of grant. A summary of the company's option
plans as of and for the years ended December 31, 2001, 2000 and 1999, reflecting
the effects of stock splits and dividends declared, including the 5% stock
dividend declared and distributed in 2001, is as follows:
Outstanding Options Exercisable Options
------------------------------- -----------------------------
Shares Weighted Weighted
Available Average Average
for Future Number Exercise Number Exercise
Grants Outstanding Price Outstanding Price
---------- ----------- --------- ----------- ---------
At December 31, 1998 158,995 1,268,848 $ 4.45 356,206 $ 4.16
Options granted/vested (70,203) 70,203 10.89 270,554 4.70
Options exercised -- (82,719) 4.01 (82,719) 4.01
Options forfeited 11,937 (11,937) 7.00 -- --
-------- ---------- -------- ---------- -------
At December 31, 1999 100,729 1,244,395 4.81 544,041 4.45
Options authorized 71,703 -- -- -- --
Options granted/vested (115,133) 115,133 7.93 285,667 3.98
Options exercised -- (19,879) 4.22 (19,879) 4.22
Options forfeited 32,607 (32,607) 7.36 (6,861) 7.40
-------- ---------- -------- ---------- -------
At December 31, 2000 89,906 1,307,042 5.04 802,968 4.60
Options authorized 126,588 -- -- -- --
Options granted/vested (86,725) 86,725 7.20 296,785 4.98
Options exercised -- (19,100) 4.20 (19,100) 4.20
Options forfeited 60,175 (60,175) 9.04 (22,268) 9.47
-------- ---------- -------- ---------- -------
At December 31, 2001 189,944 1,314,492 $ 5.01 1,058,385 $ 4.61
======== ========== ======== ========== =======
Page 55
Stock Option Plans (Continued)
The company has elected to follow APB Opinion 25, Accounting for Stock Issued to
Employees ("APB 25"), and related interpretations in accounting for its stock
options as permitted under SFAS No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). In accordance with APB 25, no compensation cost is recognized by
the company when stock options are granted because the exercise price equals the
market price of the underlying common stock on the date of grant. If the company
had used the fair value-based method of accounting for stock options as
prescribed by SFAS 123, compensation cost would have increased by $552,000 in
2001, $497,000 in 2000 and $468,000 in 1999. The pro forma effects on net income
and net income per common share, together with the assumptions used in
estimating the fair values of options granted, are displayed below:
2001 2000 1999
--------- --------- ---------
(Amounts in thousands,
except per share data)
Net income:
As reported $ 2,105 $ 2,416 $ 1,536
Pro forma 1,553 1,919 1,068
Basic earnings per share:
As reported $ .25 $ .31 $ .20
Pro forma .19 .25 .14
Diluted earnings per share:
As reported $ .24 $ .30 $ .19
Pro forma .18 .24 .13
Assumptions in estimating option values:
Risk-free interest rate 4.00% 5.50% 5.00%
Dividend yield 0.00% 0.00% 0.00%
Volatility 18.00% 23.00% 20.00%
Expected life 7 years 7 years 6 years
(10) LEASES
The company leases its office space under non-cancelable operating leases.
Future minimum lease payments under these leases for the years ending December
31 are as follows (amounts in thousands):
2002 $ 426
2003 400
2004 421
2005 413
2006 177
2007 and thereafter 494
--------
Total $ 2,331
========
Total rental expense under operating leases was $427,000 in 2001, $352,000 in
2000, and $342,000 in 1999.
