ITEM 1. DESCRIPTION OF BUSINESS
General
Southern Community Bancorp (“Southern”) is a bank holding company which owns and operates three Florida chartered banks. These banks are as follows:
Name of Bank
Principal Office
Southern Community Bank of Central Florida
Orlando, Florida
Southern Community Bank of Southwest Florida
Bonita Springs, Florida
Southern Community Bank of South Florida
Boca Raton, Florida
Southern was formed in 1999 and became a bank holding company in July 1999 when it acquired all of the shares of Southern Community Bank of Central Florida (the “Central Florida Bank”) in a share exchange with the shareholders of the Central Florida Bank.
Southern acquired Peninsula Bancorp, Inc. (“Peninsula”) on April 30, 2001. Peninsula was the parent company of Peninsula Bank of Central Florida (the “Daytona Beach Bank”). The name of the Daytona Beach Bank was subsequently changed to Southern Community Bank, Atlantic. In August 2003, the assets and liabilities of the Daytona Beach Bank were transferred to the Central Florida Bank, and the charter for the Daytona Beach Bank was sold to a third party.
Southern opened Southern Community Bank of Southwest Florida (the “Southwest Florida Bank”) in January 2001. Southern opened Southern Community Bank of South Florida (the “South Florida Bank”) in August 2002.
Proposed Merger with First National Bankshares of Florida, Inc.
On March 19, 2004, First National Bankshares of Florida, Inc. (“FLB”) and Southern entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which FLB agreed to acquire Southern through the merger of Southern with and into FLB.
Under the terms of the Merger Agreement, at the effective time of the merger, each outstanding share of the Southern’s common stock will be converted into the right to receive 1.62 shares of FLB common stock; provided, that if the average closing price of FLB’s common stock exceeds $20.00 over the 20 consecutive trading days ending on the fifth day prior to the merger (such average closing price, the “Closing FLB Value”), the exchange ratio will be reduced to an amount that will result in each share of Southern common stock being exchanged for a number of shares of FLB common stock having a value (based on the Closing FLB Value) equal to the average of $32.40 ($20.00 multiplied by 1.62) and the product of 1.62 multiplied by the Closing FLB Value. If the average closing price of FLB common stock over the twenty trading days ending on the day the last required regulatory or shareholder approval of the merger is obtained is less than $15.00, Southern will have the right to terminate the Merger Agreement.
The merger is intended to constitute a tax-free reorganization under the Internal Revenue Code of 1986, as amended (except for any cash paid to a Southern shareholder in lieu of a fractional share of FLB common stock).
Consummation of the merger is subject to various conditions, including: (i) approval of the Merger Agreement by the shareholders of FLB and Southern; (ii) receipt of banking regulatory approvals; and (iii) receipt of opinions of counsel as to the tax-free nature of certain aspects of the merger.
Strategy
Southern’s goal is to operate its banks in the substantially the same manner as local community banks, emphasizing local leadership and local decision-making. The management of each bank makes its own credit decisions. Each bank prices and markets its own loan and deposit products. Each bank has its own board of directors, drawn mainly from members of the local business community. Each board has full authority over the bank, in contrast to an “advisory” board which lacks authority. Each bank endeavors to be an active supporter of local charities and civic organizations.
Southern’s strategy is to capitalize on the opportunities created by the consolidation in the Florida banking industry. Southern believes that this consolidation has reduced the levels of personalized services as the larger regional financial institutions have increasingly focused on larger corporate customers and standardized loan and deposit products. More specifically, many financial institutions have centralized their loan approval practices for small businesses, leaving less responsibility and authority with the traditional loan officer. By virtue of their banking experience in Florida, Southern’s management believes that the most frequent customer complaints are based on a
lack of personalized service and turnover in lending personnel, which limits the customer’s ability to develop a relationship with his or her banker. As a result of these factors, Southern believes there currently exists a significant opportunity to attract and maintain customers who are dissatisfied with their banks. Southern also believes it can attract experienced management personnel within its identified markets.
Southern’s holding company structure provides flexibility for the future expansion of its banking business through the possible acquisition of other financial institutions and the formation of new banks. In addition, Southern’s holding company structure also makes it easier to raise additional capital for its banks because Southern can issue securities without the need for prior banking regulatory approval.
Southern Community Bank of Central Florida
The Central Florida Bank is a Florida state-chartered bank which commenced operations in December 1998. The Central Florida Bank’s principal office is located in the central business district in Orlando, Florida, and it maintains branch offices in the cities of Winter Park, Altamonte Springs, Longwood, south Orlando, Lake Mary, Ormond Beach, Port Orange and Daytona Beach, Florida. At December 31, 2003, the Central Florida Bank had total assets of $605.4 million.
Southern Community Bank of Southwest Florida
The Southwest Florida Bank is a Florida state-chartered bank which opened in January 2001. The Southwest Florida Bank serves the Bonita Springs and Naples, Florida markets. The main office of the Southwest Florida Bank is located in Bonita Springs. The bank also operates branch offices in Naples and Ft. Myers, Florida. The Southwest Florida Bank expects to open an additional branch in Estero, Florida in the next 12 months. At December 31, 2003, the Southwest Florida Bank had total assets of $161.2 million.
Southern Community Bank of South Florida
The South Florida Bank is a Florida state-chartered bank which opened in August 2002. Its principal office is located in Boca Raton, Florida, and it operates branch offices in Fort Lauderdale, Palm Beach, West Palm Beach and Palm Beach Gardens, Florida and a loan production office in West Palm Beach, Florida. At December 31, 2003, the South Florida Bank had total assets of $140.1 million.
Southern Community Insurance Agency, Inc.
Southern owns and operates an insurance agency named Southern Community Insurance Agency, Inc. The agency is a wholly owned subsidiary of the Central Florida Bank. The agency refers customers of Southern’s banks to another insurance agency, Insurance Office of America, Inc., for the purchase of insurance products. Insurance Office of America pays the agency a percentage of the commissions generated from customers which are referred. One of the principal shareholders of Insurance Office of America is John Ritenour, one of Southern’s directors.
