Back to GetFilings.com
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2001
[ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from ____________ to ____________
Commission file number 000-33227
SOUTHERN COMMUNITY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
North Carolina 56-2270620
--------------------------------------------- ----------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4701 Country Club Road
Winston-Salem, North Carolina 27104
--------------------------------------------- ----------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (336) 768-8500
Securities Registered Pursuant to Section 12(b) of the Exchange Act:
None
Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, No Par Value
7.25% Convertible Junior Subordinated Debentures
Guarantee with respect to 7.25% Convertible Trust Preferred Securities
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's Common Stock at March 1, 2002,
held by those persons deemed by the registrant to be non-affiliates, was
approximately $53.3 million.
As of March 1, 2002, (the most recent practicable date), the registrant had
outstanding 8,354,990 shares of Common Stock, no par value.
Page 1
Documents Incorporated By Reference
Document Where Incorporated
-------- ------------------
1. Proxy Statement for the Annual Meeting of Shareholders to be held April Part III
25, 2002 to be mailed to shareholders within 120 days of December 31,
2001.
Form 10-K Table of Contents
Index PAGE
- ----- ----
PART I
Item 1. Business................................................................................. 3
Item 2. Properties............................................................................... 13
Item 3. Legal.................................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders...................................... 14
PART II
Item 5. Market for Common Stock Equity and Related Stockholder Matters........................... 14
Item 6. Selected Financial Data.................................................................. 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................... 41
Item 8. Financial Statements..................................................................... 41
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..... 63
PART III
Item 10. Directors and Executive Officers of the Registrant....................................... 63
Item 11. Executive Compensation................................................................... 63
Item 12. Security Ownership of Certain Beneficial Owners and Management........................... 63
Item 13. Certain Relationships and Related Transactions........................................... 63
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 63
Page 2
PART I
ITEM 1. BUSINESS
Who We Are
Southern Community Financial Corporation ("company") is the holding
company for Southern Community Bank and Trust ("bank"). The bank commenced
operations on November 18, 1996 and effective October 1, 2001 became a
wholly-owned subsidiary of the newly formed holding company. We are based in
Winston-Salem, North Carolina which is located in the north central region of
the state, an area also known as the Piedmont Triad. The Piedmont Triad area
includes the cities of Winston-Salem, Greensboro and High Point.
At December 31, 2001, we had total assets of $481.2 million, net loans
of $354.9 million, deposits of $392.9 million, and shareholders' equity of $42.5
million. We had net income of $2.1 million and $2.4 million and diluted earnings
per share of $.24 and $.30 for the years ended December 31, 2001 and 2000,
respectively. We had net income of $1.5 million and diluted earnings per share
of $.19 for the year ended December 31, 1999.
We have been, and intend to remain, a community-focused financial
institution offering a full range of financial services to individuals,
businesses and nonprofit organizations in the communities we serve. Our banking
services include checking and savings accounts; commercial, installment,
mortgage, and personal loans; safe deposit boxes; and other associated services
to satisfy the needs of our customers. In addition, to more fully serve the
specialized needs of certain commercial and retail customers, the bank has
established four subsidiaries as described below.
In our five years of existence we have accomplished the following:
- Assembled a management team with knowledge of our local
markets and over 100 years of banking experience;
- Registered 14 consecutive quarters of profitability after
becoming profitable in our seventh quarter of operation;
- Established seven banking offices including four in
Winston-Salem and one each in Clemmons, Kernersville and
Yadkinville;
- Focused on growing internally reaching total assets of $481.2
million as of December 31, 2001 without any acquisitions;
- Created four subsidiaries of the bank, each managed by
professionals with substantial previous experience in their
discipline:
- Southern Credit Services, Inc., which is engaged in
the business of accounts receivable financing;
- Southern Investment Services, Inc., which provides
investment brokerage services;
- Southeastern Acceptance Corporation, a consumer
finance agency with offices in Winston-Salem and Mt.
Airy, North Carolina; and
- VCS Management, LLC, the managing general partner of
Venture Capital Solutions, L.P., a small business
investment company in which the bank is an investor,
with offices in Winston-Salem, North Carolina and
Atlanta, Georgia.
- Received regulatory approval during August, 2001 for trust
powers and expect to soon begin offering trust services
including investment management, administration and advisory
services primarily for individuals, partnerships and
corporations;
- Increased our equity to $42.5 million as a result of our
initial public offering which raised $12 million, two
secondary stock offerings in February 1998 and January 2001,
raising $18.7 million and $4.9 million respectively, and the
retention of earnings;
- Listed our common stock on the Nasdaq National Market System
on January 2, 2002; o Created a capital trust, Southern
Community Capital Trust I, that issued 1,725,000 cumulative
convertible trust preferred securities in February 2002
generating gross proceeds of $17.3 million; and
- Implemented a strong credit culture. As of December 31, 2001,
our non-performing assets totaled $1.2 million or 0.26% of
total assets and our allowance for loan losses was $5.4
million or 1.50% of total loans and 604% of non-performing
loans.
Page 3
The website for the bank is www.smallenoughtocare.com. The bank is a
member of the Federal Reserve System and the Federal Deposit Insurance
Corporation insures its deposits up to applicable limits. The address of our
principal executive office is 4701 Country Club Road, Winston-Salem, North
Carolina 27104 and our telephone number is (336) 768-8500. Our common stock is
currently traded on the Nasdaq National Market System under the symbol "SCMF".
OUR MARKET AREA
We consider our primary market area to be the Piedmont Triad area of
North Carolina including Winston-Salem and the cities of Clemmons, Kernersville
(all in Forsyth County) and Yadkinville (Yadkin County), North Carolina, and to
a lesser extent, adjoining counties. We opened the Clemmons and Kernersville
branches during 2000. We plan to open an additional branch in Winston-Salem
during 2002. We expect our presence in the Piedmont Triad market area to
increase in the future, however presently, Forsyth and Yadkin Counties represent
our primary market area.
The Piedmont Triad is a 12 county region located in the north central
Piedmont of North Carolina and is named for the three largest cities in the
region, Winston-Salem, Greensboro and High Point. The region has one fifth of
the state's population and one fifth of its labor force. Manufacturing (26%) and
services (24%) are the two largest employment sectors. In 1999, the Piedmont
Triad region generated approximately $1.1 billion in new and expanded industry
investment and 7,265 new jobs.
Forsyth and Yadkin Counties are part of the largest Metropolitan
Statistical Area located entirely in North Carolina. The MSA is also one of the
top 50 in the country in both total population and number of households. Forsyth
County had an estimated population of 306,067 in 2000 and Yadkin County was
estimated at 36,348 in 2000. Winston-Salem is the largest city in Forsyth County
and the fourth largest city in North Carolina with an estimated population of
over 173,000. Forsyth County is the economic hub of northwest North Carolina.
The median family income in 1999 was over $45,000, over 14% higher than the
national figure and over 17% higher than the state figure. Forsyth County has a
very balanced and diversified economy. Approximately 99% of the work force is
employed in nonagricultural wage and salary positions. The major employment
sectors in 1999 were trade (23%), services (29%), manufacturing (21%), finance,
communications and utilities (13%), government (9%) and construction (4%).
There has been significant consolidation of banking institutions in
this market area. One of the two largest regional commercial banks in North
Carolina with its headquarters in Winston-Salem, with assets in excess of ten
billion dollars, recently merged with a financial institution in another city in
North Carolina. Another community bank, headquartered in Kernersville, also
recently announced a proposal to be acquired by a financial institution in
another county. We expect this consolidation to offer significant opportunities
for growth in our market area.
The bank serves our market area through seven full service banking
offices, including four branches located in Winston-Salem. Our television and
radio advertising has extended into this market area for several years,
providing the bank name recognition in the Piedmont Triad area. The bank's
customers may access various banking services through eight ATMs owned by the
bank and ATMs owned by others, through debit cards, and through the bank's
automated telephone and internet electronic banking products. These products
allow the bank's customers to apply for loans, access account information and
conduct various transactions from their telephones and computers.
BUSINESS STRATEGY
We established our bank with the objective of becoming a vital,
long-term player in our markets with a reputation for quality customer service
provided by a financially sound organization. Our business strategy is to
operate as an institution that is well capitalized, strong in asset quality,
profitable, independent, customer-oriented and connected to our community.
A commitment to customer service is at the foundation of our approach.
Our commitment is to put our customers first and we believe it differentiates us
from our competitors. Making good quality, profitable loans, which result in a
long-standing relationship with our borrowers, will continue to be a cornerstone
of our strategy.
Page 4
We intend to leverage the core relationships we build by providing a variety of
services to our customers. With that focus, we target:
- Small and medium sized businesses, and the owners and managers
of these entities;
- Professional and middle managers of locally based companies;
- Residential real estate developers; and
- Individual consumers.
We intend to grow our franchise through new and existing relationships
developed by our management team, by taking advantage of the opportunity to
acquire new relationships resulting from recent significant consolidation among
banks in our markets, including Wachovia Corporation's merger with First Union
Corporation, and by expanding to contiguous areas through de novo entry and
potentially through acquisitions which make strategic and economic sense.
We also intend to continue to diversify our revenue in order to
generate non-interest income. These efforts have included the formation of our
investment brokerage subsidiary, our mortgage loan department, and our small
business investment company manager (which generates management fees in addition
to interest income on its investments) and the creation of our trust department.
For the year ended December 31, 2001 our non-interest income represented 20.3%
of our total revenue. We believe that the profitability of these added
businesses and services, not just revenue generated, is critical to our success.
Key aspects of our strategy and mission include:
- To provide community-oriented banking services by
delivering a broad range of financial services to our
customers through responsive service and
communication;
- To form a partnership with our customers whereby our
decision making and product offerings are geared
toward their best long-term interests;
- To be recognized in our community as long-term
players with employees, stockholders and board
members committed to that effort; and
- To be progressive in our adoption of new technology
so that we can provide our customers access to
products and services that meet their needs for
convenience and efficiency.
Our belief is that this way of doing business will build a profitable
corporation and shareholder value. We want to consistently reward our
shareholders for their investment and trust in us.
SUBSIDIARIES
The bank operates four subsidiaries that provide financial services in
addition to those offered directly by the bank. The company formed another
subsidiary to issue trust preferred securities. Each subsidiary is described
below.