Page 56
(11) INCOME TAXES
The significant components of the provision for income taxes for the years ended
December 31, 2001, 2000 and 1999 are as follows:
2001 2000 1999
------- ------- ------
(In thousands)
Current tax provision $ 1,238 $ 1,811 $ 978
Deferred tax provision (benefit) (91) (345) (368)
------- ------- ------
Provision for income tax expense before
adjustment to deferred tax asset
valuation allowance 1,147 1,466 610
Decrease in valuation allowance -- -- (317)
------- ------- ------
Net provision for income taxes $ 1,147 $ 1,466 $ 293
======= ======= ======
The difference between the provision for income taxes and the amounts computed
by applying the statutory federal income tax rate of 34% to income before income
taxes is summarized below:
2001 2000 1999
------- ------- ------
(In thousands)
Tax computed at the statutory federal rate $ 1,106 $ 1,320 $ 622
------- ------- ------
Increase (decrease) resulting from:
State income taxes, net of federal benefit 32 147 63
Adjustment to deferred tax asset valuation allowance -- -- (317)
Other permanent differences 9 (1) (75)
------- ------- ------
41 146 (329)
------- ------- ------
Provision for income taxes included in operations $ 1,147 $ 1,466 $ 293
======= ======= ======
Page 57
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
deferred taxes at December 31, 2001, and 2000 are as follows:
2001 2000
------- -------
(In thousands)
Deferred tax assets arising from:
Allowance for loan losses $ 1,833 $ 1,594
Pre-opening costs -- 39
Deferred compensation 22 --
------- -------
Total deferred tax assets 1,855 1,633
------- -------
Deferred tax liabilities arising from:
Property and equipment (164) (206)
Loan fees and costs (321) (173)
Available for sale investment securities (504) (195)
Other (26) --
------- -------
Total deferred tax liabilities (1,015) (574)
------- -------
Net recorded deferred tax asset $ 840 $ 1,059
======= =======
(12) NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE
The major components of non-interest income for the years ended December 31,
2001, 2000 and 1999 are as follows:
2001 2000 1999
------- ------- -------
(In thousands)
Service charges and fees on deposit accounts $ 879 $ 595 $ 320
Mortgage loan origination fees 1,009 550 125
Investment brokerage fees 193 322 227
SBIC management fees 564 515 --
Income from derivative 383 -- --
Other 374 216 103
------- ------- -------
Total $ 3,402 $ 2,198 $ 775
======= ======= =======
The major components of other non-interest expense for the years ended December
31, 2001, 2000 and 1999 are as follows:
2001 2000 1999
------- ------- -------
(In thousands)
Postage, printing and office supplies $ 339 $ 261 $ 191
Advertising and promotion 519 578 434
Data processing and other outsourced services 1,033 624 537
Professional services 341 233 279
Other 1,353 995 667
------- ------- -------
Total $ 3,585 $ 2,691 $ 2,108
======= ======= =======
Page 58
(13) REGULATORY MATTERS
The bank, as a North Carolina banking corporation, may pay cash dividends to the
company only out of undivided profits as determined pursuant to North Carolina
General Statutes. However, regulatory authorities may limit payment of dividends
by any bank when it is determined that such limitation is in the public interest
and is necessary to ensure financial soundness of the bank.
The bank is subject to various regulatory capital requirements administered by
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
bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the bank must meet specific
capital guidelines that involve quantitative measures of the bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The bank's capital amounts and classifications 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 bank to maintain minimum amounts and ratios, as prescribed by
regulations, of total and Tier I capital to risk-weighted assets and of Tier I
capital to average assets. Management believes, as of December 31, 2001 and
2000, that the bank meets all capital adequacy requirements to which it is
subject, as set forth below:
Minimum To Be Well
Minimum For Capital Capitalized Under Prompt
Actual Adequacy Purposes Corrective Action Provisions
---------------------- ---------------------- -----------------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ --------- ------ --------- --------
(Dollars in thousands)
AS OF DECEMBER 31, 2001:
Total Capital (to Risk-Weighted Assets) $ 46,722 11.53% $ 32,405 8.00% $ 40,503 10.00%
Tier I Capital (to Risk-Weighted Assets) 41,655 10.28% 16,203 4.00% 24,304 6.00%
Tier I Capital (to Average Assets) 41,655 9.21% 18,090 4.00% 22,613 5.00%
AS OF DECEMBER 31, 2000:
Total Capital (to Risk-Weighted Assets) $ 40,532 13.03% $ 24,885 8.00% $ 31,107 10.00%
Tier I Capital (to Risk-Weighted Assets) 36,639 11.78% 12,441 4.00% 18,662 6.00%
Tier I Capital (to Average Assets) 36,639 9.99% 14,665 4.00% 18,331 5.00%
The company is also subject to these capital requirements. At December 31, 2001,
the company's total capital to risk-weighted assets, Tier I capital to
risk-weighted assets and Tier I capital to average assets were 11.53%, 10.28%
and 9.21%, respectively.