Material Transitions in 2003
Transfer of Assets and Liabilities of Daytona Beach Bank. In August 2003, the Daytona Beach Bank transferred substantially all of its assets to the Central Florida Bank. In consideration for the transfer of the assets, the Central Florida Bank assumed all of the liabilities of the Daytona Beach Bank and paid the Daytona Beach Bank a cash amount equal to the difference between the book value of the transferred assets and the assumed liabilities. The Central Florida Bank also hired all of the former employees of the Daytona Beach Bank. Since that time, the Central Florida Bank has continued to operate all of the facilities of the Daytona Beach Bank.
At the same time as the asset transfer, Southern entered into an agreement with an unaffiliated bank based outside of Florida to acquire the Daytona Beach Bank corporate shell and its charter. This transaction was completed immediately following the transfer of the Daytona Beach Bank’s assets and liabilities to the Central Florida Bank. In consideration for this transaction, the purchaser paid Southern an amount equal to the capital accounts of the Daytona Beach Bank at the time of the merger and a premium of $1.0 million. The purchaser acquired the Daytona Beach Bank in order to be able to establish branch offices in Florida. Southern recorded a $1.0 million pretax gain from this transaction. Except for the receipt of the $1.0 million premium from the purchaser, the transaction did not affect Southern’s consolidated assets, liabilities or stockholders’ equity.
Liquidation of Southern Community Banc Mortgage LLC. In 2001, the Central Florida Bank and an unaffiliated company, American Heritage Mortgage Affiliates, Inc. (“American Heritage Affiliates”), formed Southern Community Banc Mortgage, LLC (the “Mortgage Company”), to originate residential mortgage loans for customers of the Central Florida Bank and others. The Central Florida Bank and American Heritage Affiliates each held a 50% in the Mortgage Company. American Heritage Affiliates, through an agreement with its parent company, American Heritage Mortgage Corporation (“American Heritage Mortgage”), provided the staffing and administrative services required for the operations of the Mortgage Company. In the fall of 2003, American Heritage Mortgage was acquired by another unaffiliated company, First Horizon Home Loan Corporation (“First Horizon”). In connection with its acquisition of American Heritage Mortgage, First Horizon agreed to pay $500,000 to American Heritage Affiliates if the Mortgage Company were dissolved, with $250,000 to be paid to the Central Florida Bank upon dissolution of the Mortgage Company. The dissolution of the Mortgage Company was completed in October 2003. Since the dissolution of the Mortgage Company, the Central Florida Bank has originated residential mortgage loans for its customers directly. One of the principal shareholders of American Heritage Mortgage Corporation is Sal A. Nunziata, one of Southern’s directors.
Purchase of Bank Branch. In December 2003, the Southwest Florida Bank purchased a branch of Harris Bank, N.A. located in Ft. Myers, Florida. As part of the transaction, the Southwest Florida Bank acquired $4.0 million in loans and $1.3 million in premises and equipment. The Southwest Florida Bank paid for the branch assets by assuming $4.9 million in deposits and making a cash payment of $450,000.
Products and Services
Southern offers a broad array of traditional banking products and services to its customers, including the products and services described below.
Deposits. Southern offers a full range of interest bearing and non-interest bearing accounts, including commercial and retail checking accounts, money market accounts, individual retirement accounts, savings accounts, and other time deposits of various types, ranging from daily money market accounts to longer term certificates of deposit. Southern has tailored the rates and terms of its accounts and time deposits to compete with the rates and terms in Southern’s principal markets. Southern seeks deposits from residents, businesses and employees of businesses in these markets. The FDIC insures all of Southern’s accounts up to the maximum amount permitted by law. In addition, Southern receives service charges which are competitive with other financial institutions in its markets, covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and other similar fees.
Lending Activities. Southern uses its deposits, together with borrowings and other sources of funds, to originate and purchase loans. Southern offers a full range of short and medium-term small business and commercial, consumer and real estate loans. Southern generally seeks to allocate its loan portfolio as follows: 80% to real estate loans; 15% to small business and commercial loans; and 5% to consumer loans. Each bank has a loan approval process which provides for various levels of officer lending authority. When a loan amount exceeds an officer’s lending authority, it is reviewed by various loan committees with ascending lending authority, as established by each bank’s board of directors.
The risk of non-payment of loans is inherent in all loans. However, Southern carefully evaluates all loan applicants and attempts to minimize its credit risk exposure by use of thorough loan application and approval procedures that Southern has established for each category of loan. In determining whether to make a loan, Southern considers the borrower’s credit history, analyzes the borrower’s income and ability to service the loan, and evaluates the need for collateral to secure recovery in the event of default. Southern maintains an allowance for loan losses based upon assumptions and judgments regarding the ultimate collectability of loans in its portfolio and a percentage of the outstanding balances of specific loans when their ultimate collectability is considered questionable.
Southern directs its lending activities primarily to individuals and businesses in its markets whose demand for funds falls within Southern’s legal lending limits and who are potential deposit customers. The following is a description of each of the major categories of loans which Southern makes:
Commercial Loans. This category includes loans made to individuals, partnerships or corporate borrowers for a variety of business purposes. Southern places particular emphasis on loans to small to medium-sized professional firms, retail and wholesale businesses, light industry and manufacturing concerns operating in Southern’s markets. Southern considers “small businesses” to include commercial, professional and retail businesses with annual gross sales of less than $20 million or annual operating costs of less than $5 million. Southern’s commercial loans include term
loans with both variable and fixed interest rates secured by equipment, inventory, receivables and real estate, as well as secured and unsecured working capital lines of credit. Risks of these types of loans depend on the general business conditions of the local economy and the borrower’s ability to sell its products and services in order to generate sufficient business profits to repay the loans under the agreed upon terms and conditions. Personal guarantees may be obtained from the principals of business borrowers and third parties to further support the borrowers’ ability to service the debt and reduce the risk of non-payment.
