Annual Report

U.S. Securities and Exchange Commission

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, 2002

[   ] 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

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% Cumulative Convertible Trust Preferred Securities

7.25% Convertible Junior Subordinated Debentures

Guarantee with respect to 7.25% Cumulative 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. [ X ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [   ] No [ X ]

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $55.3 million.

As of March 11, 2003, (the most recent practicable date), the registrant had outstanding 8,791,683 shares of Common Stock, no par value.

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Documents Incorporated By Reference

Form 10-K Table of Contents

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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, 2002, we had total assets of $612.2 million, net loans of $415.6 million, deposits of $449.2 million, and shareholders’ equity of $47.5 million. We had net income of $3.2 million and $2.1 million and diluted earnings per share of $.35 and $.23 for the years ended December 31, 2002 and 2001, respectively. We had net income of $2.4 million and diluted earnings per share of $.29 for the year ended December 31, 2000.

     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; trust services; safe deposit boxes; and other associated services to satisfy the needs of our customers.

     In our six 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 18 consecutive quarters of profitability after becoming profitable in our seventh quarter of operation;
	•		Established eight banking offices including four in Winston-Salem and one each in Clemmons, Kernersville, High Point, and Yadkinville;
	•		Focused on growing internally reaching total assets of $612.2 million as of December 31, 2002 without any acquisitions;
	•		Have two subsidiaries of the bank, each managed by professionals with substantial previous experience in their discipline:

	–		Southeastern Acceptance Corporation, a consumer finance agency with offices in Winston-Salem, Greensboro, 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 began offering trust services in 2002 including investment management, administration and advisory services primarily for individuals, partnerships and corporations;
	•		Increased our equity to $47.5 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;
	•		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
	•		Maintained a strong credit culture. As of December 31, 2002, our non-performing assets totaled $2.2 million or .36% of total assets and our allowance for loan losses was $6.3 million or 1.50% of total loans and 348% of non-performing loans.

     The website for the bank is www.smallenoughtocare.com. The company is registered as a financial holding company with the Federal Reserve System. 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. Both our common stock and our trust preferred securities are traded on the Nasdaq National Market System under the symbols “SCMF” and “SCMFP”, respectively.

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Our Market Area

     We consider our primary market area to be the Piedmont Triad area of North Carolina, including Winston-Salem, Clemmons, Kernersville (all in Forsyth County), Yadkinville (Yadkin County) and High Point (Guilford County), North Carolina, and to a lesser extent, adjoining counties. We opened the High Point branch during 2002.

     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. The region’s population grew an estimated 12.3% between 1990 and 2000. It’s estimated population in 2001 was 1.179 million.

     The Piedmont Triad is 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. Winston-Salem is the largest city in Forsyth County and the fourth largest city in North Carolina. Forsyth County had an estimated population of 310,187 in 2001, Yadkin County was estimated at 36,859, and Guilford County had an estimated population of 425,097. The Piedmont Triad is the economic hub of northwest North Carolina. In 2001, the median family income in both Forsyth and Guilford Counties was over $42,000. In Yadkin County, it was over $36,600. The Piedmont Triad 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 2002 were services (29%), manufacturing (23%), trade (22%), finance, communications and utilities (11%), government (11%) and construction (5%). Unemployment has increased in the Piedmont Triad over the last two years and averaged 6.3% in Guilford County, 5.5% in Yadkin County and 5.4% in Forsyth County in 2002.

     The bank serves our market area through eight full service banking offices, including four offices 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 nine 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. 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 associates, 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.

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     We also intend to continue to diversify our revenue in order to generate non-interest income. These efforts have included offering investment brokerage services, our mortgage loan department, 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, 2002 our non-interest income represented 18.4% of our total revenue. We believe that the profitability of these added businesses and services, not just the 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 a long- term player 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 our 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 two 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.

     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 three offices in Winston-Salem, Greensboro, and Mt. Airy as well as through relationships with automobile dealers in its markets. Southeastern Acceptance has 12 employees and $13.0 million of loans outstanding as of December 31, 2002 and for year ended December 31, 2002, its revenues were $2.0 million, which represented 9.2% 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 committed $1.7 million for investment 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, 2002 VCS Management earned $542,000 of fee income, representing 2.5% 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 began paying quarterly distributions 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 $8.26 (the “Conversion Price”) or approximately 1.211 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

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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 was to infuse capital into our bank subsidiary, Southern Community Bank and Trust, to fund its operations and continued expansion, and to maintain the company’s and the bank’s status as “well capitalized” under regulatory guidelines.