(14) OFF-BALANCE SHEET RISK
The company 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. Those instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the balance
sheets. The contract or notional amounts of those instruments reflect the extent
of involvement the company has in particular classes of financial instruments.
The company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of conditions established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the company, upon extension of credit is based on
management's credit evaluation of the borrower. Collateral obtained varies but
may include real estate, stocks, bonds, and certificates of deposit.
Page 59
A summary of the contract amount of the company's exposure to off-balance sheet
risk as of December 31, 2001 is as follows (amounts in thousands):
Financial instruments whose contract amounts represent credit risk:
Loan commitments and undisbursed lines of credit $ 91,923
Undisbursed standby letters of credit 3,805
Late in 2000, the company purchased an off-balance sheet financial contract, an
interest rate floor, to assist in managing interest rate risk. An interest rate
floor is an option contract for which an initial premium is paid and for which
no ongoing interest rate risk is present. The ability of the counter party to
meet its obligation under the terms of the contract is the primary risk involved
with an interest rate floor. The company has sought to control the credit risk
associated with this instrument through a thorough analysis of the
creditworthiness of the counter party.
For the interest rate floor, the notional principal amount is used to express
the volume of transaction; however, the amount potentially subject to credit
risk is much smaller. The company's direct credit exposure is limited to the net
receivable amount on the transaction, which is generally paid quarterly. The
carrying amount of the financial instrument used for interest rate risk
management is included in other assets. The fair value is based upon quoted
market prices of similar instruments. The notional amount of the interest rate
floor contract held by the company at December 31, 2000 was $20 million. Its
fair value approximated its amortized cost of $42,000 at that date. During 2001,
the company sold the above contract. The company recognized income aggregating
$383,000 on this floor contract in 2001, including the gain realized upon its
disposal, in non-interest income. The company held no derivative instruments at
December 31, 2001.
(15) DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
Financial instruments include cash and due from banks, interest-bearing deposits
with banks, federal funds sold, investment securities, loans, deposit accounts,
federal funds purchased and other borrowings. Fair value estimates are made at a
specific moment 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 company's
entire holdings of a particular financial instrument. Because no active market
readily exists for a portion of the company'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.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
CASH AND DUE FROM BANKS, AND FEDERAL FUNDS SOLD
The carrying amounts for cash and due from banks, and federal funds
sold approximate fair value because of the short maturities of those
instruments.
INVESTMENT SECURITIES
Fair value for investment securities equals quoted market price if
such information is available. If a quoted market price is not
available, fair value is estimated using quoted market prices for
similar securities.
Page 60
LOANS
For certain homogenous categories of loans, such as residential
mortgages, fair value is estimated using the quoted market prices
for securities backed by similar loans, adjusted for differences in
loan characteristics. The fair value of other types of loans is
estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
DEPOSITS
The fair value of demand deposits is the amount payable on demand at
the reporting date. The fair value of time deposits is estimated
using the rates currently offered for deposits of similar remaining
maturities.
BORROWINGS
The fair values are based on discounting expected cash flows at the
interest rate for debt with the same or similar remaining maturities
and collected requirements.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
With regard to financial instruments with off-balance sheet risk
discussed in Note 14, it is not practicable to estimate the fair
value of future financing commitments. The fair value of the
interest rate floor, which approximated amortized cost at December
31, 2000, was determined by reference to quoted prices of similar
instruments.
