U.S. Securities and Exchange
Commission
Washington, D.C. 20549
Form 10-Q
x
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2003
o
Transition Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period ended ________________
Commission File Number 000-33227
Southern Community Financial Corporation
| North Carolina | 56-2270620 | |
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| (State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
| incorporation or organization) |
| 4605 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(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% 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
o
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes
o
No
x
As of August 6, 2003, (the most recent practicable date), the registrant had outstanding 8,820,890 shares of Common Stock, no par value.
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| Part I | FINANCIAL INFORMATION | |||
| Item 1 - | Financial Statements (Unaudited) | |||
| Consolidated Balance Sheets | ||||
| June 30, 2003 and December 31, 2002 | 3 | |||
| Consolidated Statements of Operations | ||||
| Three Months and Six Months Ended June 30, 2003 and 2002 | 4 | |||
| Consolidated Statements of Comprehensive Income | ||||
| Three Months and Six Months Ended June 30, 2003 and 2002 | 5 | |||
| Consolidated Statement of Stockholders’ Equity | ||||
| Six Months Ended June 30, 2003 | 6 | |||
| Consolidated Statements of Cash Flows | ||||
| Six Months Ended June 30, 2003 and 2002 | 7 | |||
| Notes to Consolidated Financial Statements | 8 | |||
| Item 2 - | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 13 | ||
| Item 3 - | Quantitative and Qualitative Disclosures about Market Risk | 20 | ||
| Item 4 - | Controls and Procedures | 20 | ||
| Part II | Other Information | |||
| Item 4 - | Submission of Matters to a Vote of Security Holders | 21 | ||
| Item 6 - | Exhibits and Reports on Form 8-K | 21 |
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Part I. FINANCIAL INFORMATION
SOUTHERN COMMUNITY FINANCIAL CORPORATION
* Derived from audited consolidated financial statements.
See accompanying notes.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
See accompanying notes.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
See accompanying notes.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
See accompanying notes.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
See accompanying notes.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Note 1 — Basis of Presentation
The consolidated financial statements include the accounts of Southern
Community Financial Corporation and its wholly-owned subsidiaries, Southern
Community Capital Trust I, a trust for the convertible preferred securities,
and Southern Community Bank and Trust and its wholly-owned subsidiaries,
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. In management’s opinion, the
financial information, which is unaudited, reflects all adjustments (consisting
solely of normal recurring adjustments) necessary for a fair presentation of
the financial information as of and for the three-month and six-month periods
ended June 30, 2003 and 2002, in conformity with accounting principles
generally accepted in the United States of America.
The preparation of financial statements requires management to make estimates
and assumptions that affect reported amounts of assets and liabilities at the
date of the financial statements, as well as the amounts of income and expense
during the reporting period. Actual results could differ from those estimates.
Operating results for the three-month and six-month periods ended June 30,
2003 are not necessarily indicative of the results that may be expected for the
fiscal year ending December 31, 2003.
The organization and business of Southern Community Financial Corporation (the
“Company”), accounting policies followed by the Company and other relevant
information are contained in the notes to the consolidated financial statements
filed as part of the Company’s 2002 annual report on Form 10-K. This quarterly
report should be read in conjunction with such annual report.
Note 2 — Per Share Data
Basic and diluted net income per share are computed based on the weighted
average number of shares outstanding during each period after retroactively
adjusting for a 5% stock dividend distributed October 15, 2002. Diluted net
income per share reflects the potential dilution that could occur if stock
options were exercised or convertible trust-preferred securities were
converted, resulting in the issuance of common stock that then shared in the
net income of the Company.
Basic and diluted net income per share have been computed using the weighted
average number of common shares outstanding or assumed to be outstanding as
summarized below:
Basic earnings per share are based upon net income as presented in the
accompanying consolidated statements of operations.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Note 2 — Per Share Data (Continued)
For the three months ended June 30, 2003 and 2002, there were 76,416, and
179,916 options, respectively, that were antidilutive since the exercise price
exceeded the average market price for the period. For the three months ended
June 30, 2003 and 2002, there were 2,088,975 of antidilutive shares related to
the convertible trust preferred securities. These antidilutive common stock
equivalents have been omitted from the calculation of diluted earnings per
share for their respective periods.
For the six months ended June 30, 2003 net income for determining diluted
earnings per share was $2,197 thousand, after adjusting for the $398 thousand
after tax effect of the expense associated with the dilutive convertible
preferred securities. For the six months ended June 30, 2003 and 2002, there
were 104,355, and 179,916 options, respectively, that were antidilutive since
the exercise price exceeded the average market price for the period. For the
six months ended June 30, 2003, there were 2,088,975 of dilutive shares related
to the convertible trust preferred securities. These common stock equivalents
have been included in the calculation of diluted earnings per share. For the
six months ended June 30, 2002, there were 2,088,975 of antidilutive shares
related to the convertible trust preferred securities. These antidilutive
common stock equivalents have been omitted from the calculation of diluted
earnings per share.