Southern Credit Services, Inc. was established in July 1997 and is
engaged in the business of accounts receivable financing. It either lends money
using the accounts receivable as collateral or purchases the accounts receivable
at a discount. Its office is located at our main headquarters building in
Winston-Salem. Southern Credit has 6 employees and total assets of $16 million
as of December 31, 2001. For the year ended December 31, 2001, its revenues were
$1.8 million, which represented 5.1% of total consolidated revenue.
Southern Investment Services, Inc. was established March 1999 and,
through an unaffiliated broker dealer, provides customers of the bank with
securities products and services. Through this arrangement, Southern Investment
Services earns revenues through commission sharing with the unaffiliated broker
dealer. Southern Investment Services employs one licensed securities
representative and for the year ended December 31, 2001 generated net fee income
of $193,000 or .6% of total consolidated revenue.
Southeastern Acceptance Corporation was established in December 1999 as
a consumer finance agency. Southeastern Acceptance offers a full line of
automobile and personal loans through its two offices in Winston-Salem and Mt.
Airy as well as through relationships with automobile dealers in its markets.
Southeastern
Page 5
Acceptance has 9 employees and $8.3 million of loans outstanding as of December
31, 2001 and for year ended December 31, 2001, its revenues were $1.6 million,
which represented 4.7% of total consolidated revenue.
VCS Management, LLC was formed in March 2000 as the managing general
partner of Venture Capital Solutions, L.P., a small business investment company
licensed by the Small Business Administration. Southern Community Bank and Trust
has $1.7 million invested in the partnership, which has a total of $9.2 million
of committed capital from various private investors including the bank. The
partnership can also borrow funds on a non-recourse basis from the Small
Business Administration to increase its capital available for investment. The
partnership makes investments in the form of subordinated debt and earns revenue
through interest received on its investments and potentially through gains
realized from warrants that it receives in conjunction with its debt
investments. The bank shares in any earnings of the partnership through its
investment in the partnership. VCS Management earns management fees for managing
the investment activities of the partnership. For year ended December 31, 2001
VCS Management earned $564,000 of fee income, representing 1.6% of total
consolidated revenue.
In February of 2002, Southern Community Capital Trust I (the "Trust"),
a newly formed subsidiary of the company, issued 1,725,000 Cumulative
Convertible Trust Preferred Securities (the "Securities"), generating total
proceeds of $17.3 million. The Securities pay distributions at an annual rate of
7.25% and mature on March 31, 2032. The Securities will pay distributions
quarterly beginning on March 31, 2002. The company has fully and unconditionally
guaranteed the obligations of the Trust. The Securities can be converted at any
time into common stock at a price of $8.67 (the "Conversion Price") or 1.153
shares of the company's common stock for each convertible preferred security.
The Securities issued by the Trust are redeemable in whole or in part at any
time after April 1, 2007. The Securities are also redeemable in whole at any
time prior to March 31, 2007 as long as the trading price of our common stock
has been at least 125% of the Conversion Price for a period of twenty
consecutive trading days ending within five days of the notice of redemption.
The proceeds from the Securities were utilized to purchase convertible junior
subordinated debentures from us under the same terms and conditions as the
Securities. We have the right to defer payment of interest on the debentures at
any time and from time to time for a period not exceeding five years, provided
that no deferral period extend beyond the stated maturities of the debentures.
Such deferral of interest payments by the company will result in a deferral of
distribution payments on the related Securities. Should we defer the payment of
interest on the debentures, the company will be precluded from the payment of
cash dividends to shareholders. Subject to certain limitations, the Securities
qualify as Tier 1 capital of the company for regulatory capital purposes. The
principal use of the net proceeds from the sale of the convertible debentures is
to infuse capital into our bank subsidiary, Southern Community Bank and Trust,
to fund its operations and continued expansion, the operations and continued
expansion of the bank's subsidiaries, and to maintain the bank's status as "well
capitalized" under regulatory guidelines.
COMPETITION
The activities we and the bank engage in are highly competitive.
Commercial banking in North Carolina is extremely competitive due to state laws
which permit state-wide branching. Consequently, many commercial banks have
branches located in several communities. One of the largest regional commercial
banks in North Carolina, with assets in excess of ten billion dollars, and one
savings institution have their headquarters in Winston-Salem. Another community
bank is headquartered in Kernersville. As of June 2001, there were 104 branches
in Forsyth County operated by twelve commercial banks and one savings
institution. Approximately $10.0 billion in deposits are located in Forsyth
County. Yadkin County has eight banks with eleven branches and approximately
$375.0 million in deposits. Deposits of the bank on that date were $299.5
million in Forsyth County and $70.1 million in Yadkin County. Therefore, in its
market area, the bank has significant competition for deposits and loans from
other depository institutions.
Other financial institutions such as savings and loan associations,
credit unions, consumer finance companies, insurance companies, brokerage
companies and other financial institutions with varying degrees of regulatory
restrictions compete vigorously for a share of the financial services market.
Brokerage companies continue to become more competitive in the financial
services arena and pose an ever increasing challenge to banks. Legislative
changes also greatly affect the level of competition we face. During 1998
federal legislation allowed credit unions to expand their membership criteria
and compete more intensely for traditional bank business. Additionally, the
Gramm-Leach-Bliley Financial Services Modernization Act of 1999 expanded the
types of activities in which a bank holding company can engage. Currently, we
must compete against some institutions
Page 6
located in the Piedmont Triad area which have capital resources and legal loan
limits substantially in excess of those available to us and the bank. We expect
competition to continue to be significant.
EMPLOYEES
At December 31, 2001, the bank employed 121 full time equivalent
persons (including our executive officers). None of the employees are
represented by any unions or similar groups, and we have not experienced any
type of strike or labor dispute. We consider our relationship with our employees
to be good. Southern Community Financial Corporation has no employees of its
own.
SUPERVISION AND REGULATION
Banking is a complex, highly regulated industry. The primary goals of
the bank regulatory scheme are to maintain a safe and sound banking system and
to facilitate the conduct of sound monetary policy. In furtherance of these
goals, Congress has created several largely autonomous regulatory agencies and
enacted numerous laws that govern banks, bank holding companies and the banking
industry. The descriptions of and references to the statutes and regulations
below are brief summaries and do not purport to be complete. The descriptions
are qualified in their entirety by reference to the specific statutes and
regulations discussed.
SOUTHERN COMMUNITY FINANCIAL CORPORATION
Southern Community Financial Corporation is a bank holding company that
has elected to be treated as a financial holding company. As a bank holding
company under the Bank Holding Company Act of 1956, as amended, we are
registered with and subject to regulation by the Federal Reserve. We are
required to file annual and other reports with, and furnish information to, the
Federal Reserve. The Federal Reserve conducts periodic examinations of us and
may examine any of our subsidiaries, including the bank.
The Bank Holding Company Act provides that a bank holding company must
obtain the prior approval of the Federal Reserve for the acquisition of more
than five percent of the voting stock or substantially all the assets of any
bank or bank holding company. In addition, the Bank Holding Company Act
restricts the extension of credit to any bank holding company by its subsidiary
bank. The Bank Holding Company Act also provides that, with certain exceptions,
a bank holding company may not engage in any activities other than those of
banking or managing or controlling banks and other authorized subsidiaries or
own or control more than five percent of the voting shares of any company that
is not a bank. The Federal Reserve has deemed limited activities to be closely
related to banking and therefore permissible for a bank holding company.
However, with the passage of the Gramm-Leach-Bliley Financial Services
Modernization Act of 1999, which became effective on March 11, 2000, the types
of activities in which a bank holding company may engage were significantly
expanded. Subject to various limitations, the Modernization Act generally
permits a bank holding company to elect to become a "financial holding company."
A financial holding company may affiliate with securities firms and insurance
companies and engage in other activities that are "financial in nature." Among
the activities that are deemed "financial in nature" are, in addition to
traditional lending activities, securities underwriting, dealing in or making a
market in securities, sponsoring mutual funds and investment companies,
insurance underwriting and agency activities, certain merchant banking
activities as well as activities that the Federal Reserve considers to be
closely related to banking.
A bank holding company may become a financial holding company under the
Modernization Act if each of its subsidiary banks is "well capitalized" under
the Federal Deposit Insurance Corporation Improvement Act prompt corrective
action provisions, is well managed and has at least a satisfactory rating under
the Community Reinvestment Act. In addition, the bank holding company must file
a declaration with the Federal Reserve that the bank holding company wishes to
become a financial holding company. A bank holding company that falls out of
compliance with these requirements may be required to cease engaging in some of
its activities. Southern Community Financial Corporation has elected, and been
authorized by the Federal Reserve, to become a financial holding company.
Page 7
Under the Modernization Act, the Federal Reserve serves as the primary
"umbrella" regulator of financial holding companies, with supervisory authority
over each parent company and limited authority over its subsidiaries. Expanded
financial activities of financial holding companies generally will be regulated
according to the type of such financial activity: banking activities by banking
regulators, securities activities by securities regulators and insurance
activities by insurance regulators. The Modernization Act also imposes
additional restrictions and heightened disclosure requirements regarding private
information collected by financial institutions. We cannot predict the full
sweep of this legislation.
Enforcement Authority. We will be required to obtain the approval of
the Federal Reserve prior to engaging in or, with certain exceptions, acquiring
control of more than 5% of the voting shares of a company engaged in, any new
activity. Prior to granting such approval, the Federal Reserve must weigh the
expected benefits of any such new activity to the public (such as greater
convenience, increased competition, or gains in efficiency) against the risk of
possible adverse effects of such activity (such as undue concentration of
resources, decreased or unfair competition, conflicts of interest, or unsound
banking practices). The Federal Reserve has cease-and-desist powers over bank
holding companies and their nonbanking subsidiaries where their actions would
constitute a serious threat to the safety, soundness or stability of a
subsidiary bank. The Federal Reserve also has authority to regulate debt
obligations (other than commercial paper) issued by bank holding companies. This
authority includes the power to impose interest ceilings and reserve
requirements on such debt obligations. A bank holding company and its
subsidiaries are also prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
Interstate Acquisitions. Federal banking law generally provides that a
bank holding company may acquire or establish banks in any state of the United
States, subject to certain aging and deposit concentration limits. In addition,
North Carolina banking laws permit a bank holding company which owns stock of a
bank located outside North Carolina to acquire a bank or bank holding company
located in North Carolina. This type of acquisition may occur only if the North
Carolina bank to be directly or indirectly controlled by the out-of-state bank
holding company has existed and continuously operated as a bank for a period of
at least five years. In any event, federal banking law will not permit a bank
holding company to own or control banks in North Carolina if the acquisition
would exceed 20% of the total deposits of all federally-insured deposits in
North Carolina.