Consumer and Installment Loans. Consumer loans include lines of credit and term loans secured by second mortgages on the residences of borrowers for a variety of purposes, including home improvements, education and other personal expenditures. Consumer loans also include installment loans to individuals for personal, family and household purposes, including automobile loans to individuals and pre-approved lines of credit. Consumer loans generally involve more risk than first mortgage loans because the collateral for a defaulted loan may not provide an adequate source of repayment of the principal. This risk is due to the potential for damage to the collateral or other loss of value, while the remaining deficiency often does not warrant further collection efforts. In addition, consumer loan performance depends on the borrower’s continued financial stability and is, therefore, more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Real Estate Loans. Southern makes commercial real estate loans, construction and development loans, and residential real estate loans.
Commercial Real Estate. Southern offers commercial real estate loans to developers of both commercial and residential properties. Southern manages credit risk associated with these loans by actively monitoring such measures as advance rate, cash flow, collateral value and other appropriate credit factors. Risks associated with commercial real estate loans include the general risk of the failure of the commercial borrower, which are different for each type of business and commercial entity. Southern evaluates each business on an individual basis and attempts to determine such business’ risks and credit profile. Southern attempts to reduce credit risks in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. In addition, Southern may also require personal guarantees of the principal owners.
Acquisition, Construction and Development Loans. Southern makes acquisition, construction and development loans on a pre-sold and speculative basis. If the borrower has entered into an arrangement to sell or lease the property prior to beginning construction, Southern considers the loan to be on a pre-sold or pre-leased basis. If the borrower has not entered into an agreement to sell the property prior to beginning construction, Southern considers the loan to be on a speculative basis. Southern makes residential and commercial construction loans to builders and developers and to consumers who wish to build their own home. Southern limits the term of most construction and development loans to 18 months, although it may structure the payments based on a longer amortization basis. Southern bases speculative loans on the borrower’s financial strength and cash flow position. Southern disburses loan proceeds based on the percentage of completion and only after an experienced construction lender or appraiser inspects the project. These loans generally command higher rates and fees commensurate with the risks warranted in the construction lending field. The risk in construction lending depends upon the performance of the builder, building the
project to the plans and specifications of the borrower and Southern’s ability to administer and control all phases of the construction disbursements. Upon completion of the construction, Southern typically converts construction loans to permanent loans.
Residential Real Estate Loans. Southern makes residential real estate loans to qualified individuals for the purchase of existing single-family residences in its markets. Southern makes these loans in accordance with its appraisal policy and real estate lending policy which detail maximum loan to value ratios and maturities. Southern believes that these loan to value ratios are sufficient to compensate Southern for fluctuations in real estate market value and to minimize losses that could result from a downturn in the residential real estate market. Southern sells mortgage loans that do not conform to its policies in the secondary markets. The risk of these loans depends on the marketability of the loans to national investors and on interest rate changes. Southern retains loans for its portfolio when there is sufficient liquidity to fund the needs of the established customers and when rates are favorable to retain the loans. The loan underwriting standards and policies are generally the same for both loans sold in the secondary market and those retained in Southern’s portfolio.
Asset and Liability Management
Southern’s primary assets are its loan portfolio and investment account. Southern’s liabilities consist primarily of deposits. Southern’s objective is to support asset growth primarily through the growth of core deposits, which include deposits of all categories made by individuals, partnerships, corporations and other entities. Consistent with the requirements of prudent banking necessary to maintain liquidity, Southern seeks to match maturities and rates of loans and the investment portfolio with those of deposits, although exact matching is not always possible. Southern seeks to invest the largest portion of its assets in commercial, consumer and real estate loans. Southern’s investment account consists primarily of marketable securities of the United States government, federal agencies and state and municipal governments, generally with varied maturities.
Southern monitors its asset/liability mix on a regular basis with a monthly report detailing interest-sensitive assets and interest-sensitive liabilities presented to each bank’s board of directors. The objective of this policy is to control interest-sensitive assets and liabilities in order to minimize the impact of substantial movements in interest rates on Southern’s earnings.
Correspondent Banking
Correspondent banking involves providing services by one bank to another bank which, from an economic or practical standpoint, cannot provide that service for itself. Southern may purchase correspondent services offered by larger banks, including check collections, purchase of federal funds, securities safekeeping, investment services, coin and currency supplies, overline and liquidity loan participations, and sales of loans to or participations with correspondent banks. Southern will sell loan participations to correspondent banks with respect to loans which exceed Southern’s lending limits. As compensation for services provided by a correspondent bank, Southern may maintain balances with correspondents in non-interest bearing accounts.
Other Services
Southern’s other services include cash management services, safe deposit boxes, traveler’s checks, direct deposit of payroll and social security checks, wire transfers, telephone banking, and automatic drafts for various accounts. Southern offers a debit card and VISA and/or MasterCard credit card services through Southern’s correspondent banks. Southern offers extended banking hours, both drive-in and lobby, and after-hours depositories. Southern is associated with a shared network of automated teller machines that customers may use throughout Southern’s market areas and other regions. Southern is associated with third party Internet banking service providers that enable it to provide customers with a cost effective, secure and reliable Internet banking solution.
Customers
Southern believes that the recent consolidation of the Florida banking industry provides community banks significant opportunities to build successful, locally-oriented banks. Southern further believes that many of the larger financial institutions do not provide the high level of personalized services desired by many small and medium-sized businesses and their principals. Southern focuses its marketing efforts on attracting small and medium-sized businesses and individuals, including service companies, manufacturing companies, commercial real estate developers, entrepreneurs and professionals, such as physicians and attorneys.
Although Southern concentrates its lending efforts on commercial business, Southern also attracts a significant amount of consumer business. Many of its retail customers are the principals of Southern’s small and medium-sized business customers. Southern emphasizes “relationship banking,” with the goal that each customer will identify and establish a comfort level with Southern’s bank officers. Southern seeks to further develop its retail business with individuals who appreciate a high level of personal service, contact with their lending officer and responsive decision-making. Southern develops most of its new business through Southern’s lending officers and local boards of directors and by pursuing an aggressive strategy of calling on customers throughout its market areas.