The carrying amounts and estimated fair values of the company's financial
instruments, none of which are held for trading purposes, are as follows at
December 31, 2001 and 2000:
2001 2000
--------------------------- -------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
--------- ---------- -------- ----------
(In thousands)
Financial assets:
Cash and due from banks $ 18,878 $ 18,878 $ 11,197 $ 11,197
Federal funds sold 22,926 22,926 21,045 21,045
Investment securities available for sale 30,678 30,678 39,005 39,005
Investment securities held to maturity 34,529 35,225 20,244 20,419
Loans, net 354,888 355,888 277,878 278,800
Interest rate contract -- -- 42 42
Financial liabilities:
Deposits 392,851 393,282 338,753 341,600
Short-term borrowings 19,980 19,980 6,000 6,000
Long-term borrowings 25,000 25,085 -- --
Page 61
(16) CONVERTIBLE SECURITIES OF A TRUST SUBSIDIARY
In February of 2002, Southern Community Capital Trust I (the "Trust"), a newly
formed subsidiary of the company, issued 1,725,000 Cumulative Convertible Trust
Preferred Securities (the "Securities"), generating total proceeds of $17.3
million. The Securities pay distributions at an annual rate of 7.25% and mature
on March 31, 2032. The Securities will pay distributions quarterly beginning on
March 31, 2002. The company has fully and unconditionally guaranteed the
obligations of the Trust. The Securities can be converted at any time into
common stock at a price of $8.67 (the "Conversion Price") or 1.153 shares of the
company's common stock for each convertible preferred security. The Securities
issued by the Trust are redeemable in whole or in part at any time after April
1, 2007. The Securities are also redeemable in whole at any time prior to March
31, 2007 as long as the trading price of the company's common stock has been at
least 125% of the Conversion Price for a period of twenty consecutive trading
days ending within five days of the notice of redemption. The proceeds from the
Securities were utilized to purchase convertible junior subordinated debentures
from the company under the same terms and conditions as the Securities. The
company has the right to defer payment of interest on the debentures at any time
and from time to time for a period not exceeding five years, provided that no
deferral period extend beyond the stated maturities of the debentures. Such
deferral of interest payments by the company will result in a deferral of
distribution payments on the related Securities. Should the company defer the
payment of interest on the debentures, the company will be precluded from the
payment of cash dividends to shareholders. Subject to certain limitations, the
Securities qualify as Tier 1 capital of the company for regulatory capital
purposes. The principal use of the net proceeds from the sale of the convertible
debentures is to infuse capital to the company's bank subsidiary, Southern
Community Bank and Trust, to fund its operations and continued expansion, the
operations and continued expansion of the bank's subsidiaries, and to maintain
the company's status as "well capitalized" under regulatory guidelines.
(17) PARENT COMPANY FINANCIAL DATA
Southern Community Financial Corporation became the holding company for Southern
Community Bank and Trust effective October 1, 2001. Following are condensed
financial statements of Southern Community Financial Corporation as of and for
the three months ended December 31, 2001.
CONDENSED BALANCE SHEET
(In thousands)
Asset:
Investment in Southern Community Bank and Trust $42,451
=======
Stockholders' equity:
Common stock $40,285
Retained earnings 1,362
Accumulated other comprehensive income 804
-------
$42,451
=======
CONDENSED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001
(In thousands)
Equity in net income of subsidiaries $ 403
-------
Net income $ 403
=======
Page 62
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from the company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on April 25, 2002.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference from the company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on April 25, 2002.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference from the company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on April 25, 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from the company's definitive proxy statement, to be
filed with the Securities and Exchange Commission with respect to the Annual
Meeting of Shareholders to be held on April 25, 2002.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. The following financial statements and
supplementary data are included in Item 8 of this report.
Financial Statements Form 10-K Page
-------------------- --------------
Independent Auditor's Report............................................................... 42
Consolidated Balance Sheets as of December 31, 2001 and 2000............................... 43
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999........................................................... 44
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2001, 2000 and 1999........................................................... 45
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999........................................................... 46
Notes to Consolidated Financial Statements................................................. 47-62
(a)(2) Financial Statement Schedules. All applicable financial statement
schedules required under Regulation S-X have been included in the Notes
to the Consolidated Financial Statements.