Competition

     The activities in which the bank, as our operating subsidiaries, engage 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 over $50 billion dollars, and one savings institution have their headquarters in Winston-Salem. As of June 2002, there were 100 branches in Forsyth County operated by eleven commercial banks and one savings institution. Approximately $9.0 billion in deposits are located in Forsyth County. Yadkin County had eight banks with ten branches and approximately $375.9 million in deposits. Twenty banks and two savings institutions were operating in Guilford County with 137 branches and approximately $6.0 billion in deposits. Deposits of the bank in June 2002 were $369.3 million in Forsyth County, $66.9 million in Yadkin County, and $1.0 million in Guilford 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 located in the Piedmont Triad area that 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, 2002, the company employed 141 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 extremely important to our long-term success. The Board and management continually seek ways to enhance their benefits and well being. Southern Community Financial Corporation has no employees of its own.

SUPERVISION AND REGULATION

     Southern Community Financial Corporation is registered as a financial holding company with the Federal Reserve. The bank is a North Carolina chartered banking corporation and a member bank of the Federal Reserve System. Banking is a complex, highly regulated industry. The primary goals of bank regulations 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.

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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 elected, and was authorized by the Federal Reserve, to be a financial holding company.

     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.

      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

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North Carolina to acquire a bank or bank holding company located in North Carolina. 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, 2002, our Tier 1 leverage capital ratio and total capital were 9.84% and 13.78%, 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 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, 2002, 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. 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 company 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

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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.

      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.

     Federal law provides for nationwide interstate banking and branching, subject to certain aging and deposit concentration limits that may be imposed under applicable state laws. 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 prohibit an out-of-state bank from using 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 host state communities served by the out-of-state bank.

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      Reserve Requirements. Pursuant to regulations of the Federal Reserve, the bank must maintain average daily reserves against its transaction accounts. No reserves are required to be maintained on the first $5.7 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $5.7 million and $41.8 million, and reserves equal to 10.0% plus $1.2 million must be maintained on aggregate balances in excess of $41.8 million. These percentages are subject to adjustment by the Federal Reserve. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets. As of December 31, 2002, the bank met its reserve requirements.

      Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the federal bank regulatory agencies, in connection with their examination of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. The bank received a “satisfactory” rating in its most recent CRA examination.

      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, growth, 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 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.

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     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.

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     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 on a periodic basis.

     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 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 cannot predict what other legislation might be enacted or what other regulations might be adopted or the effects thereof.

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Item 2. Properties

     We currently operate out of seven banking offices, three consumer finance offices, and three operations/administrative offices. All banking offices have ATMs. A summary of our offices is as follows:

     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 are also well along with the construction of a new corporate office. The new headquarters will be a 27,000 square foot facility and is expected to be completed in the first half of 2003 at an expected total capitalized cost of approximately $4.2 million (including $400,000 of land cost) of which $3.6 million had been expended as of December 31, 2002. This facility will be located at 4605 Country Club Road, Winston-Salem, North Carolina.

     All of our properties, including land, buildings and improvements, furniture, equipment and vehicles, had a net book value at December 31, 2002 of $15.9 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.

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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, 2002.

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 “SCMT” until January 2, 2002 when it was accepted for listing on the Nasdaq National Market System under the symbol “SCMF”. The following table sets forth the high and low sales prices per share of our common stock and our convertible preferred securities (“SCMFP”), based on published financial sources, for the last two years. The convertible preferred securities did not begin trading until the first quarter of 2002. All information has been adjusted for stock splits and stock dividends effected during the periods presented.

     At December 31, 2002, there were approximately 5,200 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 be paid if the bank is undercapitalized

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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.

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 material assets other than those of the bank. Therefore, the financial statements of the bank prior to October 1, 2001 are the historical consolidated 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.

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(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 consist of non-accrual 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 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 5% stock dividends in 2001 and 2002.

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 have 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.

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CRITICAL ACCOUNTING POLICY

     The company’s most significant critical accounting policy is the determination of its allowance for loan losses. A critical accounting policy is one that is both very important to the portrayal of the company’s financial condition and results of operations, and requires management’s most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. For further discussion, see “Nonperforming Assets” and “Analysis of Allowance for Loan Losses” under “ASSET QUALITY.”

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 $612 million in total assets in just over six years of operations.