Competition
Southern faces substantial competition in all phases of its operations from a variety of different competitors. This competition includes:
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Large national and super-regional financial institutions which have well-established branches and significant market share in the communities served by Southern.
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Finance companies, investment banking and brokerage firms, and insurance companies that offer bank-like products.
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Credit unions, which can offer highly competitive rates on loans and deposits because they receive tax advantages not available to commercial banks.
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Other community banks, including start-up banks, that can compete with Southern for customers who desire a high degree of personal service.
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Technology-based financial institutions including large national and super-regional banks offering on-line deposit, bill payment, and mortgage loan application services.
Other existing community banks, and many new community bank start-ups, have marketing strategies similar to Southern’s. These other community banks may open new branches in the communities served by Southern and compete directly for customers who want the level of service offered by community banks. Other community banks also compete for the same management personnel in Florida.
Various legislative actions in recent years have led to increased competition among financial institutions. Since the enactment of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and other laws and regulations affecting interstate bank expansion, it has been relatively easy for financial institutions located outside of the State of Florida to enter the Florida market, including Southern’s targeted markets. In addition, recent legislative and regulatory changes and technological advances have enabled customers to conduct banking activities without regard to geographic barriers through computer and telephone-based banking and similar services. There can be no assurance that the United States Congress, the Florida Legislature or bank regulatory agencies will not enact legislation or promulgate rules that may further increase competitive pressures on Southern. Southern’s failure to compete effectively for customers in its market areas could have a material adverse effect on its business, future prospects, financial condition or results of operations.
Employees
As of December 31, 2003, Southern had approximately 194 full-time equivalent employees. Southern expects to hire additional employees as needed to support its growth.
Supervision and Regulation
Southern is subject to an extensive body of state and federal banking laws and regulations which impose specific requirements and restrictions on, and provide for general regulatory oversight with respect to, virtually all aspects of Southern’s operations. Southern is also affected by government monetary policy and by regulatory measures affecting the banking industry in general. The actions of the Federal Reserve System affect the money supply, and in general, the lending abilities of banks by increasing or decreasing the costs and availability of funds to the banks. Additionally, the Federal Reserve System regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on bank borrowings, and changes in the reserve requirements against bank deposits.
The following is a brief summary of some of the statutes, rules and regulations which affect Southern. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of all applicable statutes or regulations. Any change in applicable laws or regulations may have a material adverse effect on Southern’s business and prospects.
Holding Company Regulations
Southern is a bank holding company within the meaning of the Federal Bank Holding Company Act of 1956 and the Florida Interstate Banking Act. It is registered as a bank holding company with the Federal Reserve System and is required to file annual reports and other information regarding its business operations and its subsidiaries. It is also subject to the supervision of the Federal Reserve.
The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
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acquiring all or substantially all of the assets of a bank.
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acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank.
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merging or consolidating with another bank holding company.
Except as authorized by the Gramm-Leach-Bliley Act of 1999, a bank holding company is generally prohibited by the Bank Holding Company Act from engaging in, or acquiring direct or indirect control of more than five percent of the voting shares of any company engaged in any business other than the business of banking or managing and controlling banks. Some of the activities the Federal Reserve has determined by regulation to be proper incidents to the business of banking, and thus permissible for bank holding companies, include:
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making or servicing loans and certain types of leases and related activities.
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engaging in certain insurance and discount brokerage activities.
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underwriting and dealing in government securities and certain other securities and financial instruments.
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providing certain data processing and data transmission services.
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acting in certain circumstances as a fiduciary or investment or financial advisor.
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management consulting and counseling activities.
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issuing and selling retail monetary instruments such as money orders, savings bonds and travelers’ checks and providing check printing and courier services.
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operating trust companies and non-bank depository institutions such as savings associations.
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making investments in corporations or projects designed primarily to promote community welfare.
In determining whether an activity is so closely related to banking as to be permissible for bank holding companies, the Federal Reserve is required to consider whether the performance of the particular activities by a bank holding company or its subsidiaries can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition and gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests and unsound banking practices. Generally, bank holding companies are required to obtain prior approval of the Federal Reserve to engage in any new activity not previously approved by the Federal Reserve. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of any of its bank subsidiaries.
The Bank Holding Company Act and the Federal Change in Bank Control Act, together with regulations promulgated by the Federal Reserve, require that, depending on the particular circumstances, either the Federal Reserve’s approval must be obtained or notice must be furnished to the Federal Reserve and not disapproved prior to any person or company acquiring control of a bank holding company, subject to certain exemptions. Control is conclusively presumed to exist when an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns a greater percentage of that class of voting securities immediately after the transaction.
The Federal Reserve, pursuant to regulation and published policy statements, has maintained that a bank holding company must serve as a source of financial strength to its subsidiary banks. In adhering to the Federal Reserve’s policy, a bank holding company may be required to provide financial support to a subsidiary bank at a time when, absent such Federal Reserve policy, it might not be deemed advisable to provide such assistance. Under the Bank Holding Company Act, the Federal Reserve may also require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that the activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
Bank Regulation
Each of Southern’s banks is a state bank organized under the laws of Florida. They are all subject to the supervision of the Florida Office of Financial Institutions and Securities Regulation and the Federal Deposit Insurance Corporation (the “FDIC”). Their deposits are insured by the FDIC for a maximum of $100,000 per depositor. For this protection, the banks must pay a semi-annual statutory assessment and comply with the rules and regulations of the FDIC. The Florida
Office of Financial Institutions and Securities Regulation and the FDIC regulate and monitor all areas of a bank’s operations, including:
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security devices and procedures.
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adequacy of capitalization and loss reserves.
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issuance of securities.
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interest rates payable on deposits.
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interest rates or fees chargeable on loans.
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establishment of branches.
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corporate reorganizations.
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maintenance of books and records.
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adequacy of staff training to carry out safe lending and deposit gathering practices.
In addition, banks are prohibited from engaging in tie-in arrangements in connection with any extension of credit, or the offer of any product or service. Bank regulatory requirements also set forth various conditions regarding the eligibility and qualifications of their officers and directors.