Note 3 — Stock Compensation Plans
Statement of Financial Accounting Standards (“SFAS”) No. 123,
Accounting for
Stock-Based Compensation
, encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to
Employees,
whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over
the amount an employee must pay to acquire the stock. Stock options issued
under the Company’s stock option plans have no intrinsic value at the grant
date and, under Opinion No. 25, no compensation cost is recognized for them.
The Company has elected to continue with the accounting methodology in Opinion
No. 25. Presented below are the pro forma disclosures of net income and
earnings per share and other disclosures as if the fair value based method of
accounting had been applied.
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Note 4 — Loans
Following is a summary of loans at each of the balance sheet dates presented:
An analysis of the allowance for loan losses is as follows:
The following is a summary of nonperforming assets at the periods presented:
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Note 5 — Non-Interest Income and Other Non-Interest Expenses
The major components of non-interest income are as follows:
The major components of other non-interest expense are as follows:
Note 6 — Guarantees
The Company has issued guarantees under standby letters of credit, which
require the Company to fund the guarantee in part or in entirety, in the event
the customer fails to perform under an obligating agreement. These standby
letters of credit typically have terms ranging from 12 to 60 months.
The maximum amount of the Company’s guarantees under these standby letters of
credit along with the carrying amount of the liability under these guarantees
are as follows (in thousands):
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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Note 7 — Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated
with Exit or Disposal Activities
(Statement 146). This statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force (EITF) Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring).
A
liability for a cost associated with an exit or disposal activity shall be
recognized and measured initially at its fair value in the period in which the
liability is incurred, except for certain qualifying employee termination
benefits. The adoption of Statement 146 by the Company on January 1, 2003 had
no significant impact to the consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities
. This interpretation addresses the
consolidation by business enterprises of variable interest entities as defined
in the interpretation. FIN 46 applies immediately to variable interests in
variable interest entities created after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31, 2003. For
public enterprises with a variable interests in a variable interest entity
created before February 1, 2003, FIN 46 applies no later than the beginning of
the first interim or annual period beginning after June 15, 2003. The Company
is in the process of determining the impact of FIN 46 on its consolidated
financial statements.
In April 2003, the FASB issued SFAS No. 149,
Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities
(Statement 149). Statement 149
improves financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. In particular, Statement 149
clarifies under what circumstances a contract with an initial net investment
meets the characteristic of a derivative, clarifies when a derivative contains
a financing component, amends the definition of an “underlying” to conform it
to language used in FIN 45 and amends certain other existing pronouncements.
Statement 149 is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003. In
addition, with some exceptions, all provisions of Statement 149 should be
applied prospectively. The Company does not expect the requirements of
Statement 149 to have a material impact on its consolidated financial
statements.
Note 8 — Subsequent Event
On July 30, 2003, the Company announced the execution of a definitive agreement
in which the Company will acquire The Community Bank, Pilot Mountain, NC, in a
fixed exchange of cash and stock. The total per share consideration is
expected to be the sum of $9.49 plus 0.8 times 5.00 shares of the Company’s
stock times the average price of the Company’s common stock during a period of
time shortly before closing. As a result of the pending acquisition, the
Company anticipates to pay approximately $15.2 million in cash and issue
approximately 6.4 million shares of its common stock. The transaction is
valued at approximately $76 million. This transaction is expected to close in
the fourth quarter of 2003 and has been approved by the directors of both the
Company and The Community Bank, but is subject to approval of shareholders of
each, Federal and State Banking authorities.
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Item 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
This Quarterly Report on Form 10-Q may contain certain forward-looking
statements consisting of estimates with respect to our financial condition,
results of operations and business 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 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 our operations, pricing,
products and services.
Effective October 1, 2001, 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. 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, Guilford 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, 2002 the bank became a member
of the Federal Reserve System. The bank undergoes periodic examinations by
those regulatory authorities.
Financial Condition at June 30, 2003 and December 31, 2002
During the six-month period ending June 30, 2003, total assets increased by
$113.9 million, or 18.6%, to $726.1 million. This increase is primarily the
result of growth in the loan and investment portfolios. The growth in assets
was supported by an increase in deposits coupled with wholesale borrowings.
Continued strong loan demand resulted in total loans increasing $49.2 million
or 11.7% to $471.1 million from $421.9 million at year-end 2002. Commercial
mortgage loans experienced the greatest growth, increasing by $36.5 million, or
26.5%. In addition, loans secured by residential mortgages increased $6.7
million or 5.7%, while commercial and industrial lending increased $5.1 million
or 7.0%, during the first six months of 2003. The investment portfolio
increased $70.2, million or 49.5%, to $211.9 million versus $141.7 million at
the beginning of the period. This growth is primarily due to planned growth
combined with pre-investment of projected maturities for the remainder of the
year.