     We began operations in November 1996 with $11 million in capital, a single branch facility and thirteen employees. Through December 31, 2002, Southern Community Financial Corporation has grown to a total of eight full-service banking offices with $449 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 also have two subsidiaries offering financial services that augment our traditional banking products and services. These subsidiaries are Southeastern Acceptance Corporation (Consumer Finance), and VCS Management, LLC (Manager of a Small Business Investment Company). More recently we have created a Trust Department that began 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. During the first half of 2003 we expect to complete the construction of a new headquarters facility on property adjacent to our current headquarters in Winston-Salem.

     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 mortgages, at both fixed and variable rates, earning fees for loans originated and additional income for loans sold to others. 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.

Financial Condition at December 31, 2002 and 2001

     During the year ended December 31, 2002, our total assets increased by $131 million, or 27.2%, to $612.2 million. Of this increase in total assets, $125.3 represented growth in interest-earning assets. Continued strong loan demand drove an increase of $60.7, or 17.1%, in net loans receivable, while investment securities available for sale and held to maturity increased by $66.3 million and $10.2 million, respectively. The only category of interest-earning assets that decreased was federal funds sold, which ended 2002 at $11.1 million as compared with $22.9 million at the end of 2001. Federal funds sold provided the lowest yield among all interest-earning assets, declining from 1.70% at the beginning to 1.16% at year-end. Premises and equipment increased by $3.9 million, principally as a result of the investment of $422,000 in a new branch facility located in Kernersville, NC, and the investment of $3.1 million in a new corporate headquarters that is scheduled for occupancy in the first half of 2003. Other assets increased by $4.1 million, including additional investments in bank-owned life insurance of $557,000. Our total investment in

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bank-owned life insurance at December 31, 2002 was $2.8 million. This investment is included in other assets in our balance sheet and yielded a tax exempt return of 5.20% during the year 2002.

     Loan growth in 2002 was concentrated in commercial and real estate lending. Our loan growth of $60.7 million in 2002 was spread among our residential and commercial mortgage loans, which increased by $13.2 million and $48.5 million, respectively. Construction loans and loans to individuals increased by $2.9 million and $2.9 million, respectively, while commercial and industrial loans decreased by $5.9 million. During 2002 we continued our active program of originations of residential mortgage loans for sale in the secondary market. At the end of the year loans held for sale totaled $4.9 million.

     Our total liquid assets, defined as cash and due from banks, federal funds sold and investment securities, increased by $62.4 million during the year, to $169.4 million at December 31, 2002 versus $107 million at the beginning of the year. Liquid assets represented 27.7% of total assets at December 31, 2002 as compared to 22.2% at the beginning of the year. We have been able to generate significant funds for investment both through deposit growth and through borrowings. These available funds have exceeded our lending needs, so we have invested at a positive interest rate spread in securities. In order to optimize our ability to manage interest rate risk, substantially all of our increased investment in liquid assets in 2002 has been in investments available for sale.

     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. Brokered and out-of-market deposits totaled $115.7 million and $61.0 million at year-end 2002 and 2001, respectively. At December 31, 2002, deposits totaled $449.2 million, an increase of $56.4 million or 14.4% from year-end 2001. As explained above, we have also utilized borrowings to fund growth in 2002. Total borrowings, including $17.3 million in convertible preferred securities issued during 2002, aggregated $113 million at December 31, 2002. Borrowings also included $75.5 million from the Federal Home Loan Bank of Atlanta (FHLB) and securities sold under agreements to repurchase of $20.2 million. 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, 2002, our stockholders’ equity totaled $47.5 million, an increase of $5 million from the December 31, 2001 balance. This increase includes net income of $3.2 million earned during the year and other comprehensive income of $1.8 million.

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 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 chose 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 helped to somewhat mitigate the effect of the overall declining trend in interest rates during the year.

     Customer deposits continue to be our primary funding source in 2001. 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 contributed to our deposit growth. However, loan growth in 2001 outpaced our growth in deposits. We therefore utilized borrowings from the Federal Home Loan Bank of Atlanta (FHLB) to fill this funding gap.

     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 2001, proceeds of $2.8 million received in February 2001 from the sale of 344,000 shares of our common stock and $493,000 of other comprehensive income.

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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 levels 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, 2002, 2001 and 2000, our average interest-earning assets were $523.3 million, $397.0 million, and $296.6 million, respectively. During these same years, our net interest margins were 3.34%, 3.36% and 4.01%, respectively.

      Average Balances and Average Rates Earned and Paid. The following table sets forth, for the years 2000 through 2002, 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 yield.