Capital Adequacy Requirements
Both bank holding companies and individual banks are subject to regulatory capital requirements imposed by the Federal Reserve and the FDIC which vary based on differences in risk profiles. The capital adequacy guidelines issued by the Federal Reserve are applied to bank holding companies on a consolidated basis. The FDIC’s risk-based capital guidelines apply directly to insured state banks regardless of whether they are subsidiaries of a bank holding company. Both agencies’ requirements, which are substantially similar, provide that banking organizations must have capital (as defined in the rules) of at least 8% of risk-weighted assets. The risk weights
assigned to assets are based primarily on credit risks. Depending upon the riskiness of a particular asset, it is assigned to a risk category. For example, securities with an unconditional guarantee by the United States government are assigned to the lowest risk category. The aggregate amount of assets assigned to each risk category is multiplied by the risk weight assigned to that category to determine the weighted values, which are added together to determine total risk-weighted assets.
Both the Federal Reserve and the FDIC have also adopted minimum capital leverage ratios to be used in tandem with the risk-based guidelines in assessing the overall capital adequacy of banks and bank holding companies. The guidelines define a two-tier capital framework. Tier 1 capital consists of common and qualifying preferred shareholder’s equity, less goodwill and other adjustments. Tier 2 capital consists of mandatory convertible, subordinated, and other qualifying term debt, preferred stock not qualifying for Tier 1, and a limited allowance for credit losses up to a designated percentage of risk-weighted assets. Under these guidelines, institutions must maintain a specified minimum ratio of “qualifying” capital to risk-weighted assets. At least 50% of an institution’s qualifying capital must be “core” or “Tier 1” capital, and the balance may be “supplementary” or “Tier 2” capital. The guidelines imposed on the banks include a minimum leverage ratio standard of capital adequacy. The leverage standard requires top-rated institutions to maintain a minimum Tier 1 capital to assets ratio of 3%, with institutions receiving less than the highest rating required to maintain a ratio of 4% or greater, based upon their particular circumstances and risk profiles.
Federal bank regulatory authorities have adopted regulations revising the risk-based capital guidelines to further ensure that the guidelines take adequate account of interest rate risk. Interest rate risk is the adverse effect that changes in market interest rates may have on a bank’s financial condition and is inherent to the business of banking. Under the regulations, when evaluating a bank’s capital adequacy, the revised capital standards now explicitly include a bank’s exposure to declines in the economic value of its capital due to changes in interest rates. The exposure of a bank’s economic value generally represents the change in the present value of its assets, less the change in the value of its liabilities, plus the change in the value of its interest rate off-balance sheet contracts.
The foregoing capital guidelines could affect Southern and its banks in several ways. If Southern’s banks grow rapidly, their respective capital bases may become insufficient to support continued growth, making additional capital infusions necessary. The capital guidelines could also impact each bank’s ability to pay dividends. Rapid growth, poor loan portfolio performance or poor earnings performance, or a combination of these factors, could change each bank’s capital position in a relatively short period of time. Failure to meet these capital requirements would require a bank to develop and file with the FDIC a plan describing the means and a schedule for achieving the minimum capital requirements. In addition, Southern would not be able to receive regulatory approval of any application that required consideration of capital adequacy, such as a branch or merger application, unless it could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.
Dividends
The ability of Southern to pay cash dividends depends entirely upon the amount of dividends paid by its bank subsidiaries. Additionally, the Florida Business Corporation Act provides that a Florida corporation may only pay dividends if the dividend payment would not render the corporation insolvent or unable to meet its obligations as they come due.
Florida state banks are subject to regulatory restrictions on the payment of dividends, including a prohibition of payment of dividends from the banks’ capital without the prior approval of the Florida Office of Financial Institutions and Securities Regulation and the FDIC. Except with such prior approval, all dividends of any Florida bank must be paid out of retained net profits from the current period and the previous two years, after deducting expenses, including losses and bad debts. In addition, any Florida bank is required to transfer at least 20% of its net income to surplus until its surplus equals the amount of paid-in capital.
Other Laws
State usury laws and federal laws concerning interest rates limit the amount of interest and various other charges collected or contracted by a bank. The lending operations of Southern are subject to federal laws applicable to credit transactions, such as the:
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Federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers.
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Community Reinvestment Act requiring financial institutions to meet their obligations to provide for the total credit needs of the communities they serve, including investing their assets in loans to low and moderate-income borrowers.
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Home Mortgage Disclosure Act requiring financial institutions to provide information to enable public officials to determine whether a financial institution is fulfilling its obligations to meet the housing needs of the community it serves.
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Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit.
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Fair Credit Reporting Act governing the manner in which consumer debts may be collected.
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The rules and regulations of various federal agencies charged with the responsibility of implementing such federal laws.
The deposit and certain other operations of Southern are also subject to provisions of the following laws:
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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records.
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Title V of the Gramm-Leach-Bliley Act of 1999 regarding disclosure of customers’ nonpublic personal information, which requires financial institutions to publish their policies concerning disclosure of such information and give customers the opportunity to opt out of unwanted disclosure.
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Electronic Funds Transfer Act and Regulation E, issued by the Federal Reserve to implement that act, which govern automatic deposits to, and withdrawals from, deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
Interstate Banking and Branching
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, eligible bank holding companies in any state are permitted, with Federal Reserve approval, to acquire banking organizations in any other state. As a result, most of the limitations on interstate acquisitions of banking organizations have been eliminated. The Interstate Banking and Branching Efficiency Act also removed substantially all of the prohibitions on interstate branching by banks. The authority of a bank to establish and operate branches within a state continues to be subject to applicable state branching laws. Subject to these laws, a bank operating in any state may now establish one or more branches within any other state without the establishment of a separate banking structure within the other state through the merger with an existing bank in that state. Under current Florida law, Florida banks may open branch offices without geographic restriction with the prior approval of the Florida Office of Financial Institutions and Securities Regulation and the FDIC and, in the case of interstate branches, subject to certain laws of the “host” state. In addition, with prior regulatory approval, Southern will be able to acquire existing banking operations in other states.