Our total liquid assets, defined as cash and due from banks, federal funds sold
and investment securities, increased by $61.9 million during the six months, to
$231.3 million at June 30, 2003 versus $169.4 million at the beginning of the
period. Our composition of liquid assets has benefited from the increase in
investment securities. However, our investment in federal funds sold decreased
from $11.1 million at December 31, 2002 to $1.1 million at June 30, 2003 to
support growth in both our loan and investment portfolios.
Deposits continue to be our primary funding source. At June 30, 2003, deposits
totaled $505.4 million, an increase of $56.2 million or 12.5% from year-end
2002. We increased both short-term and long-term borrowings to support our
earning asset growth. Short-term borrowings increased $44.3 million to $85.0
million from $40.7 million at year-end. Over this same six-month period,
long-term debt increased $11.0 million or 20.0%. The emphasis on short-term
borrowings has assisted the Company in reducing funding costs to support our
margin in the wake of a series of interest rate cuts by the Federal Reserve.
We will utilize various funding sources, as necessary, to support balance sheet
management and growth. Demand deposits increased $11.5 million from year-end
and totaled $53.4 million as of June 30, 2003 comprising 10.6% of total
deposits, an increase from $41.9 million or 9.3% of total deposits at December
31, 2002.
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 June 30, 2003, our stockholders’ equity totaled $49.0 million,
an increase of $1.5 million from the December 31, 2002 balance. The increase
is the result of retained net income from operations during the period of $1.8
million, net of decreases in unrealized gains on investment securities
available-for-sale and cash flow hedges in the amounts of $154,000 and
$176,000, net of tax, respectively.
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Results of Operations for the Three Months Ended June 30, 2003 and 2002
Net Income.
Our net income for the three months ended June 30, 2003 was
$852,000, an increase of $178,000 from the same three-month period in 2002.
Net income per share was $.10 basic and $.09 diluted for the three months ended
June 30, 2003, as compared with $.08 basic and $.07 diluted for the same period
in 2002. We have continued to experience strong growth, with total assets
averaging $666.7 million during the current three-month period as compared to
$543.4 million in the prior period, an increase of $123.3 million or 22.7%.
Our interest rate spread and net yield on average interest-earning assets
increased 23 basis points and 10 basis points, respectively. Our net interest
income grew 25.1%, from $4.1 million for the three-month period ending June
2002 to $5.1 million for the current quarter. Net income was also supported by
a $541,000 increase in non-interest income. These improvements were partially
offset by a 28.9% increase in non-interest expenses. Our expense growth was
concentrated in additional personnel costs, and to a lesser extent, other
infrastructure associated with expansion of our business. While these expenses
represent investments in building our franchise, they initially hinder our
earnings.
Net Interest Income.
During the three months ended June 30, 2003, our net
interest income increased by $1.0 million or 25.1% over the second quarter 2002
results to $5.1 million. Net-interest income benefited from strong growth in
average earning assets, coupled with a reduction in cost on interest-bearing
liabilities which offset lower asset yields caused by the decline in interest
rates from period to period. The rates earned on a significant portion of our
loan portfolio adjust immediately when index rates, such as prime, change.
Conversely, most of our interest-bearing liabilities, including certificates of
deposit and borrowings, have rates fixed. As a result, interest rate
reductions generally result in an immediate drop in our interest income on
loans, with a delayed impact on interest expense because reductions in interest
costs will only occur upon renewals of certificates of deposit or borrowings.
Because rates stabilized at a lower level during 2002, downward repricings of
our interest-bearing liabilities have been larger than our downward repricings
of our interest-earning assets. Average total interest-earning assets
increased $110.8 million, or 21.4%, during the three months ended June 30, 2003
as compared to the same period in 2002. Our average yields on total
interest-earning assets for the same periods decreased by 71 basis points from
6.33% to 5.62%. Our average total interest-bearing liabilities increased by
$107.7 million, or 23.2%. Our average cost of total interest-bearing
liabilities decreased by 94 basis points from 3.49% to 2.55%. For the three
months ended June 30, 2003, our net interest spread was 3.07% and our net
interest margin was 3.31%. For the three months ended June 30, 2002, our net
interest spread was 2.84% and our net interest margin was 3.21%.
On May 1, 2003, the bank terminated one of the two interest rate swap contracts
for $1.0 million, which included $59,000 of accrued interest receivable. The
swap had a notional value of $25 million and under the contract we received a
fixed rate of interest and paid a rate based on the daily average Prime. The
unwinding of this transaction resulted in proceeds to the Company and a related
gain of $951,000, which will be amortized over a twenty-six month period, the
remaining life of the swap contact, and will contribute approximately $36,500
to interest income on a monthly basis.
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Average Yield/Cost Analysis
The following table contains information relating to the Company’s average
balance sheet and reflects the average yield on assets and cost of liabilities
for the periods indicated. Such annualized yields and costs are derived by
dividing income or expense by the average balances of assets or liabilities,
respectively, for the periods presented. The average loan portfolio balances
include non-accrual loans.
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Provision for Loan Losses.