Capital Adequacy. The Federal Reserve has promulgated capital adequacy
regulations for all bank holding companies with assets in excess of $150
million. The Federal Reserve's capital adequacy regulations are based upon a
risk based capital determination, whereby a bank holding company's capital
adequacy is determined in light of the risk, both on- and off-balance sheet,
contained in the company's assets. Different categories of assets are assigned
risk weightings and are counted at a percentage of their book value.
The regulations divide capital between Tier 1 capital (core capital)
and Tier 2 capital. For a bank holding company, Tier 1 capital consists
primarily of common stock, related surplus, noncumulative perpetual preferred
stock, minority interests in consolidated subsidiaries and a limited amount of
qualifying cumulative preferred securities. Goodwill and certain other
intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an
amount equal to the allowance for loan and lease losses up to a maximum of 1.25%
of risk weighted assets, limited other types of preferred stock not included in
Tier 1 capital, hybrid capital instruments and term subordinated debt.
Investments in and loans to unconsolidated banking and finance subsidiaries that
constitute capital of those subsidiaries are excluded from capital. The sum of
Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1
component must comprise at least 50% of qualifying total capital.
Every bank holding company has to achieve and maintain a minimum Tier 1
capital ratio of at least 4.0% and a minimum total capital ratio of at least
8.0%. In addition, banks and bank holding companies are required to maintain a
minimum leverage ratio of Tier 1 capital to average total consolidated assets
(leverage capital ratio) of at least 3.0% for the most highly-rated, financially
sound banks and bank holding companies and a minimum leverage ratio of at least
4.0% for all other banks. The Federal Deposit Insurance Corporation and the
Federal Reserve define Tier 1 capital for banks in the same manner for both the
leverage ratio and the risk-based capital ratio. However, the Federal Reserve
defines Tier 1 capital for bank holding companies in a slightly different
manner. As of December 31, 2001, our Tier 1 leverage capital ratio and total
capital were 9.21% and 11.53%, respectively.
The guidelines also provide that banking organizations experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory level, without
Page 8
significant reliance on intangible assets. The guidelines also indicate that the
Federal Reserve will continue to consider a "Tangible Tier 1 Leverage Ratio" in
evaluating proposals for expansion or new activities. The Tangible Tier 1
Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted
from Tier 1 capital, to quarterly average total assets. As of December 31, 2001,
the Federal Reserve had not advised us of any specific minimum Tangible Tier 1
Leverage Ratio applicable to us.
Source of Strength for Subsidiaries. Bank holding companies are
required to serve as a source of financial strength for their depository
institution subsidiaries, and, if their depository institution subsidiaries
become undercapitalized, bank holding companies may be required to guarantee the
subsidiaries' compliance with capital restoration plans filed with their bank
regulators, subject to certain limits.
Dividends. As a bank holding company that does not, as an entity,
currently engage in separate business activities of a material nature, our
ability to pay cash dividends depends upon the cash dividends we receive from
our subsidiary bank. Our only source of income is dividends paid by the bank. We
must pay all of our operating expenses from funds we receive from the bank.
Therefore, shareholders may receive dividends from us only to the extent that
funds are available after payment of our operating expenses. In addition, the
Federal Reserve generally prohibits bank holding companies from paying dividends
except out of operating earnings, and the prospective rate of earnings retention
appears consistent with the bank holding company's capital needs, asset quality
and overall financial condition. We expect that, for the foreseeable future, any
dividends paid by the bank to us will likely be limited to amounts needed to pay
any separate expenses of Southern Community Financial Corporation and/or to make
required payments on our debt obligations, including the convertible debentures
which fund the interest payments on the convertible preferred securities, issued
by our trust subsidiary.
Change of Control. State and federal banking law restrict the amount of
voting stock of the bank that a person may acquire without the prior approval of
banking regulators. The Bank Holding Company Act requires that a bank holding
company obtain the approval of the Federal Reserve before it may merge with a
bank holding company, acquire a subsidiary bank, acquire substantially all of
the assets of any bank, or before it may acquire ownership or control of any
voting shares of any bank or bank holding company if, after such acquisition, it
would own or control, directly or indirectly, more than 5% of the voting shares
of that bank or bank holding company. The overall effect of such laws is to make
it more difficult to acquire us by tender offer or similar means than it might
be to acquire control of another type of corporation. Consequently, our
shareholders may be less likely to benefit from rapid increases in stock prices
that often result from tender offers or similar efforts to acquire control of
other types of companies.
THE BANK
The bank is subject to various requirements and restrictions under the
laws of the United States and the State of North Carolina. As a North Carolina
bank, our subsidiary bank is subject to regulation, supervision and regular
examination by the North Carolina Banking Commission. As a member of the Federal
Reserve, the bank is subject to regulation, supervision and regular examination
by the Federal Reserve. The North Carolina Banking Commission and the Federal
Reserve have the power to enforce compliance with applicable banking statutes
and regulations. These requirements and restrictions include requirements to
maintain reserves against deposits, restrictions on the nature and amount of
loans that may be made and the interest that may be charged thereon and
restrictions relating to investments and other activities of the bank.
Transactions with Affiliates. The bank may not engage in specified
transactions (including, for example, loans) with its affiliates unless the
terms and conditions of those transactions are substantially the same or at
least as favorable to the bank as those prevailing at the time for comparable
transactions with or involving other nonaffiliated entities. In the absence of
comparable transactions, any transaction between the bank and its affiliates
must be on terms and under circumstances, including credit standards, that in
good faith would be offered or would apply to nonaffiliated companies. In
addition, transactions referred to as "covered transactions" between the bank
and its affiliates may not exceed 10% of the bank's capital and surplus per
affiliate and an aggregate of 20% of its capital and surplus for covered
transactions with all affiliates. Certain transactions with affiliates, such as
loans, also must be secured by collateral of specific types and amounts. The
bank also is prohibited from purchasing low quality assets from an affiliate.
Every company under common control with the bank, including us and Southern
Community Capital Trust I, is deemed to be an affiliate of the bank.
Page 9
Loans to Insiders. Federal law also constrains the types and amounts of
loans that the bank may make to its executive officers, directors and principal
shareholders. Among other things, these loans are limited in amount, must be
approved by the bank's board of directors in advance, and must be on terms and
conditions as favorable to the bank as those available to an unrelated person.
Regulation of Lending Activities. Loans made by the bank are also
subject to numerous federal and state laws and regulations, including the
Truth-In-Lending Act, Federal Consumer Credit Protection Act, the Equal Credit
Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate
mortgage disclosure requirements. Remedies to the borrower or consumer and
penalties to the bank are provided if the bank fails to comply with these laws
and regulations. The scope and requirements of these laws and regulations have
expanded significantly in recent years.
Branch Banking. All banks located in North Carolina are authorized to
branch statewide. Accordingly, a bank located anywhere in North Carolina has the
ability, subject to regulatory approval, to establish branch facilities near any
of our facilities and within our market area. If other banks were to establish
branch facilities near our facilities, it is uncertain whether these branch
facilities would have a material adverse effect on our business.
In 1994 Congress adopted the Reigle-Neal Interstate Banking and
Branching Efficiency Act of 1994. That statute provides for nationwide
interstate banking and branching, subject to certain aging and deposit
concentration limits that may be imposed under applicable state laws. Current
North Carolina law permits interstate branching only through acquisition of a
financial institution that is at least five years old, and after the
acquisition, the resulting institution and its affiliates cannot hold more than
20% of the total deposits in the state. Furthermore, the Reigle-Neal Act and
applicable North Carolina statutes permit regulatory authorities to approve de
novo branching in North Carolina by institutions located in states that would
permit North Carolina institutions to branch on a de novo basis into those
states. Federal regulations under the Riegle-Neal Act prohibit an out-of-state
bank from using the new interstate branching authority primarily for the purpose
of deposit production. These regulations include guidelines to insure that
interstate branches operated by an out-of-state bank in a host state are
reasonably helping to meet the credit needs of the communities served by the
out-of-state bank.
Governmental Monetary Policies. The commercial banking business is
affected not only by general economic conditions but also by the monetary
policies of the Federal Reserve. Changes in the discount rate on member bank
borrowings, control of borrowings, open market transactions in United States
government securities, the imposition of and changes in reserve requirements
against member banks and deposits and assets of foreign bank branches, and the
imposition of and changes in reserve requirements against certain borrowings by
banks and their affiliates are some of the monetary policies available to the
Federal Reserve. Those monetary policies influence to a significant extent the
overall growth of all bank loans, investments and deposits and the interest
rates charged on loans or paid on time and savings deposits in order to mitigate
recessionary and inflationary pressures. These techniques are used in varying
combinations to influence overall growth and distribution of bank loans,
investments, and deposits, and their use may also affect interest rates charged
on loans or paid for deposits.
The monetary policies of the Federal Reserve Board have had a
significant effect on the operating results of commercial banks in the past and
are expected to continue to do so in the future. In view of changing conditions
in the national economy and money markets, as well as the effect of actions by
monetary and fiscal authorities, no prediction can be made as to possible future
changes in interest rates, deposit levels, loan demand or the business and
earnings of the bank.
Dividends. All dividends paid by the bank are paid to us, the sole
shareholder of the bank. The general dividend policy of the bank is to pay
dividends at levels consistent with maintaining liquidity and preserving our
applicable capital ratios and servicing obligations. The dividend policy of the
bank is subject to the discretion of the board of directors of the bank and will
depend upon such factors as future earnings, financial condition, cash needs,
capital adequacy, compliance with applicable statutory and regulatory
requirements and general business conditions.