Financial Modernization
The Gramm-Leach-Bliley Act of 1999 modernized the federal bank regulatory framework by allowing the consolidation of banking institutions with other types of financial services firms, subject to various restrictions and requirements. In general, the Gramm-Leach-Bliley Act repealed most of the federal statutory barriers which separated commercial banking firms from insurance and securities firms and authorized the consolidation of such firms in a “financial services holding company.” Southern has no immediate plans to utilize the structural options created by the Gramm-Leach-Bliley Act, but Southern may develop such plans in the future. In the meantime, Southern provides its customers with a range of financial products and services, including various insurance products and securities brokerage services, through cooperative arrangements with third-party vendors.
USA Patriot Act
On October 26, 2001, President Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). The USA Patriot Act is intended to allow the federal government to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. Title III of the USA Patriot Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.
Among its provisions, the USA Patriot Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls with respect to its private banking accounts and correspondent banking accounts involving foreign individuals and certain foreign banks; and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign bank that does not have a physical presence in any country. In addition, the USA Patriot Act contains a provision encouraging cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. The federal banking agencies have begun proposing and implementing regulations interpreting the USA Patriot Act. It is not anticipated that the USA Patriot Act will have a significant impact on Southern’s financial condition or results of operations.
Stock Dividend
On August 6, 2001, Southern declared a 2-for-1 stock split in the form of a 100% stock dividend. The dividend was issued to stockholders of record as of October 19, 2001. As a result of the dividend, Southern issued 2,730,101 shares of common stock. All amounts in this Annual Report on Form 10-K have been restated to reflect the stock dividend, except as otherwise noted.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
Southern’s principal executive office is located at 250 North Orange Avenue, Orlando, Florida. Southern shares this office with the main office of the Central Florida Bank. Southern’s three bank subsidiaries currently operate a total of 18 offices. In addition, Southern has two parcels of land for future banking offices. The following table sets forth information regarding each of the current branch locations.
Southern’s branch at Bonita Springs, Florida is located on the site of a former gas station at which leaking underground fuel storage tanks caused some contamination of the subsurface groundwater. The Florida Department of Environmental Protection has accepted this site for clean up under the state’s remediation program and has reserved $250,000 to cover the estimated clean-up costs. Due to the relatively low priority level of the site in the State’s clean-up program, Southern cannot predict when the state will commence or complete the clean-up of the site. Southern has received an environmental engineering assessment of the contamination and the required remediation. Based on this report, Southern believes that the clean-up of the site will not disrupt Southern’s proposed banking services at the site.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, Southern is involved in litigation arising from the ordinary course of its business, such as claims to collect past due loans. As of the date of this report, Southern is not engaged in any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF SOUTHERN
The following table sets forth certain information with respect to Southern’s executive officers.
Dennis G. Bedley has served as a director of Southern as well as president of the South Florida Bank since August 2002. From March 2001 to August 2002, he also served as the vice president of Southern, as well as the vice president of the Central Florida Bank. From 1998 through March 2001, he was president of Colonial Bank, West Palm Beach, Florida. From 1996 to 1998, he was a senior banking executive for Capital Bank in Fort Lauderdale, Florida.
Charlie W. Brinkley, Jr. has served as chairman of the board and chief executive officer of Southern since its organization in 1999, and chairman of the Central Florida Bank since 1999. He also serves as a director of the South Florida Bank and Southwest Florida Bank. Mr. Brinkley was an organizing director of Southern Bank of Central Florida and served as its only president and chief executive officer from 1988 to 1996 when it was acquired by Colonial Bank of Montgomery, Alabama. From 1996 until 1998, Mr. Brinkley continued to serve as president of Colonial Bank, Florida region. Mr. Brinkley began his banking career in the Orlando area in 1978 at ComBank of Casselberry, which was acquired by Freedom Savings and Loan Association in 1983.
Thomas H. Dargan, Jr. has served as a director Southern since 2001 and served as Chief Executive Officer of the Central Florida Bank since August 2003. He served as president and chief executive officer of the Daytona Beach Bank from its founding in 1998 through August 2003. He has 22 years of banking experience in Florida, including 15 years in the Daytona Beach community. He served as president and chief executive officer of Tomoka State Bank from 1994 until its sale in 1997 to Colonial Bank. Subsequent to the transaction, he served as president for the Volusia area of Colonial Bank.
Sharyn E. Dickerson has served as executive vice president and chief information officer of Southern since 2000 and of the Central Florida Bank since 1999. She previously served as senior vice president and cashier of Citrus Bank, Orlando, from 1997 to 1999. Before that, she served as senior vice president and cashier of Southern Bank of Central Florida from 1988 to 1994 and as senior operations officer for the Florida region for Colonial Bank from 1994 until 1997.
Richard L. Garner became a vice president of Southern in 2000 and became a director in 2001 upon the opening of the Southwest Florida Bank, of which he is chairman and chief executive officer. He previously served as president and chief executive officer of First National Bank of Bonita Springs (subsequently known as First National Bank of Florida) from 1994 until the acquisition of that bank by The Colonial BancGroup, Montgomery, Alabama, in 1998. From 1998 until 1999, Mr. Garner served as regional president and CEO of Colonial Bank, Southwest Florida region.
Stephen R. Jeuck has served as senior vice president and chief financial officer of Southern since 2003. He has also served as the controller of the Company since its organization in 1999, and as vice president and chief financial officer of the Central Florida Bank since its organization in 1998. From 1995 until 1997, Mr. Jeuck served as vice president and controller of Southern Bank of Central Florida and Colonial Bank, Florida.
John G. Squires has served as president of Southern since its organization in 1999. He served as chief executive officer of the Central Florida Bank from its organization in 1998 to 2003.