Our provision for loan losses for the three months
ended June 30, 2003 was $685,000 representing an increase of $265,000 from the
$420,000 provision we made for the three months ended June 30, 2002. We have
continued to increase the level of our allowance for loan losses in response to
the growth in our loan portfolio. In evaluating the allowance for loan losses,
we consider factors that include 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. We have increased our provision during
the current three-month period due to the growth in our loan portfolio and in
part because of an increased level of net loan charge-offs, which totaled
$472,000 during the three months ended June 30, 2003, up from $137,000 during
the three months ended June 30, 2002. Included in these charge-offs was
$257,000 that was related to a $2.0 million purchased loan participation which
paid out in the second quarter. On an annualized basis, our percentage of net
loan charge-offs to average loans outstanding was .41% and .14% for the three
months ended June 30, 2003 and 2002, respectively. Non-performing assets
increased to $1.8 million, or 0.24% of total assets at June 30, 2003 from $1.3
million, or 0.23% of total assets at June 30, 2002. At June 30, 2003, the
allowance for loan losses stood at $6.8 million and represented 1.45% of
period-ending loans. At December 31, 2002, the allowance for loan losses stood
at $6.3 million and represented 1.50% of period-ending loans. We believe that
the allowance is adequate to absorb probable losses inherent in our loan
portfolio.
Non-Interest Income.
For the three months ended June 30, 2003, non-interest
income increased by $541,000 or 61.3% to $1.4 million from $883,000 for the
same period in the prior year despite a $69,000 gain on sale of investment
securities realized in the second quarter of 2002. Increases for the three
months ended June 30, 2003 include an increase of $87,000, or 30.3%, in service
charges and fees on deposit accounts as a result of deposit growth, increases
of $224,000, or 110.8%, in mortgage origination operations from increased
activity due to the low interest rate environment, and $287,000 or 586.5% in
investment brokerage fees as we have increased our marketing efforts to offer
investment brokerage services to both the bank’s existing customer base as well
as new clients. Other operational income decreased by $13,000, or 9.4%.
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 support and
service our growth. From 1998 forward through the current three-month period,
we have consistently maintained our ratio of non-interest expenses to average
total assets below 3%. Because of our growth we have consistently seen
increases in every major component of our non-interest expenses. For the three
months ended June 30, 2003, our non-interest expense increased $1.0 million, or
28.9% over the same period in 2002. Salaries and employee benefit expense
increased $665,000, or 38.0%, and reflects the addition of personnel in our new
branches as well as additions of personnel to expand our business, and, to a
lesser degree, normal salary increases. Occupancy and equipment expense
increased $136,000, or 21.3%. Other expenses increased $231,000, or 19.5%,
reflecting the increased volume of business activity, principally increases in
lending and growth in deposit accounts and increases in advertising and
promotions. For the three months ended June 30, 2003, on an annualized basis,
our ratio of non-interest expenses to average total assets increased to 2.76%
as compared with 2.63% for the same three months in 2002.
Provision for Income Taxes.
Our provision for income taxes, as a percentage of
income before income taxes, was 35.0% and 34.4%, respectively, for the three
months ended June 30, 2003 and 2002.
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Results of Operations for the Six Months Ended June 30, 2003 and 2002
Net Income.
Our net income for the six months ended June 30, 2003 was $1.8
million, an increase of $571,000 from the same six-month period in 2002. Net
income per share was $.20 basic and $.19 diluted for the six-months ended June
30, 2003, as compared with $.14 basic and $.13 diluted for the same period in
2002. We have continued to experience strong growth, with total assets
averaging $634.2 million during the current six-month period as compared to
$526.4 million in the prior period, an increase of $107.8 million or 20.5%.
Our interest rate spread and net yield on average interest-earning assets
increased 37 basis points and 26 basis points, respectively. Our net interest
income grew 29.5%, from $7.7 million for the six-month period ending June 2002
to $10.0 million for the current year-to-date through June 30, 2003. Net
income was also supported by a $949,000 increase in non-interest income. These
improvements were partially offset by a 28.4% increase in non-interest
expenses. Our expense growth primarily is a result of additional personnel
costs, and to a lesser extent, other infrastructure associated with expansion
of our business. While these expenses represent investments in building our
franchise, they initially hinder our earnings.
Net Interest Income.
During the six months ended June 30, 2003, our net
interest income increased by $2.3 million or 29.5% over $7.7 million for the
same six-month period in 2002. Net-interest income benefited from strong
growth in average earning assets, coupled with a reduction in cost on
interest-bearing liabilities which offset lower asset yields caused by the
decline in interest rates from period to period. The rates earned on a
significant portion of our loan portfolio adjust immediately when index rates,
such as prime, change. Conversely, most of our interest-bearing liabilities,
including certificates of deposit and borrowings, have rates fixed. As a
result, interest rate reductions generally result in an immediate drop in our
interest income on loans, with a delayed impact on interest expense because
reductions in interest costs will only occur upon renewals of certificates of
deposit or borrowings. Because rates stabilized at a lower level during 2002,
downward repricing of our interest-bearing liabilities have been larger than
our downward repricing of our interest-earning assets during 2003. Average
total interest-earning assets increased $98.1 million, or 19.7%, during the six
months ended June 30, 2003 as compared to the same period in 2002. Our average
yields on total interest-earning assets for the same periods decreased by 55
basis points from 6.35% to 5.80%. Our average total interest-bearing
liabilities increased by $92.8 million, or 20.7%. Our average cost of total
interest-bearing liabilities decreased by 92 basis points from 3.58% to 2.66%.