The ability of the bank to pay dividends is restricted under applicable
law and regulations. Under North Carolina banking law, dividends must be paid
out of retained earnings and no cash dividends may be paid if the bank's surplus
is less than 50% of its paid-in capital. Also, under federal banking law, no
cash dividend may be paid if the bank is undercapitalized or insolvent or if
payment of the cash dividend would render the bank
Page 10
undercapitalized or insolvent, and no cash dividend may be paid by the bank if
it is in default of any deposit insurance assessment due to the Federal Deposit
Insurance Corporation.
The exact amount of future dividends on the stock of the bank will be a
function of the profitability of the bank in general and applicable tax rates in
effect from year to year. The bank's ability to pay dividends in the future will
directly depend on the its future profitability, which cannot be accurately
estimated or assured. We expect that, for the foreseeable future, profits
resulting from the bank's operations will be retained by the bank as additional
capital to support its operations and growth other than dividends paid by the
bank to us as needed to pay any separate expenses of Southern Community
Financial Corporation and/or to make required payments on our debt obligations,
including the convertible debentures which fund the interest payments on the
convertible preferred securities, issued by our trust subsidiary.
Capital Adequacy. The capital adequacy regulations which apply to state
banks, such as the bank, are similar to the Federal Reserve requirements
promulgated with respect to bank holding companies discussed above.
Changes in Management. Any depository institution that has been
chartered less than two years, is not in compliance with the minimum capital
requirements of its primary federal banking regulator, or is otherwise in a
troubled condition must notify its primary federal banking regulator of the
proposed addition of any person to the board of directors or the employment of
any person as a senior executive officer of the institution at least 30 days
before such addition or employment becomes effective. During this 30-day period,
the applicable federal banking regulatory agency may disapprove of the addition
of such director or employment of such officer. The bank is not subject to any
such requirements.
Enforcement Authority. The federal banking laws also contain civil and
criminal penalties available for use by the appropriate regulatory agency
against certain "institution-affiliated parties" primarily including management,
employees and agents of a financial institution, as well as independent
contractors such as attorneys and accountants and others who participate in the
conduct of the financial institution's affairs and who caused or are likely to
cause more than minimum financial loss to or a significant adverse affect on the
institution, who knowingly or recklessly violate a law or regulation, breach a
fiduciary duty or engage in unsafe or unsound practices. These practices can
include the failure of an institution to timely file required reports or the
submission of inaccurate reports. These laws authorize the appropriate banking
agency to issue cease and desist orders that may, among other things, require
affirmative action to correct any harm resulting from a violation or practice,
including restitution, reimbursement, indemnification or guarantees against
loss. A financial institution may also be ordered to restrict its growth,
dispose of certain assets or take other action as determined by the primary
federal banking agency to be appropriate.
Prompt Corrective Action. Banks are subject to restrictions on their
activities depending on their level of capital. Federal "prompt corrective
action" regulations divide banks into five different categories, depending on
their level of capital. Under these regulations, a bank is deemed to be "well
capitalized" if it has a total risk-based capital ratio of 10% or more, a core
capital ratio of six percent or more and a leverage ratio of five percent or
more, and if the bank is not subject to an order or capital directive to meet
and maintain a certain capital level. Under these regulations, a bank is deemed
to be "adequately capitalized" if it has a total risk-based capital ratio of
eight percent or more, a core capital ratio of four percent or more and a
leverage ratio of four percent or more (unless it receives the highest composite
rating at its most recent examination and is not experiencing or anticipating
significant growth, in which instance it must maintain a leverage ratio of three
percent or more). Under these regulations, a bank is deemed to be
"undercapitalized" if it has a total risk-based capital ratio of less than eight
percent, a core capital ratio of less than four percent or a leverage ratio of
less than three percent. Under these regulations, a bank is deemed to be
"significantly undercapitalized" if it has a risk-based capital ratio of less
than six percent, a core capital ratio of less than three percent and a leverage
ratio of less than three percent. Under such regulations, a bank is deemed to be
"critically undercapitalized" if it has a leverage ratio of less than or equal
to two percent. In addition, the applicable federal banking agency has the
ability to downgrade a bank's classification (but not to "critically
undercapitalized") based on other considerations even if the bank meets the
capital guidelines.
If a state member bank, such as the bank, is classified as
undercapitalized, the bank is required to submit a capital restoration plan to
the Federal Reserve. An undercapitalized bank is prohibited from increasing its
assets, engaging in a new line of business, acquiring any interest in any
company or insured depository institution, or opening or acquiring a new branch
office, except under certain circumstances, including the acceptance by the
Federal Reserve of a capital restoration plan for the bank.
Page 11
If a state member bank is classified as undercapitalized, the Federal
Reserve may take certain actions to correct the capital position of the bank. If
a state member bank is classified as significantly undercapitalized, the Federal
Reserve would be required to take one or more prompt corrective actions. These
actions would include, among other things, requiring sales of new securities to
bolster capital, changes in management, limits on interest rates paid,
prohibitions on transactions with affiliates, termination of certain risky
activities and restrictions on compensation paid to executive officers. If a
bank is classified as critically undercapitalized, the bank must be placed into
conservatorship or receivership within 90 days, unless the Federal Deposit
Insurance Corporation determines otherwise.
The capital classification of a bank affects the frequency of
examinations of the bank and impacts the ability of the bank to engage in
certain activities and affects the deposit insurance premiums paid by the bank.
The Federal Reserve is required to conduct a full-scope, on-site examination of
every member bank at least once every twelve months.
Banks also may be restricted in their ability to accept brokered
deposits, depending on their capital classification. "Well capitalized" banks
are permitted to accept brokered deposits, but all banks that are not well
capitalized are not permitted to accept such deposits. The Federal Reserve may,
on a case-by-case basis, permit member banks that are adequately capitalized to
accept brokered deposits if the Federal Reserve determines that acceptance of
such deposits would not constitute an unsafe or unsound banking practice with
respect to the bank.
Deposit Insurance. The bank's deposits are insured up to $100,000 per
insured account by the Bank Insurance Fund of the Federal Deposit Insurance
Corporation. The bank's deposit insurance assessments may increase depending
upon the risk category and subcategory, if any, to which the bank is assigned.
The Federal Deposit Insurance Corporation assesses insurance premiums on a
bank's deposits at a variable rate depending on the probability that the deposit
insurance fund will incur a loss with respect to the bank. The Federal Deposit
Insurance Corporation determines the deposit insurance assessment rates on the
basis of the bank's capital classification and supervisory evaluations. Each of
these categories has three subcategories, resulting in nine assessment risk
classifications. The three subcategories with respect to capital are "well
capitalized," "adequately capitalized" and "less than adequately capitalized"
(that would include "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized" banks). The three subcategories with respect to
supervisory concerns are "healthy," "supervisory concern" and "substantial
supervisory concern." A bank is deemed "healthy" if it is financially sound with
only a few minor weaknesses. A bank is deemed subject to "supervisory concern"
if it has weaknesses that, if not corrected, could result in significant
deterioration of the bank and increased risk to the Bank Insurance Fund of the
Federal Deposit Insurance Corporation. A bank is deemed subject to "substantial
supervisory concern" if it poses a substantial probability of loss to the Bank
Insurance Fund. Any increase in insurance assessments could have an adverse
effect on the bank's earnings.
Our management and the bank's management cannot predict what other
legislation might be enacted or what other regulations might be adopted or the
effects thereof.
Page 12
ITEM 2. PROPERTIES
We currently operate out of seven banking offices, two consumer finance
offices, and two operations/administrative offices. All banking offices have
ATMs. A summary of our offices is as follows:
Approximate Year
Square Established Owned or
Footage or Acquired Leased
-------------- --------------- --------------
BANKING OFFICES:
WINSTON SALEM, NORTH CAROLINA
4701 Country Club Rd. - Headquarters 5,500 1996 Leased
3151 Peters Creek Parkway 2,400 1998 Leased
225 Hanes Mill Rd. 2,800 2001 Owned
536 South Stratford Rd. 1,600 1998 Leased
YADKINVILLE, NORTH CAROLINA
532 East Main Street 6,000 1998 Owned
CLEMMONS, NORTH CAROLINA
2755 Lewisville Clemmons Rd. 2,000 2000 Leased
KERNERSVILLE, NORTH CAROLINA
104 Harmon Lane 1,300 2000 Leased
CONSUMER FINANCE OFFICES:
WINSTON SALEM, NORTH CAROLINA
1209 Silas Creek Parkway 2,400 2000 Leased
MT. AIRY, NORTH CAROLINA
1201 West Lebanon Street 1,300 2000 Leased
OPERATIONS AND ADMINISTRATIVE OFFICES:
WINSTON SALEM, NORTH CAROLINA
4625 Country Club Rd. 3,200 1998 Owned
1600 Hanes Mall Blvd. 10,500 2000 Owned
In addition to the above locations, we have two off site ATMs located
at 3484 Robinhood Road, Winston-Salem and at 4575 Yadkinville Road, Pfafftown,
North Carolina. We have also committed to the construction or development of a
new headquarters, a new branch office and an office that will house our
mortgage, trust and brokerage operations. The new headquarters will be a 27,000
square foot facility to be built at a construction cost to us of approximately
$2.8 million on land that we acquired for $400,000, and will be located at 4605
Country Club Road, Winston-Salem, North Carolina. The new branch will be a 7,700
square foot facility to be built at a construction cost to us of approximately
$950,000 on land that we acquired for $500,000, and will be located at 1207
South Main Street, Kernersville, North Carolina. This new branch in Kernersville
will replace our temporary facility there. We moved our mortgage, trust and
brokerage operations in January 2002 to a leased facility located at 112
Cambridge Park, Winston-Salem, North Carolina.
All of our properties, including land, buildings and improvements,
furniture, equipment and vehicles, including the land acquisitions described
above, had a net book value at December 31, 2001 of $12.1 million.
Additional banking offices may be opened at later dates if deemed
appropriate by the Board of Directors and if regulatory approval can then be
obtained. The Board of Directors may acquire property in which a director,
directly or indirectly, has an interest. In such event, the acquisition of such
facilities shall be approved by a majority of the Board of Directors, excluding
any individual who may have such an interest in the property.