Page 63
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are
listed below.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
Exhibit 3.1: Articles of Incorporation (incorporated by reference to Exhibit 3(i) to the Current Report on Form
8K dated October 1, 2001)
Exhibit 3.2: Bylaws (incorporated by reference to Exhibit 3(ii) to the Current Report on Form 8K dated October 1, 2001)
Exhibit 3.3: Amendment to Articles of Incorporation
Exhibit 4.1: Specimen certificate for Common Stock of Southern Community Financial Corporation (incorporated by reference
to Exhibit 4 to the Current Report on Form 8K dated October 1, 2001)
Exhibit 4.2: Form of 7.25% Convertible Junior Subordinated Debenture (incorporated by reference to Exhibit 4.2 to the
Registration Statement on Form S-2 dated November 28, 2001, Registration No. 333-74084 (the "Registration
Statement"))
Exhibit 4.3: Form of Certificate for 7.25% Trust Preferred Security of Southern Community Capital Trust I (incorporated by
reference to Exhibit 4.6 to Amendment Number One to the Registration Statement dated January 10, 2002)
Exhibit 10.1: Incentive Stock Option Plan of Southern Community Financial Corporation (incorporated by reference to
Exhibit 10.1 to Amendment Number One to the Registration Statement dated January 10, 2002)
Exhibit 10.2: Non-Statutory Stock Option Plan of Southern Community Financial Corporation (incorporated by reference to
Exhibit 10.2 to Amendment Number One to the Registration Statement dated January 10, 2002)
Exhibit 10.3: Indenture with respect to the Company's 7.25% Convertible Junior Subordinated Debentures
Exhibit 10.4: Amended and Restated Trust Agreement of Southern Community Capital Trust I
Exhibit 10.5: Guarantee Agreement for Southern Community Capital Trust I
Exhibit 10.6: Agreement as to Expenses and Liabilities with respect to Southern Community Capital Trust I
Exhibit 21: Subsidiaries of the Registrant
(b) Current Reports on Form 8-K filed during the fourth quarter of 2001.
Type Date Filed Reporting Purpose
---- --------------------- ------------------------------------------------
Item 2. October 3, 2001 Acquisition of 100% voting shares of Southern
Community Bank and Trust.
Item 5. December 5, 2001 Report filing of a registration statement with the
Securities and Exchange Commission for public
Offering of convertible trust preferred securities.
Page 64
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
behalf of the undersigned, thereunto duly authorized.
SOUTHERN COMMUNITY
FINANCIAL CORPORATION
Date: March 8, 2002 By: /s/ F. Scott Bauer
---------------------------------------
F. Scott Bauer
President and Chief Executive
Officer
Date: March 8, 2002 By: /s/ Richard M. Cobb
---------------------------------------
Richard M. Cobb
Executive Vice President, Chief
Operating Officer and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ F. Scott Bauer Chairman of the Board
- ---------------------------------------
F. Scott Bauer March 8, 2002
/s/ Don Gray Angell Vice Chairman of the Board
- ---------------------------------------
Don Gray Angell March 8, 2002
Director
- ---------------------------------------
C.J. Ramey March 8, 2002
/s/Matthew G. Gallins Director
- ---------------------------------------
Matthew G. Gallins March 8, 2002
/s/ Billy D. Prim Director
- --------------------------------------- March 8, 2002
Billy D. Prim
Director
- --------------------------------------- March 8, 2002
Annette Scippio
/s/ Durward A. Smith, Jr. Director
- ---------------------------------------
Durward A. Smith, Jr. March 8, 2002
Page 65
/s/ William G. Ward Director
- ---------------------------------------
William G. Ward March 8, 2002
/s/ Anthony H. Watts Director
- --------------------------------------- March 8, 2002
Anthony H. Watts
/s/ James G. Chrysson Director
- ---------------------------------------
James G. Chrysson March 8, 2002
/s/ Dianne M. Neal Director
- ---------------------------------------
Dianne M. Neal March 8, 2002
/s/ Nolan G. Brown Director
- ---------------------------------------
Nolan G. Brown March 8, 2002
Page 66