For the six months ended June 30, 2003, our net interest spread was 3.14% and
our net interest margin was 3.39%. For the three months ended June 30, 2002,
our net interest spread was 2.77% and our net interest margin was 3.13%.
On May 1, 2003, the bank terminated one of the two interest rate swap contracts
for $1.0 million, which included $59,000 of accrued interest receivable. The
swap had a notional value of $25 million and under the contract we received a
fixed rate of interest and paid a rate based on the daily average Prime. The
unwinding of this transaction resulted in proceeds to the Company and a related
gain of $951,000, which will be amortized over a twenty-six month period, the
remaining life of the swap contact, and will contribute approximately $36,500
to interest income on a monthly basis.
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Average Yield/Cost Analysis
The following table contains information relating to the Company’s average
balance sheet and reflects the average yield on assets and cost of liabilities
for the periods indicated. Such annualized yields and costs are derived by
dividing income or expense by the average balances of assets or liabilities,
respectively, for the periods presented. The average loan portfolio balances
include non-accrual loans.
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Provision for Loan Losses.
Our provision for loan losses for the six months
ended June 30, 2003 was $1.2 million representing an increase of $445,000 from
the $780,000 provision we made for the six months ended June 30, 2002. We have
continued to increase the level of our allowance for loan losses in response to
the growth in our loan portfolio. In evaluating the allowance for loan losses,
we consider factors that include 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. We have increased our provision during
the current six-month period due to the growth in our loans portfolio and in
part because of an increased level of net loan charge-offs, which totaled
$751,000 during the six months ended June 30, 2003, up from $204,000 during the
six months ended June 30, 2002. Included in these charge-offs was $257,000
related to a $2.0 million purchased loan participation which paid out in the
second quarter. On an annualized basis, our percentage of net loan charge-offs
to average loans outstanding was .55% and .41% for the six months ended June
30, 2003 and 2002, respectively. Non-performing assets increased to $1.8
million, or 0.24% of total assets at June 30, 2003 from $1.3 million, or 0.23%
of total assets at June 30, 2002. At June 30, 2003, the allowance for loan
losses stood at $6.8 million and represented 1.45% of period-ending loans. At
December 31, 2002, the allowance for loan losses stood at $6.3 million and
represented 1.50% of period-ending loans. We believe that the allowance is
adequate to absorb probable losses inherent in our loan portfolio.
Non-Interest Income.
For the six months ended June 30, 2003, non-interest
income increased by $949,000 or 57.7% to $2.6 million from $1.6 million for the
same period in the prior year despite a $69,000 gain on sale of investment
securities realized in the second quarter of 2002. Increases for the six
months ended June 30, 2003 include an increase of $137,000, or 25.7%, in
service charges and fees on deposit accounts as a result of deposit growth,
increases of $391,000, or 94.2%, in mortgage origination operations from
increased activity due to the low interest rate environment, and $456,000 or
549.9% in investment brokerage fees as we have increased our marketing efforts
to offer investment brokerage services to both the bank’s existing customer
base as well as new clients. Other operational income increased by $24,000, or
8.9%.
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 support and
service our growth. From 1998 forward through the current three-month period,
we have consistently maintained our ratio of non-interest expenses to average
total assets below 3%. Because of our growth we have consistently seen
increases in every major component of our non-interest expenses. For the six
months ended June 30, 2003, our non-interest expense increased $1.9 million, or
28.4% over the same period in 2002. Salaries and employee benefits expense
increased $1.1 million, or 34.0%, and reflects the addition of personnel in our
new branches as well as additions of personnel to expand our business, and, to
a lesser degree, normal salary increases. Occupancy and equipment expense
increased $260,000, or 21.6%. Other expenses increased $499,000, or 23.3%,
reflecting the increased volume of business activity, principally increases in
lending and growth in deposit accounts and increases in advertising and
promotions. For the six months ended June 30, 2003, on an annualized basis,
our ratio of non-interest expenses to average total assets increased to 2.72%
as compared with 2.55% for the same six months in 2002.
Provision for Income Taxes.
Our provision for income taxes, as a percentage of
income before income taxes, was 35.0% and 34.9%, respectively, for the six
months ended June 30, 2003 and 2002.
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.
Liquidity is defined as our ability to meet anticipated customer demands for
funds under credit commitments and deposit withdrawals at a reasonable cost and
on a timely basis. 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.
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 dealers and
customers 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 position
of liquidity in the form of federal funds sold and investment securities.