Page 13
ITEM 3. LEGAL
We are party to legal proceedings arising in the normal conduct of
business. Our management believes that this litigation is not material to our
financial position or results of our operations or the operations of the bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our security holders
during the fourth quarter of our fiscal year ended December 31, 2001.
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
Our common stock was quoted on the OTC Bulletin Board under the symbol
"SCMF" until January 2, 2002 when it was accepted for listing on the Nasdaq
National Market System. The following table sets forth the high and low sales
prices per share of our common stock, based on published financial sources, for
the last two years. All information has been adjusted for stock splits and stock
dividends effected during the periods presented.
PRICE
-----
YEAR QUARTERLY PERIOD HIGH LOW
------- ---------------- ------ ------
2000 First quarter.................................... $ 9.52 $ 7.79
Second quarter................................... 9.09 6.49
Third quarter.................................... 9.09 6.49
Fourth quarter................................... 8.69 6.49
2001 First quarter.................................... 8.57 7.02
Second quarter................................... 7.86 6.91
Third quarter.................................... 7.62 6.48
Fourth quarter................................... 8.65 5.00
At December 31, 2001, there were approximately 5,500 holders of record
of our common stock.
Holders of our common stock will be entitled to receive any cash
dividends the Board of Directors may declare. The declaration and payment of
future dividends to holders of our common stock will be at the discretion of our
Board of Directors and will depend upon our earnings and financial condition,
regulatory conditions and considerations and such other factors as our Board of
Directors may deem relevant. We expect that, for the foreseeable future, profits
resulting from the bank's operations will be retained by the bank as additional
capital to support its operations and growth other than dividends paid by the
bank to us as needed to pay any separate expenses of Southern Community
Financial Corporation and/or to make required payments on our debt obligations,
including the convertible debentures which will fund the interest payments on
the convertible preferred securities, issued by our trust subsidiary.
As a holding company, Southern Community Financial Corporation is
ultimately dependent upon its bank subsidiary to provide funding for its
operating expenses, debt service and dividends. Various banking laws applicable
to our bank subsidiary limit the payment of dividends, management fees and other
distributions by the bank to us and may therefore limit our ability to make
dividend payments. Under North Carolina banking law, dividends must be paid out
of retained earnings and no cash dividends may be paid if the bank's surplus is
less than 50% of its paid-in capital. Under federal banking law, no cash
dividend may paid if the bank is undercapitalized or insolvent or if payment of
the cash dividend would render the bank undercapitalized or insolvent, or if it
is in default of any deposit insurance assessment due to the Federal Deposit
Insurance Corporation.
Page 14
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA
Effective October 1, 2001, the Southern Community Bank and Trust became
a wholly owned subsidiary of Southern Community Financial Corporation. Southern
Community Financial Corporation has no assets other than those of the bank.
Therefore, the financial statements of the bank prior to October 1, 2001 are the
historical financial statements of Southern Community Financial Corporation. The
information set forth below does not purport to be complete and should be read
in conjunction with the company's consolidated financial statements appearing
elsewhere in this annual report.
For the Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
OPERATING DATA:
Interest income $ 31,366 $ 26,831 $ 16,562 $ 10,103 $ 3,309
Interest expense 18,034 14,944 8,481 4,907 1,477
---------- ---------- ---------- ---------- ----------
Net interest income 13,332 11,887 8,081 5,196 1,832
Provision for loan losses 2,320 1,480 1,135 1,200 650
---------- ---------- ---------- ---------- ----------
Net interest income after
provision for loan losses 11,012 10,407 6,946 3,996 1,182
Non-interest income 3,403 2,198 775 339 74
Non-interest expense 11,162 8,723 5,892 3,810 1,868
---------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes 3,252 3,882 1,829 525 (612)
Provision for income taxes 1,147 1,466 293 -- --
---------- ---------- ---------- ---------- ----------
Net income (loss) $ 2,105 $ 2,416 $ 1,536 $ 525 $ (612)
========== ========== ========== ========== ==========
PER SHARE DATA: (7)
Net income (loss)
Basic $ .25 $ .31 $ .20 $ .08 $ (.17)
Diluted .24 .30 .19 .07 (.17)
Cash dividends .00 .00 .00 .00 .00
Book value 5.08 4.63 4.13 3.94 2.97
Weighted average shares
Basic 8,293,027 7,711,955 7,655,147 6,854,172 3,532,780
Diluted 8,612,963 8,047,853 8,133,612 7,020,162 3,532,780
BALANCE SHEET DATA:
Total assets $ 481,220 $ 384,027 $ 254,172 $ 174,474 $ 68,597
Loans receivable 360,288 282,161 200,312 127,095 47,937
Allowance for loan losses 5,400 4,283 3,013 1,905 725
Deposits 392,851 338,753 218,953 143,850 57,788
Short-term borrowings 19,980 6,000 2,500 -- --
Long-term debt 25,000 -- -- -- --
Stockholders' equity 42,451 36,950 31,766 29,926 10,480
CAPITAL RATIOS: (5)
Total risk-based capital 11.53% 13.03% 16.40% 23.22% 22.23%
Tier 1 risk-based capital 10.28% 11.78% 15.15% 21.97% 20.98%
Leverage ratio 9.21% 11.16% 14.26% 21.57% 18.48%
Equity to assets ratio 8.82% 9.62% 12.50% 17.15% 15.28%
Page 15
For the Years Ended December 31,
----------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(Dollars in thousands, except per share data)
SELECTED PERFORMANCE RATIOS:
Return on average assets .50% .77% .71% .41% (1.45)%
Return on average equity 5.13% 7.27% 5.00% 2.03% (5.70)%
Net interest spread (2) 2.82% 3.22% 3.02% 2.93% 2.92%
Net interest margin (1) 3.36% 4.01% 3.90% 4.20% 4.52%
Non-interest income as a
percentage of total
revenue (6) 20.33% 15.61% 8.75% 6.12% 3.88%
Non-interest income as a
percentage of average
assets .80% .70% .36% .26% .18%
Non-interest expense to
average assets 2.63% 2.79% 2.71% 2.97% 4.45%
Efficiency ratio (3) 66.70% 61.93% 66.53% 68.83% 98.01%
Dividend payout ratio .00% .00% .00% .00% .00%
ASSET QUALITY RATIOS:
Nonperforming loans to
period-end loans .25% .10% .00% .01% .00%
Allowance for loan losses
to period-end loans 1.50% 1.52% 1.50% 1.50% 1.51%
Allowance for loan losses
to nonperforming loans 604% 1,552% NM 12,700% NM
Nonperforming assets
to total assets (4) .26% .07% .00% .01% .00%
Net loan charge-offs
to average loans outstanding .38% .09% .02% .02% .00%
OTHER DATA:
Number of banking offices 7 7 5 4 1
Number of full time
equivalent employees 121 104 70 46 24
(1) Net interest margin is net interest income divided by average interest
earning assets.
(2) Net interest spread is the difference between the average yield on
interest earning assets and the average cost of interest bearing
liabilities.
(3) Efficiency ratio is non-interest expense divided by the sum of net
interest income and non-interest income.
(4) Nonperforming assets consists of nonaccrual loans, restructured loans,
and Real Estate owned, where applicable.
(5) Capital ratios are for the bank.
(6) Total revenue consists of net interest income and non-interest income.
(7) All per share data has been restated to reflect the dilutive effect of
a stock split effected in the form of a 25% stock dividend in 1997, a
stock split effected in the form of a 10% stock dividend in 1998, a
two-for-one stock split in 1999, a stock split effected in the form of
a 10% stock dividend in 2000, and a 5% stock dividend in 2001.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following presents management's discussion and analysis of our
financial condition and results of operations and should be read in conjunction
with the financial statements and related notes included elsewhere in this
annual report. This discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ significantly from
those anticipated in these forward-looking statements as a result of various
factors. All share data has been adjusted to give retroactive effect to stock
splits and stock dividends. The following discussion is intended to assist in
understanding the financial condition and results of operations of the company.
Page 16
OVERVIEW
Our founders recognized an opportunity to fulfill the financial service
needs of individuals and organizations left underserved by consolidation within
the financial services industry. To fill a part of this void, we began in 1995
the process by which Southern Community Financial Corporation was created,
finally beginning operations on November 18, 1996 in the banking office that
still serves as our headquarters. From inception, we have strived to serve the
financial needs of small to medium-sized businesses, individuals, residential
homebuilders and others in and around Winston-Salem and the Piedmont Triad area
of North Carolina. We offer a broad array of banking and other financial
products - products similar to those offered by our larger competitors, but with
an emphasis on superior customer service. We believe that our emphasis on
quality customer service is the single most important factor among many that
have fueled our growth to $481 million in total assets in just over five years
of operations.
We began operations in November 1996 with $11 million in capital, a
single branch facility and thirteen employees. Through December 31, 2001,
Southern Community Financial Corporation has grown to a total of seven
full-service banking offices with $393 million in customer deposit accounts. In
support of this growth, we have generated $24 million of additional capital
through sales of common stock in 1998, 2000 and 2001. We have also formed four
subsidiaries offering a diversity of financial services that augment our
traditional banking products and services. These subsidiaries, and the services
each provides, include Southeastern Acceptance Corporation (Consumer Finance),
Southern Credit Services (Asset Based Commercial Finance), Southern Investment
Services (which, through an unaffiliated broker-dealer, provides customers of
the bank with securities products and services and earns revenues through
sharing of commissions) and VCS Management, LLC (Manager of a Small Business
Investment Company). More recently we have created a Trust Department that we
expect will begin operating in the first quarter of 2002. In October of 2001, we
formed Southern Community Financial Corporation , a financial holding company,
to become the parent company of Southern Community Bank and Trust. Our immediate
plans for expansion include the construction of both a new headquarters facility
on property adjacent to our current headquarters in Winston-Salem and a new full
service branch office in Kernersville.
Real estate secured loans, including construction loans and loans
secured by existing commercial and residential properties, comprise the majority
of our loan portfolio, with the balance of our loans consisting of commercial
and industrial loans and loans to individuals. Through associations with various
mortgage lending companies, we originate residential and commercial long-term
mortgages, at both fixed and variable rates, earning fees for loans originated.
It has been our strategy to recruit skilled banking professionals who are well
trained and highly knowledgeable about our market area, enabling us to develop
and maintain a loan portfolio of sound credit quality.