He also serves as a director of the Central Florida Bank, the South Florida Bank and Southwest Florida Bank. Mr. Squires was also an organizing director of Southern Bank of Central Florida in 1988 and served as its vice-chairman until its acquisition by Colonial Bank in 1996. From 1996 until 1997, Mr. Squires served as an executive vice president and director of Colonial Bank, Florida region. Mr. Squires began his Florida banking career in 1978 as president and director of ComBank of Casselberry which was acquired by Freedom Savings and Loan Association in 1983.
Joel E. Whittenhall has served as a vice president of Southern since 2000 and as a director since 2001. He also has served as president, chief lending officer and director of the Southwest Florida Bank since 2001. He previously served as executive vice president and senior lending officer of First National Bank of Florida (subsequently acquired by Colonial Bank) from 1994 to 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Trading Information
There is no established public trading market for Southern’s common stock.
Record Holders
As of February 15, 2004, there were approximately 1,000 holders of record of the Southern’s common stock.
Dividends
As a holding company, Southern has no significant independent sources of revenue. Its principal source of funds are cash dividends and other payments that it receives from its bank subsidiaries. Southern expects that its bank subsidiaries will retain most of their earnings in order to increase their capital and only pay dividends to Southern to cover Southern’s overhead expenses. Southern’s bank subsidiaries’ ability to pay dividends is restricted under Federal and state banking law. As a result, Southern has never paid any dividends and does not anticipate that it will do so in the foreseeable future.
Private Sales of Securities
During the fourth quarter of 2003, Southern issued 51,877 shares of its common stock, pursuant to Section 4(2) of the Securities Act of 1933 (the “Securities Act”) in the following transactions:
Equity Compensation Plan Information
The following table presents information regarding Southern’s equity compensation plans at December 31, 2003:
(1)
This amount consists of options to purchase 133,250 shares issued by Peninsula Bancorp, Inc. and assumed by Southern in connection with the acquisition of Peninsula Bancorp in 2001.
(2)
This amount includes 50,000 shares which may be issued to Charlie W. Brinkley, Southern’s chairman and chief executive officer under an agreement providing for restricted stock grants. The agreement provides that Mr. Brinkley will be granted the right to receive 10,000 shares each year for a period of 10 years, commencing on January 1, 1999 and on each January 1st thereafter through the year 2008. Mr. Brinkley has previously received grants of 50,000 shares under the agreement and all of these shares are fully vested. The board will determine the level of all grants after year 2003 based on the performance of Southern. These grants, if any, will vest ratably over a three year period from the date of grant, with one third of such shares being vested on each of the first, second and third anniversary of the date of grant. In the event that a majority of Southern’s outstanding shares are acquired in a merger or other transaction, all shares issuable under the agreement will be granted to Mr. Brinkley and become fully vested. If Mr. Brinkley is terminated without cause, all of the shares granted to him will be fully vested. If Mr. Brinkley is terminated for cause, Mr. Brinkley will forfeit his rights to all unvested shares.
(3)
This amount includes 57,378 shares available for issuance under Southern’s employee stock purchase plan. Under the terms of the plan, Southern is authorized to sell up to 100,000 shares to Southern’s employees. Employees are eligible to participate in the plan if they are full-time employees for at least 90 consecutive days. The plan permits eligible employees to purchase common stock through payroll deductions, which, subject to certain limitations, may not exceed 10% of an employee’s compensation. The purchase price of each share of common stock under the purchase plan will be equal to the fair market value of common stock. In the event that an employee participating in the plan ceases to be a Southern employee, Southern has the right to repurchase all or any portion of the shares purchased by such employee under the plan at any time during the following 24 months for a purchase price equal to the fair market value of the stock at the time of such repurchase. The plan will terminate upon the earlier of September 16, 2004, or the date on which all of the shares reserved under the plan have been purchased, unless the board of directors terminates the plan on an earlier date.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical financial data as of and for the years ended December 31, 2003, 2002, 2001, 2000 and 1999, that have been derived from, and are qualified by reference to, Southern’s audited financial statements. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included elsewhere in this report.
On October 19, 2001, Southern effected a 2 for 1 stock split. All amounts set forth in the preceding table have been revised to reflect this stock split.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Southern’s consolidated financial statements and the related notes included elsewhere in this report. Unless otherwise noted, all share amounts have been revised to reflect Southern’s two for one stock split which was effective on October 19, 2001.
Average Balance Sheets
The following tables set forth the information concerning the average balance sheets and related interest and dividends and yield for Southern for each of the last three fiscal years.
Net Interest Income and Expense
(1)
Includes interest-earning deposits, federal funds sold and Federal Home Loan Bank stock.
(2)
Represents the difference between average interest-earning assets and average interest-bearing liabilities.
(3)
Represents net interest income divided by average interest-earning assets.
(4)
Includes advances from Federal Home Loan Bank, subordinated debentures and other borrowings.
Net Interest Income and Expense
(1)
Includes interest-earning deposits, federal funds sold and Federal Home Loan Bank stock.
(2)
Represents the difference between average interest-earning assets and average interest-bearing liabilities.
(3)
Represents net interest income divided by average interest-earning assets.
Net Interest Income and Expense
(1)
Includes interest-earning deposits, federal funds sold and Federal Home Loan Bank stock.
(2)
Represents the difference between average interest-earning assets and average interest-bearing liabilities.
(3)
Represents net interest income divided by average interest-earning assets.
Rate/Volume Analysis
The following table sets forth certain information regarding changes in interest income and interest expense of Southern for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (change in rate multiplied by prior volume), (2) changes in volume (change in volume multiplied by prior rate) and (3) changes in rate-volume (change in rate multiplied by change in volume).
Results of Operations for the Years Ended December 31, 2003 and 2002
Southern had net earnings of $6.1 million for the year ended December 31, 2003 compared to net earnings of $2.2 million for the year ended December 31, 2002. Earnings before income taxes in 2003 were $9.5 million compared to $3.5 million in 2002. The improvement in earnings was primarily due to a substantial increase in net interest income, which grew from $18.4 million in 2002 to $26.8 million in 2003. The increase in net interest income was principally a result of the growth of Southern’s assets and an improvement in Southern’s net interest margin. Southern also benefited from higher service charges and fees, as well as a $1.0 million gain from the sale of the Daytona Beach Bank charter. These items more than offset increases in non-interest expenses, such as salaries and occupancy costs.