These aggregated $213.0 million at June 30, 2003 an increase of $60.2 million
from
-19-
$152.8 million at December 31, 2002. The increase is the result of growth
in the investment portfolio, a portion of which was pre-investing anticipated
bond maturities for the remainder of the year. Supplementing customer deposits
as a source of funding, we have available lines of credit in the amounts of
$27.0 million and $115.0 million from various correspondent banks to purchase
federal funds and repurchase agreements, respectively, on a short-term basis.
We also have credit availability to borrow up to $153.2 million from the
Federal Home Loan Bank of Atlanta, with $106.5 million outstanding at June 30,
2003 and the ability to borrow up to $112.0 million from the Federal Reserve
Bank of Richmond, with no outstanding balances at June 30, 2003. At June 30,
2003, our outstanding commitments to extend credit consisted of loan
commitments of $40.3 million and amounts available under home equity credit
lines, other credit lines and standby letters of credit of $41.4 million, $36.0
million and $11.8 million, respectively. We believe that our combined aggregate
liquidity position is sufficient to meet the funding requirements of loan
demand and deposit maturities and withdrawals in the near term.
Throughout our six-year history, our loan demand has exceeded our growth in
core deposits. We have therefore relied heavily on time deposits as a source
of funds. Time deposits represented 62% of our total deposits at June 30,
2003, and 65% at December 31, 2002. Certificates of deposit of $100,000 or
more represented 33% of our total deposits at June 30, 2003 and 29% at December
31, 2002. The bank utilizes brokered and out-of-market deposits which amounted
to $154.3 million at June 30, 2003.
At June 30, 2003, our Tier I capital to average quarterly asset ratio was
8.43%, and all of our capital ratios exceeded the minimums established for a
well-capitalized bank by regulatory measures. Our Tier I risk-based capital
ratio at
June 30, 2003 was 10.11%.
Item 3. Quantitative and Qualitative Disclosures about 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.
The Company’s market risk arises primarily from interest rate risk inherent in
its lending and deposit-taking and borrowing activities. The structure of the
Company’s loan and liability portfolios is such that a significant decline in
interest rates may adversely impact net market values and net interest income.
The Company does not maintain a trading account nor is the Company subject to
currency exchange risk or commodity price risk.
Management believes, with the exception of the
investment securities portfolio due to recent growth in this asset
category and market conditions which has resulted in yields reducing
from 5.84% to 4.90% and wholesale borrowing overall costs which have
declined from 3.25% to 2.55% from year-end 2002 and June 30,
2003, respectively, there has not been any significant change in the overall
analysis of financial instruments considered market risk sensitive, as measured
by the factors of contractual maturities, average interest rates and estimated
fair values, since the analysis prepared and presented in conjunction with the
Form 10-K Annual Report for the fiscal year ended December 31, 2002.
Item 4. Controls and Procedures
The Company’s management, including the Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of the Company’s disclosure controls and procedures within 90 days prior to the
filing of this quarterly report, and, based on their evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that these
disclosure controls and procedures are effective. There were no significant
changes in the Company’s internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
-20-
CONSOLIDATED BALANCE SHEETS
June 30, 2003
December 31,
(Unaudited)
2002*
(Amounts in thousands,
except share data)
$
18,346
$
16,632
1,097
11,084
157,486
96,930
54,383
44,749
471,145
421,938
(6,816
)
(6,342
)
464,329
415,596
18,041
15,962
12,439
11,286
$
726,121
$
612,239
$
53,357
$
41,869
136,938
115,981
315,078
291,366
505,373
449,216
44,505
20,180
106,475
75,526
17,250
17,250
3,510
2,528
677,113
564,700
43,123
43,123
3,629
1,830
2,256
2,586
49,008
47,539
$
726,121
$
612,239
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands, except per share data)
$
6,718
$
6,291
$
13,179
$
12,221
1,177
1,163
2,850
2,006
896
690
1,118
1,411
10
21
24
70
8,801
8,165
17,171
15,708
295
366
506
691
2,158
2,807
4,422
5,784
95
87
125
149
753
451
1,449
861
324
317
647
484
3,625
4,028
7,149
7,969
5,176
4,137
10,022
7,739
685
420
1,225
780
4,491
3,717
8,797
6,959
1,424
883
2,594
1,645
2,413
1,748
4,513
3,367
776
640