We recognize that our growth may expose us to increased operational and
market risk, primarily with respect to managing overhead, funding costs and
credit quality. We have developed critical functions such as Training, Audit,
and Credit Administration to assist in managing and monitoring these and other
risks. We are committed to creating a solid and diversified financial services
organization with a focus on customer service. It is our firm belief that this
foundation will continue building our loyal customer base while attracting new
clients and providing opportunities for future growth. As bank consolidations
continue to take place in our marketplace, Southern Community Financial
Corporation is positioned to continue to benefit from their effects.
Additionally, we expect to benefit from the recent merger of First Union and
Wachovia, both of which have a significant presence in our marketplace.
FINANCIAL CONDITION AT DECEMBER 31, 2001 AND 2000
During the year ended December 31, 2001, our total assets increased by
$97.2 million, or 25.3%, to $481.2 million. Consistent with prior years, strong
loan demand has provided the primary impetus for this overall asset growth. At
December 31, 2001, loans totaled $360.3 million, an increase of $78.1 million or
27.7% during the year. This growth was spread among our mortgage, construction
and commercial loans. Our commercial mortgage loans and non-mortgage commercial
loans increased by $29.9 million and $17.5 million, respectively, and
collectively provided 60.8% of our overall loan growth. We also generated growth
of $21.1 million and $8.8 million, respectively, in residential mortgage loans
and construction loans.
Our total liquid assets, defined as cash and due from banks, federal
funds sold and investment securities, increased by $15.5 million during the
year, to $107 million at December 31, 2001 versus $91.5 million at the beginning
of the year. Liquid assets represented 22.2% of total assets at December 31,
2001 as compared to 23.8% at the beginning of the year. Because of the
significant rate cuts enacted by the Federal Reserve Board, we have chosen to
invest more heavily in investments held to maturity, which we increased by $14.3
million to $34.5 million at December 31, 2001. The higher yields on these
investments help to somewhat mitigate the effect of the overall declining trend
in interest rates.
Page 17
Customer deposits continue to be our primary funding source. While our
deposits are primarily generated through our growing branch network, we do
utilize some out-of-market and brokered deposits to support our funding base. At
December 31, 2001, deposits totaled $392.9 million, an increase of $54.1 million
or 16.0% from year-end 2000. During the fourth quarter of 2000 we opened two
branches, which has contributed to our deposit growth. However, loan growth this
year has outpaced our growth in deposits. We have utilized borrowings from the
Federal Home Loan Bank of Atlanta (FHLB) to fill this funding gap. We will use
FHLB advances and other funding sources as necessary to support balance sheet
management and growth. However, we believe that as our branch network grows and
matures, the volume of core deposits will become a relatively larger portion of
our funding mix, which should contribute to a reduction in our overall funding
cost.
Our capital position remains strong, with all of our regulatory capital
ratios at levels that make us "well capitalized" under federal bank regulatory
capital guidelines. At December 31, 2001, our stockholders' equity totaled $42.5
million, an increase of $5.5 million from the December 31, 2000 balance. This
increase includes net income of $2.1 million earned during the year, proceeds of
$2.8 million received in February 2001 from the sale of 344,000 shares of our
common stock and $493,000 that resulted from an increase in the fair value of
our available-for-sale investments.
FINANCIAL CONDITION AT DECEMBER 31, 2000 AND 1999
Throughout 2000 we continued to aggressively follow our business plan
objectives of serving the banking needs of small to medium-sized businesses,
individuals, residential homebuilders and others in our market area. In doing so
we generated consistent strong growth and profitability during the year. Our
total assets increased by $129.9 million, or 51.1%, to $384.0 million at the
year-end 2000. We opened two new branches in 2000, and otherwise focused our
efforts at increasing our deposit base, with the result that we generated growth
in deposits of $119.8 million to $338.8 million, an increase of 54.7% over the
year-end 1999 deposit total of $219.0 million.
Loan growth continued to be strong in 2000, with total loans increasing
by $81.9 million, or 40.9%, to $282.2 million at December 31, 2000 from $200.3
million at December 31, 1999. This loan growth was well spread across our
portfolio, as each major category of loans grew in excess of 28%. Our credit
quality continued to be strong as well, with non-performing loans at year-end
and net loan charge-offs for the year below .10% of total year-end loans and
average loans for the year, respectively. Because our deposit growth
substantially exceeded our loan growth in 2000, we were able to significantly
increase our liquidity position during the year. Our total liquid investments,
which consists of federal funds sold and investment securities, grew from $36.7
million to $80.3 million, with available for sale and held to maturity
investment securities totaling $39.0 million and $20.2 million, respectively,
and federal funds sold of $21.0 million, at December 31, 2000.
Our total stockholders' equity increased by $5.2 million in 2000
principally as a result of net income for the year of $2.4 million and proceeds
of $2.2 million from the sale of common stock through a public offering and the
exercise of options. We also recorded an increase in accumulated other
comprehensive income of $578,000 arising from appreciation in the market value
of our available for sale investment securities during the year. At December 31,
2000, all of our regulatory capital ratios were at levels deemed "well
capitalized" under federal bank regulatory capital guidelines.
NET INTEREST INCOME
Like most financial institutions, the primary component of our earnings
is net interest income. Net interest income is the difference between interest
income, principally from loans and investments, and interest expense,
principally on customer deposits and borrowings. Changes in net interest income
result from changes in volume and changes in interest rates earned and paid. By
volume, we mean the average dollar level of interest-earning assets and
interest-bearing liabilities. Spread refers to the difference between the
average yield on interest-earning assets and the average cost of
interest-bearing liabilities, and margin refers to net interest income divided
by average interest-earning assets. Spread and margin are influenced by the
level and relative mix of interest-earning assets and interest-bearing
liabilities, as well as by levels of noninterest-bearing liabilities. During the
years ended December 31, 2001, 2000 and 1999, our average interest-earning
assets were $397.0 million, $296.6 million, and $207.1 million, respectively.
During these same years, our net interest margins were 3.36%, 4.01%, and 3.90%,
respectively.
Page 18
Average Balances and Average Rates Earned and Paid. The following table
sets forth, for the years 1999 through 2001, information with regard to average
balances of assets and liabilities, as well as the total dollar amounts of
interest income from interest-earning assets and interest expense on
interest-bearing liabilities, resultant yields or costs, net interest income,
net interest spread, net interest margin and ratio of average interest-earning
assets to average interest-bearing liabilities. Average loans include
nonaccruing loans, the effect of which is to lower the average rate shown.
For the Years Ended December 31,
----------------------------------------------------------------------------------------
2001 2000 1999
----------------------------- ---------------------------- -----------------------------
Interest Interest Interest
Average earned/ Average Average earned/ Average Average earned/ Average
balance paid yield/cost balance paid yield/cost balance paid yield/cost
-------- ------ ---------- -------- ------- ---------- ---------- -------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans $318,696 $ 26,292 8.25% $240,888 $23,351 9.69% $160,718 $14,026 8.73%
Investment securities
available for sale 36,439 2,320 6.37% 26,821 1,733 6.46% 16,102 944 5.86%
Investment securities
held to maturity 32,261 2,201 6.82% 14,897 849 5.70% 14,189 802 5.65%
Other 9,620 553 5.75% 14,012 898 6.41% 16,109 790 4.90%
-------- -------- -------- -------- -------- -------
Total interest-earning assets 397,016 31,366 7.90% 296,618 26,831 9.05% 207,118 16,562 8.00%
-------- ---- -------- ---- ------- ----
Other assets 27,158 16,119 10,282
-------- -------- ---------
Total assets $424,174 $312,737 $217,400
======== ======== =========
Interest-bearing liabilities:
Deposits:
NOW and money market $ 80,695 2,135 2.65% $ 52,144 2,079 3.99% $ 43,044 1,470 3.42%
Time deposits greater
than $100,000 96,542 5,795 6.00% 68,553 4,282 6.25% 47,405 2,864 6.04%
Other time deposits 155,979 9,063 5.81% 130,752 8,229 6.29% 79,621 4,139 5.20%
Borrowings 21,810 1,041 4.77% 5,086 354 6.96% 125 8 6.40%
-------- -------- -------- -------- -------- -------
Total interest-bearing
liabilities 355,026 18,034 5.08% 256,535 14,944 5.83% 170,195 8,481 4.98%
-------- ---- -------- ---- ------- ----
Demand deposits 25,749 20,932 15,548
Other liabilities 2,351 2,042 902
Stockholders' equity 41,048 33,228 30,755
-------- -------- ---------
Total liabilities and
stockholders' equity $424,174 $312,737 $ 217,400
======== ======== =========
Net interest income and
net interest spread $ 13,332 2.82% $ 11,887 3.22% $ 8,081 3.02%
======== ==== ======== ==== ======= ====
Net interest margin 3.36% 4.01% 3.90%
==== ==== ====
Ratio of average interest-earning
assets to average interest-bearing
liabilities 111.83% 115.62% 121.69%
======== ======== =========
Page 19
RATE/VOLUME ANALYSIS
The following table analyzes the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume), and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated equally to both the changes attributable
to volume and the changes attributable to rate.
Year Ended Year Ended
December 31, 2001 vs. 2000 December 31, 2000 vs. 1999
------------------------------------------- ------------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
------------------------------------------- ------------------------------------------
Volume Rate Total Volume Rate Total
----------- ---------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Interest income:
Loans $ $ 6,981 $ (4,040) $ 2,941 $ 7,384 $ 1,941 $ 9,325
Investment securities available
for sale 617 (30) 587 661 128 789
Investment securities held
to maturity 1,087 265 1,352 40 7 47
Other (267) (78) (345) (119) 227 108
----------- ---------- ----------- ---------- ----------- -----------
Total interest income 8,418 (3,883) 4,535 7,966 2,303 10,269
----------- ---------- ----------- ---------- ----------- -----------
Interest expense:
Deposits:
NOW and money market 947 (890) 57 337 272 609
Time deposits greater
than $100,000 1,714 (201) 1,513 1,299 119 1,418
Other time deposits 1,527 (693) 834 2,938 1,152 4,090
Borrowings 981 (294) 687 331 15 346
----------- ---------- ----------- ---------- ----------- -----------
Total interest expense 5,169 (2,078) 3,091 4,905 1,558 6,463
----------- ---------- ----------- ---------- ----------- -----------
Net interest income increase
(decrease) $ 3,249 $ (1,805) $ 1,444 $ 3,061 $ 745 $ 3,806
=========== ========== =========== ========== =========== ===========
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Income. Our net income for 2001 was $2.1 million, a decrease of
$311,000 below net income of $2.4 million earned in 2000. Net income per share
was $.25 basic and $.24 diluted for the year ended December 31, 2001, down from
$.31 basic and $.30 diluted for 2000. We have continued to experience strong
growth, with total assets averaging $424.2 million during the current year as
compared to $312.7 million in 2000, an increase of 35.6%. Our percentage growth
in non-interest income of 54.8% exceeded our rate of asset growth, while our
28.0% increase in non-interest expenses was below our rate of asset growth.
While such trends generally contribute to improved profitability, their positive
effects were more than offset by an increase in our provision for loan losses
coupled with the effects of declining interest rates that caused our interest
rate spread and net yield on average interest earning assets to decline by 40
basis points and 65 basis points, respectively. As a result, our increases of
$1.4 million in net interest income and $1.2 million in non-interest income were
not enough to overcome the combined impact of increases of $840,000 in our
provision for loan losses and $2.4 million in our non-interest expenses. Our
expense growth included the costs of two new branches, additional branch
personnel, as well as personnel costs associated with expansion of our business.
While these expenses represent investments in building our franchise, they are
initially a drag on earnings. Also contributing to the decline in earnings per
share was the increase in shares outstanding as result of our sale of 344,118
shares of common stock early in 2001.
Page 20
Net Interest Income. During 2001, our net interest income increased by
$1.4 million or 12.2% to $13.3 million. Our total interest income benefited from
strong growth in the level of average earning assets, which offset lower asset
yields caused by the dramatic trend of declining interest rates throughout the
period. The rates earned on a significant portion of our loans adjust
immediately when index rates such as our prime rate change. Conversely, most of
our interest-bearing liabilities, including certificates of deposit and
borrowings, have rates fixed until maturity. As a result, interest rate
reductions will generally result in an immediate drop in our interest income on
loans, with a more delayed impact on interest expense because reductions in
interest costs will only occur upon renewals of certificates of deposit or
borrowings. Average total interest-earning assets increased $100.4 million, or
33.8%, during 2001 as compared to 2000, while our average yield dropped by 115
basis points from 9.05% to 7.90%. Our average total interest-bearing liabilities
increased by $98.5 million, or 38.4%, consistent with our increase in
interest-earning assets. However, because our interest costs generally do not
react as quickly to rate changes, our average cost of interest-bearing
liabilities decreased by only 75 basis points from 5.83% to 5.08%, resulting in
the compression in interest margins described above. For the year ended December
31, 2001, our net interest spread was 2.82% and our net interest margin was
3.36%. For the year ended December 31, 2000, our net interest spread was 3.22%
and our net interest margin was 4.01%.
Provision for Loan Losses. We recorded a $2.3 million provision for
loan losses for the year ended December 31, 2001, representing an increase of
$840,000 over the $1.5 million provision we made for the year ended December 31,
2000. Provisions for loan losses are charged to income to bring our allowance
for loan losses to a level deemed appropriate by management based on the factors
discussed under "Analysis of Allowance for Loan Losses." We have continued to
increase the level of our allowance for loan losses principally as a result of
the continued growth in our loan portfolio. Total loans receivable increased by
$78.1 million during 2001, and by $81.8 million during 2000. Our higher
provision for loan losses for the current year was made largely in response to
an increase in net loan charge-offs, which totaled $1.2 million during 2001, up
from $210,000 during the year ended December 31, 2000. On an annualized basis,
our percentage of net loan charge-offs to average loans outstanding was .38% for
the year ended December 31, 2001 as compared with .09% for the year ended
December 31, 2000. For all full fiscal years through 2000, our loan loss
experience was similar to that of other new banks, with net loan charge-offs in
each year of less than .10% of average loans outstanding. The increase in our
net charge-offs reflects the relatively higher charge-offs associated with our
consumer finance subsidiary, as well as the maturation of our loan portfolio.
During 2001, our consumer finance subsidiary had net loan charge-offs of
$290,000, which is consistent with our budgeted level for that line of business.
On a stand-alone basis, the rate of net loan charge-offs to average loans
outstanding in our bank was .29%, which we believe reflects the maturation and
seasoning of our loan portfolio. Nonperforming loans totaled $894,000 or .25% of
total loans at December 31, 2001, up from $276,000 or .10% of total loans at
December 31, 2000. The allowance for loan losses at December 31, 2001 of $5.4
million represents 1.50% of total loans and 604% of nonperforming loans. The
allowance for loan losses at December 31, 2000 of $4.3 million equaled 1.52% of
total loans outstanding at that date.
Non-Interest Income. For the year ended December 31, 2001, non-interest
income increased $1.2 million or 54.8% to $3.4 million from $2.2 million for the
prior year. This favorable increase resulted from factors that include an
increase of $284,000, or 47.7% to $879,000, in service charges and fees on
deposit accounts as a result of deposit growth, an increase of $459,000, or
83.5% to $1.0 million, in income from the origination of residential mortgage
loans sold into the secondary market and income of $383,000 realized from an
interest rate floor contract.
Non-Interest Expense. We strive to maintain non-interest expenses at
levels that we believe are appropriate given the nature of our operations and
the investments in personnel and facilities that have been necessary to generate
our growth. From 1998 forward, we have consistently maintained our ratio of
non-interest expenses to average total assets below 3%. Because of our growth
and the costs associated with building our franchise, we have consistently seen
increases in every major component of our non-interest expenses. For the year
ended December 31, 2001, our non-interest expense increased $2.4 million, or
28.0%. Salary and employee benefit expense increased $934,000, or 20.4%, and
reflects the addition of personnel in our two new branches as well as additions
of personnel to expand our lines of business, and, to a lesser degree, normal
salary increases. Occupancy and equipment expense increased $611,000, or 42.0%,
reflecting the expenses associated with our two newest branches and our
operations center, all of which were opened in the fourth quarter of 2000. Other
non-interest expenses increased $894,000, or 33.2%, reflecting the increased
volume of business activity, principally increases in lending and growth in
deposit accounts. For the year ended December 31, 2001, on an annualized basis,
our ratio of non-interest expenses to average total assets improved to 2.63% as
compared with 2.79% for 2000.
Provision for Income Taxes. Our provision for income taxes, as a
percentage of income before income taxes, was 35.3% and 37.8%, respectively, for
the years ended December 31, 2001 and 2000. The decline in the effective rate
for the current period principally results from a higher level of investment in
federally issued debt instruments that are not subject to state income taxes.
Page 21
YEARS ENDED DECEMBER 31, 2000 AND 1999
Net Income. We generated net income of $2.4 million during 2000
compared to $1.5 million in 1999, a 57% increase. As a result, diluted net per
share increased to $0.30 per share compared to $0.19 per share in 1999, an
increase of 58%. Operating results were considerably impacted by increases in
all categories of revenue and expenses as we experienced significant growth
during the year. In addition, we diversified and enhanced our earnings stream by
adding consumer finance and small business investment company activities.
Net Interest Income. Net interest income for 2000 was $11.9 million
compared to $8.1 for 1999. The increase was largely driven by asset growth and
to a lesser degree by a widening of our net interest margin. Total assets
increased $129.9 million, or 51%, during the year. The yield on average
interest-earning assets and the rate on average interest-bearing liabilities
increased in 2000 over 1999 as interest rates rose during this time period.
Since our interest-bearing assets, mostly loans, repriced more quickly than our
interest-bearing liabilities, the Federal Open Market Committee's decision to
raise the federal funds target rate during 2000 had a direct benefit on the
bank's net interest spread and net interest margin. Our net interest spread and
net interest margin increased to 3.22% and 4.01% in 2000, respectively from
3.02% and 3.90% in 1999.
Provision for Loan Losses. We recorded a $1.5 million provision for
loan losses in 2000, representing an increase of $345,000 over the $1.1 million
provision we made in 1999. Provisions for loan losses are charged to income to
bring our allowance for loan losses to a level deemed appropriate by management
based on the factors discussed under "Analysis of Allowance for Loan Losses." In
each year the provision for loan losses was made principally in response to
growth in loans, as total loans outstanding increased by $80.2 million in 2000
and by $73.2 million in 1999. The loan loss provision for 2000 was further
impacted by a higher level of net loan charge-offs, which totaled $210,000 for
the year as compared to only $27,000 during 1999. At December 31, the allowance
for loan losses was $4.3 million for 2000 and $3.0 million for 1999,
representing 1.52% and 1.50%, respectively, of loans outstanding. At December
31, 2000, the bank had $276,000 in nonaccrual loans. The bank had no
nonperforming loans at December 31, 1999.
Non-Interest Income. Non-interest income of $2.2 million in 2000 was
significantly greater than the $775,000 in 1999. The bank experienced a
significant increase in service charges and fees on deposit accounts, by and
large due to growth in the number and activity of deposit accounts. In addition,
the bank generated higher levels of mortgage loan origination fees and stock
brokerage fees. In 2000 the bank also earned $515,000 in fees as the managing
general partner of Venture Capital Solutions, L.P., a small business investment
company licensed by the SBA. The bank had no gains or losses on investment
security transactions in either year.
Non-Interest Expense. Non-interest expense increased in 2000 to $8.7
million, or 48%, from $5.9 million in 1999. The increase in non-interest expense
in 2000 compared to 1999 is principally due to growth of the bank. Salaries and
employee benefits expense increased to $4.6 million, or 67%, from $2.7 million
and reflect continued growth in our business as we added personnel. A key
element of other non-interest expense has been advertising and promotion, which
in 2000 was $578,000 and in 1999 was $434,000. Data processing and other
outsourced services are another major expense, constituting $624,000 in 2000 and
$537,000 in 1999. In 2000, the bank opened two additional branches, which
contributed to the increase in occupancy and equipment expense, which increased
to $1.5 million, or 39%, from $1.0 million the prior year.