1,466
1,206
1,415
1,184
2,644
2,145
4,604
3,572
8,623
6,718
1,311
1,028
2,768
1,886
459
354
969
658
$
852
$
674
$
1,799
$
1,228
$
.10
$
.08
$
.20
$
.14
.09
.07
.19
.13
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands)
$
852
$
674
$
1,799
$
1,228
49
1,692
(251
)
501
(8
)
(660
)
97
(201
)
—
(69
)
—
(69
)
—
27
—
27
41
990
(154
)
258
(214
)
226
(188
)
226
102
(87
)
92
(87
)
(101
)
—
(130
)
—
39
—
50
—
(174
)
139
(176
)
139
(133
)
1,129
(330
)
397
$
719
$
1,803
$
1,469
$
1,625
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)
Accumulated
Common Stock
Other
Total
Retained
Comprehensive
Stockholders’
Shares
Amount
Earnings
Income (Loss)
Equity
(Amounts in thousands, except share data)
8,791,683
$
43,123
$
1,830
$
2,586
$
47,539
—
—
1,799
—
1,799
—
—
—
(330
)
(330
)
8,791,683
$
43,123
$
3,629
$
2,256
$
49,008
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended
June 30,
2003
2002
(Amounts in thousands)
$
1,799
$
1,228
827
600
1,225
780
—
(69
)
(4
)
(3
)
21
(19
)
(1,764
)
(3,968
)
982
1,170
3,086
(281
)
9,987
8,183
(83,431
)
(79,619
)
(44,469
)
(8,251
)
22,441
2,636
34,843
16,886
—
21,220
(50,767
)
(41,771
)
951
—
(2,789
)
(2,838
)
4
3
499
292
(72
)
—
(112,803
)
(83,259
)
56,157
43,550
3,799
20,020
51,475
—
—
17,250
—
82
111,431
80,902
1,714
(2,638
)
16,632
18,878
$
18,346
$
16,240
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
8,791,683
8,791,683
8,791,683
8,784,851
532,973
320,846
418,759
377,269
—
—
2,088,975
—
9,324,656
9,112,529
11,299,417
9,162,120
Notes to Consolidated Financial Statements
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands,
except per share data)
$
852
$
674
$
1,799
$
1,228
65
117
160
249
$
787
$
557
$
1,639
$
979
$
.10
$
.08
$
.20
$
.14
.09
.06
.19
.12
$
.09
$
.07
$
.19
$
.13
.08
.06
.18
.11
Notes to Consolidated Financial Statements
June 30, 2003
December 31, 2002
Percent
Percent
Amount
of Total
Amount
of Total
(Amounts in thousands)
$
125,292
26.59
%
$
118,572
28.10
%
174,316
37.00
%
137,812
32.66
%
65,533
13.91
%
64,500
15.29
%
77,004
16.34
%
71,948
17.05
%
29,000
6.16
%
29,106
6.90
%
471,145
100.0
%
421,938
100.0
%
6,816
6,342
$
464,329
$
415,596
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands)
$
6,603
$
5,693
$
6,342
$
5,400
685
420
1,225
780
(481
)
(146
)
(784
)
(245
)
9
9
33
41
(472
)
(137
)
(751
)
(204
)
$
6,816
$
5,976
$
6,816
$
5,976
June 30,
December 31,
2003
2002
(Amounts in thousands)
$
1,094
$
1,823
674
383
$
1,768
$
2,206
Notes to Consolidated Financial Statements
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands)
$
373
$
286
$
670
$
533
426
202
806
415
336
49
539
83
163
138
286
276
—
69
—
69
126
139
293
269
$
1,424
$
883
$
2,594
$
1,645
Three Months Ended
Six Months Ended
June 30,
June 30,
2003
2002
2003
2002
(Amounts in thousands)
$
126
$
86
$
199
$
158
229
116
388
275
298
329
631
604
138
59
256
118
624
594
1,170
990
$
1,415
$
1,184
$
2,644
$
2,145
June 30,
December 31,
2003
2002
$
11,774
$
11,090
$
13
$
16
Notes to Consolidated Financial Statements
Three Months Ended June 30, 2003
Three Months Ended June 30, 2002
Average
Average
Average
Average
Balance
Interest
Rate
Balance
Interest
Rate
(Dollars in thousands)
$
455,214
$
6,718
5.92
%
$
391,256
$
6,291
6.45
%
125,225
1,557
4.99
%
79,894
1,163
5.84
%
45,282
515
4.56
%
40,819
690
6.78
%
2,428
11
1.82
%
5,332
21
1.58
%
628,149
8,801
5.62
%
517,301
8,165
6.33
%
38,597
26,129
$
666,746
$
543,430
$
125,340
295
0.94
%
$
98,610
366
1.49
%
127,849
1,073
3.37
%
62,045
786
5.08
%
181,521
1,085
2.40
%
226,968
2,021
3.57
%
26,789
95
1.44
%
20,835
87
1.67
%
92,132
753
3.28
%
37,519
451
4.82
%
17,250
324
7.53
%
17,234
317
7.38
%
570,882
3,625
2.55
%
463,227
4,028
3.49
%
43,303
34,111
3,962
2,940
48,599
43,152
$
666,746
$
543,430
$
5,176
3.07
%
$
4,137
2.84
%
3.31
%
3.21
%
110.03
%
111.67
%
Six Months Ended June 30, 2003
Six Months Ended June 30, 2002
Average
Average
Average
Average
Balance
Interest
Rate
Balance
Interest
Rate
(Dollars in thousands)
$
442,623
$
13,179
6.00
%
$
379,639
$
12,221
6.49
%
107,565
2,849
5.34
%
68,744
2,006
5.88
%
43,279
1,118
5.21
%
41,629
1,411
6.84
%
3,278
25
1.54
%
8,624
70
1.64
%
596,745
17,171
5.80
%
498,635
15,708
6.35
%
37,443
27,747
$
634,188
$
526,382
$
117,941
506
0.87
%
$
97,274
691
1.43
%
130,820
2,100
3.24
%
89,272
2,112
4.77
%
173,801
2,322
2.69
%
193,523
3,672
3.83
%
17,540
125
1.44
%
15,802
149
1.90
%
83,875
1,449
3.48
%
36,519
861
4.75
%
17,250
647
7.57
%
15,861
484
6.15
%
541,227
7,149
2.66
%
448,383
7,969
3.58
%
41,026
32,399
3,631
2,735
48,304
42,865
$
634,188
$
526,382
$
10,022
3.14
%
$
7,739
2.77
%
3.39
%
3.13
%
110.26
%
111.21
%
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Securities Holders
The Annual Meeting of the Shareholders was held on April 24, 2003. Of 8,791,683
shares entitled to vote at the meeting, 7,216,503 shares voted. The following
matters were voted on at the meeting:
Item 6. Exhibits and Reports on Form 8-K
-21-
Proposal 1:
To elect five members of the Board of Directors
for a three-year term or until a successor has
been elected and qualified at the Annual Meeting
of Shareholders in 2006. Votes for each nominee
were as follows:
Name
For
Withheld
Abstain
7,169,095
—
47,408
7,164,093
—
52,410
7,172,763
—
43,740
7,178,181
—
38,322
7,176,726
—
39,777
The following directors continue in office after the meeting: Nolan
G. Brown, Jeff T. Clark, Richard M. Cobb, Matthew G. Gallins, Dianne
M. Neal, Billy D. Prim, Annette Y. Scippio, William G. Ward, Sr.,
M.D. and Anthony H. Watts.
Proposal 2:
The approval of the 2002 Incentive Stock Option Plan.
For
Against
Abstain
362,753
2,651,239
Proposal 3:
The approval of the 2002 Nonstatutory Stock Option Plan.
For
Against
Abstain
462,498
2,684,026
Proposal 4:
The ratification of the appointment of Dixon Odom PLLC as the independent auditor
for the Company for the fiscal year ending December 31, 2003.
For
Against
Abstain
247,000
2,619,997
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
-22-
SOUTHERN COMMUNITY FINANCIAL CORPORATION
Date: August 14, 2003
By:
/s/ F. Scott Bauer
F. Scott Bauer
Chairman, President and Chief Executive Officer
Date: August 14, 2003
By:
/s/ Richard M. Cobb
Richard M. Cobb
Executive Vice President, Chief Operating Officer
and Chief Financial Officer
Exhibit 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, F. Scott Bauer, certify that:
(1)
I have reviewed this quarterly report on Form 10-Q of Southern Community
Financial Corporation, a North Carolina holding company (the
“registrant”);
(2)
Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
(3)
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
(4)
The registrant’s other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a)
Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
(b)
Evaluated the effectiveness of the registrant’s disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c)
Disclosed in this report any change in the registrant’s internal
control over financial reporting that occurred during the registrant’s
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal
control over financial reporting; and
(5)
The registrant’s other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant’s auditors and the audit committee of the registrant’s
board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: August 14, 2003
By:
/s/ F. Scott Bauer
F. Scott Bauer
Chairman, President and Chief Executive Officer
Exhibit 31.2
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Richard M. Cobb, certify that:
(1)
I have reviewed this quarterly report on Form 10-Q of Southern Community
Financial Corporation, a North Carolina holding company (the
“registrant”);
(2)
Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
(3)
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
(4)
The registrant’s other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
(a)
Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
(b)
Evaluated the effectiveness of the registrant’s disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c)
Disclosed in this report any change in the registrant’s internal
control over financial reporting that occurred during the registrant’s
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal
control over financial reporting; and
(5)
The registrant’s other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting,
to the registrant’s auditors and the audit committee of the registrant’s
board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to
record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: August 14, 2003
By:
/s/ Richard M. Cobb
Richard M. Cobb
Executive Vice President, Chief Operating Officer
and Chief Financial Officer
Exhibit 32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
The undersigned hereby certifies that, to his knowledge,
(i)
the Form 10-Q
filed by Southern Community Financial Corporation (the “Issuer”) for the
quarter ended June 30, 2003, fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934, and
(ii)
the information
contained in that report fairly presents, in all material respects, the
financial condition and results of operations of the Issuer on the dates and
for the periods presented therein.
SOUTHERN COMMUNITY FINANCIAL CORPORATION
Date: August 14, 2003
By:
/s/ F. Scott Bauer
F. Scott Bauer
Chairman, President and Chief Executive Officer
Date: August 14, 2003
By:
/s/ Richard M. Cobb
Richard M. Cobb
Executive Vice President, Chief Operating Officer
and Chief Financial Officer