Provision for Income Taxes. The bank had an effective income tax rate
of 37.8% in 2000 and 16.0% in 1999, as the bank's earnings became fully taxable
for 2000. The effective rate for 1999 was different from fully taxable rates
predominantly because of recognition deferred tax assets generated in periods
before the bank achieved profitability.
LIQUIDITY AND CAPITAL RESOURCES
Market and public confidence in our financial strength and in the
strength of financial institutions in general will largely determine our access
to appropriate levels of liquidity. This confidence is significantly dependent
on our ability to maintain sound asset quality and appropriate levels of capital
resources.
The term "liquidity" refers to our ability to generate adequate amounts
of cash to meet our needs for funding loan originations, deposit withdrawals,
maturities of borrowings and operating expenses. Management measures our
liquidity position by giving consideration to both on- and off-balance sheet
sources of, and demands for, funds on a daily and weekly basis.
Page 22
Sources of liquidity include cash and cash equivalents, net of federal
requirements to maintain reserves against deposit liabilities, investment
securities eligible for pledging to secure borrowings from correspondent banks
pursuant to securities sold under repurchase agreements, investments available
for sale, loan repayments, loan sales, deposits, and borrowings from the Federal
Home Loan Bank and from correspondent banks under overnight federal funds credit
lines. In addition to interest rate-sensitive deposits, the company's primary
demand for liquidity is anticipated fundings under credit commitments to
customers.
Because of our continued growth, we have maintained a relatively high
level of liquidity in the form of interest-bearing bank deposits, federal funds
sold, and investment securities. These aggregated $88.1 million at December 31,
2001, compared to $80.3 million and $36.7 million at December 31, 2000 and 1999,
respectively. We achieved strong deposit growth in 2000, with a $119.8 million
increase in total customer deposit accounts generating liquidity in excess of
the amount required to fund our $81.8 million increase in total loans for that
year. This provided for the significant increase in liquid assets in 2000, and
we have maintained this higher level of liquidity during the current fiscal
year. Supplementing customer deposits as a source of funding, we have available
lines of credit from various correspondent banks to purchase federal funds on a
short-term basis of approximately $26.0 million. We also have the ability to
borrow up to $45.7 million, as of December 31, 2001, from the Federal Home Loan
Bank of Atlanta, with $35.0 million outstanding as of that date. At December 31,
2000 we had FHLB borrowings outstanding of $6.0 million. Our loan growth during
2001 has exceeded our growth in customer deposits, and we have taken advantage
of favorable interest rates offered by the FHLB to provide funding for that
higher loan growth. We also had a repurchase agreement with an outstanding
balance of $10.0 million at December 31, 2001. Securities sold under agreements
to repurchase generally mature within ninety days from the transaction date and
are collateralized by U.S. Government Agency obligations. We have repurchase
lines of credit aggregating $37.0 million from various institutions. The
repurchases must be adequately collateralized. At December 31, 2001, our
outstanding commitments to extend credit consisted of loan commitments of $26.5
million and amounts available under home equity credit lines, other credit lines
and standby letters of credit of $27.3 million, $38.1 million and $3.8 million,
respectively. We believe that our combined aggregate liquidity position from all
of these sources is sufficient to meet the funding requirements of loan demand
and deposit maturities and withdrawals in the near term.
Throughout our five-year history, our loan demand has exceeded our
growth in core deposits. We have therefore relied heavily on certificates of
deposits as a source of funds. While the majority of these funds are from our
local market area, the bank has utilized brokered and out-of-market certificates
of deposits to diversify and supplement our deposit base. Certificates of
deposits represented 66% of our total deposits at December 31, 2001, down from
72% at December 31, 2000. Certificates of deposit of $100,000 or more
represented 28.4% of our total deposits at December 31, 2001 and 22% at December
31, 2000. A portion of these deposits are controlled by members of our Board of
Directors and Advisory Board members, or otherwise comes from customers
considered to have long-standing relationships with our management. Based upon
the nature of these relationships, management does not believe we are subject to
significant liquidity risk related to these deposits. Certificates of deposit of
$100,000 or more, exclusive of these relationships, constituted 25% of our total
deposits at December 31, 2001. Large certificates of deposits are generally
considered rate sensitive. However, we believe a portion of our large
certificates of deposits are relationship-oriented, and while will need to pay
competitive rates to retain these deposits at their maturities, there are other
subjective factors that will determine their continued retention.
CAPITAL RATIOS
At December 31, 2001, our capital to asset ratio was 8.8%, and all of
our capital ratios exceeded the minimums established for a well-capitalized bank
by regulatory measures. Our Tier 1 risk-based capital ratio at December 31, 2001
was 10.28%.
The bank is subject to minimum capital requirements. See "Supervision
and Regulation." As the following table indicates, at December 31, 2001, we
exceeded our regulatory capital requirements.
At December 31, 2001
--------------------------------------------------------
Actual Minimum Well-Capitalized
Ratio Requirement Requirement
---------------- ---------------- ----------------
Total risk-based capital ratio................... 11.53% 8.00% 10.00%
Tier 1 risk-based capital ratio.................. 10.28% 4.00% 6.00%
Leverage ratio................................... 9.21% 4.00% 5.00%
Page 23
In February of 2002, Southern Community Capital Trust I (the "Trust"),
a newly formed subsidiary of the company, issued 1,725,000 Cumulative
Convertible Trust Preferred Securities (the "Securities"), generating total
proceeds of $17.3 million. The Securities pay distributions at an annual rate of
7.25% and mature on March 31, 2032. The Securities will pay distributions
quarterly beginning on March 31, 2002. The company has fully and unconditionally
guaranteed the obligations of the Trust. The Securities can be converted at any
time into common stock at a price of $8.67 (the "Conversion Price") or 1.153
shares of the company's common stock for each convertible preferred security.
The Securities issued by the Trust are redeemable in whole or in part at any
time after April 1, 2007. The Securities are also redeemable in whole at any
time prior to March 31, 2007 as long as the trading price of our common stock
has been at least 125% of the Conversion Price for a period of twenty
consecutive trading days ending within five days of the notice of redemption.
The proceeds from the Securities were utilized to purchase convertible junior
subordinated debentures from us under the same terms and conditions as the
Securities. The company has the right to defer payment of interest on the
debentures at any time and from time to time for a period not exceeding five
years, provided that no deferral period extend beyond the stated maturities of
the debentures. Such deferral of interest payments by the company will result in
a deferral of distribution payments on the related Securities. Should the
company defer the payment of interest on the debentures, the company will be
precluded from the payment of cash dividends to shareholders. Subject to certain
limitations, the Securities qualify as Tier 1 capital of the company for
regulatory capital purposes. The principal use of the net proceeds from the sale
of the convertible debentures is to infuse capital to our bank subsidiary,
Southern Community Bank and Trust, to fund its operations and continued
expansion, the operations and continued expansion of the bank's subsidiaries,
and to maintain the bank's status as "well capitalized" under regulatory
guidelines.
ASSET/LIABILITY MANAGEMENT
Our results of operations depend substantially on net interest income.
Like most financial institutions, our interest income and cost of funds are
affected by general economic conditions and by competition in the market place.
The purpose of asset/liability management is to provide stable net interest
income growth by protecting earnings from undue interest rate risk, which arises
from volatile interest rates and changes in the balance sheet mix, and by
managing the risk/return relationships between liquidity, interest rate risk,
market risk and capital adequacy. We adhere to a Board approved asset/liability
management policy that provides guidelines for controlling exposure to interest
rate risk by utilizing the following ratios and trend analysis: liquidity,
equity, volatile liability dependence, and portfolio maturities. Our policy is
to control the exposure of earnings to changing interest rates by generally
endeavoring to maintain a position within a narrow range around an "earnings
neutral position," which is defined as the mix of assets and liabilities that
generate a net interest margin that is least affected by interest rate changes.
When suitable lending opportunities are not sufficient to utilize
available funds, we have generally invested such funds in securities, primarily
U.S. Treasury securities, securities issued by governmental agencies,
mortgage-backed securities and corporate obligations. The securities portfolio
contributes to profitability and plays an important part in our overall interest
rate management. However, management of the securities portfolio alone cannot
balance overall interest rate risk. The securities portfolio must be used in
combination with other asset/liability techniques to actively manage the balance
sheet. The primary objectives in the overall management of the securities
portfolio are safety, liquidity, yield, asset/liability management (interest
rate risk), and investing in securities that can be pledged for public deposits
or for borrowings.
In reviewing the needs of our bank with regard to proper management of
its asset/liability program, we estimate future needs, taking into consideration
historical periods of high loan demand and low deposit balances, estimated loan
and deposit increases (due to increased demand through marketing), and
forecasted interest rate changes. We use a number of measures to monitor and
manage interest rate risk, including income simulations and interest sensitivity
or "gap" analyses. An income simulation model is the primary tool used to assess
the direction and magnitude of changes in net interest income resulting from
changes in interest rates. Key assumptions in the model include prepayment
speeds on mortgage-related assets, cash flows and maturities of other investment
securities, loan and deposit volumes and pricing. These assumptions are
inherently uncertain and, as a result, the model cannot precisely estimate net
interest income or precisely predict the impact of higher or lower interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude and frequency of interest rate changes and changes in
market conditions and management strategies, among other factors. Based on the
results of the income simulation model as of December 31, 2001, we would expect
an increase in net interest income of $1.3 million if interest rates increase
from current rates by 200 basis points over the next twelve months and a
decrease in net interest income of $1.1 million if interest rates decrease from
current rates by 200 basis points over the next twelve months.
Page 24
The analysis of interest rate gap (the difference between the amount of
interest-earning assets and interest-bearing liabilities repricing during a
given period of time) is another standard tool we use to measure exposure to
interest rate risk. We believe that because interest rate gap analysis does not
address all factors that can affect earnings performance, it should be used in
conjunction with other methods of evaluating interest rate risk.
Our balance sheet was asset-sensitive at December 31, 2001 in the
three-month horizon and liability-sensitive in the one-year period. An
asset-sensitive position means that there are more assets than liabilities
subject to repricing in that period as market rates change, and conversely with
a liability-sensitive position. As a result, in a falling rate environment, our
earnings position could deteriorate initially followed by improvement, with the
opposite expectation in a rising rate environment, depending on the correlation
of rate changes in these categories.