Net Interest Income. Southern’s operating results depend primarily on Southern’s net interest income, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities, consisting primarily of deposits. Net interest income is determined by the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest-rate spread”) and the relative amounts of interest-earning assets and interest-bearing liabilities. Southern’s interest-rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, Southern’s net earnings are also affected by the level of non-performing loans and foreclosed assets, as well as the level of its non-interest income, and its non-interest expenses, such as salaries and employee benefits and occupancy expense and income taxes.
Interest Income and Expense. Interest income for the year ended December 31, 2003 was $44.3 million compared to $33.5 million for the year ended December 31, 2002. The growth in interest income primarily reflects the growth in Southern’s assets, which grew from $658.8 million at December 31, 2002 to $899.2 million at December 31, 2003, or approximately 36%. The impact of this growth was partially offset by a decrease in the average yield earned on interest-earning assets. During the same period, net loans grew from $500.3 million to $719.0 million, or approximately 44%. The increase in assets and loans is attributable to the growth of all of Southern’s business, particularly the South Florida Bank which commenced operations in August 2002. Southern’s growth has been supported by the opening of 2 new branches in 2002 and 4 new branches in 2003.
Interest expense increased from $15.1 million for 2002 to $17.5 million for 2003. Interest expense on deposits was $16.6 million for 2003, compared to $15.0 million for 2002. The increase in interest expense is primarily due to higher level of deposits which were used to support the growth in loans. The deposit growth was attributable to higher deposits at all of Southern’s banks, particularly the South Florida Bank. The increase in interest expense was largely offset by a decrease in the average cost of deposits.
Interest expense on other borrowings was $918,000 for 2003 compared to $26,000 for 2002. These borrowings included $13.0 million in subordinated debentures issued by the Central Florida Bank to increase its regulatory capital and approximately $30.5 million borrowed from the Federal Home Loan Bank to fund the purchase of investment securities.
Southern’s net interest margin increased from approximately 3.49% for 2002 to approximately 3.59% for 2003. The improvement in the net interest margin was primarily due to the increase in the level of Southern’s loans relative to Southern’s other assets. This shift had a positive impact on the net interest margin because loans are Southern’s highest interest earning asset category. The net interest margin also improved because Southern reallocated a portion of its liquid assets (such as cash and cash equivalents) into investment securities, which have higher yields.
Provision for Loan Losses. The provision for loan losses totaled $3.2 million for the year ended December 31, 2003 and $2.4 million in 2002. The amount of the provision for 2003 reflects the growth in Southern’s loan portfolio. See “Allowance and Provision for Loan Losses” below.
Non-Interest Income. Non-interest income totaled $4.8 million for the year ended December 31, 2003 compared to $2.6 million for the year ended December 31, 2002. Non-interest income consists of service charges on deposit accounts, income from Southern’s mortgage origination business (which was discontinued in September 2003), income from Southern’s insurance agency and other fees and income. Customer service charges on deposit accounts totaled $811,000 in 2003, up from $624,000 in 2002, due to an increase in the average number of deposit accounts. The income from Southern’s mortgage origination business was $382,000 in 2003, compared to $148,000 in 2002. The income from Southern’s insurance agency was $226,000 in 2003, up from $148,000 in 2002. Southern had a gain on sale of securities available for sale of $403,000 in 2003, compared to $120,000 in 2002. Southern also had a gain of $1.0 million in 2003 from the sale of charter of the Daytona Beach Bank and $250,000 from the liquidation of the Mortgage Company.
Non-Interest Expenses. Non-interest expenses for the year ended December 31, 2003 totaled $18.9 million, up from $15.1 million for the year ended December 31, 2002, and was comprised of the following:
•
Other non-interest expenses in 2003 totaled $5.4 million or 29% of total non-interest expenses, and $4.1 million or 27% in 2002. Other non-interest expenses included data processing, printing and office supplies, marketing and advertising, professional fees and other expenses. The increase in these amounts was primarily due to the opening of additional branches and the overall growth of Southern.
Income Taxes. Income taxes totaled $3.4 million for 2003 (effective rate of 35.6%) and $1.3 million in 2002 (effective rate of 36.7%).
Results of Operations for the Years Ended December 31, 2002 and 2001
Southern had net earnings of $2.2 million for the year ended December 31, 2002 compared to net loss of $580,000 for the year ended December 31, 2001.
Earnings before income taxes in 2002 were $3,478,000 compared to a loss of $875,000 in 2001. The improvement in earnings was primarily due to a substantial increase in net interest income, which grew from $10.1 million in 2001 to $18.4 million in 2002. As discussed below, the increase in net interest income was principally a result of an improvement in Southern’s net interest margin and the growth in its assets. These items more than offset increases in non-interest expenses, such as salaries and occupancy costs. Southern’s net earnings in 2002 were also reduced due to losses incurred in the start up of the South Florida Bank.
Interest Income and Expense. Interest income for the year ended December 31, 2002 was $33.5 million compared to $24.4 million for the year ended December 31, 2001. The growth in interest income primarily reflects the growth in Southern’s assets, which grew from $449.1 million at December 31, 2001 to $658.8 million at December 31, 2002, or approximately 46.7%. The impact of this growth was partially offset by a decrease in the average yield earned on interest-earning assets. During the same period, net loans grew from $352.2 million to $500.3 million, or approximately 42.0%. The increase in assets and loans is primarily attributable to the growth of Southern’s business in southeast Florida.
Interest expense was $15.1 million for the year ended December 31, 2002, compared to $14.4 million for the year ended December 31, 2001. The increase in interest expense is primarily due to the higher level of deposits which were used to support the growth in loans. Most of the deposit growth was attributable to Southern’s new operations in southeast Florida. The increase in interest expense was largely offset by a decrease in the average cost of deposits.
Southern’s net interest margin increased from approximately 3.11% for 2001 to approximately 3.49% for 2002. The positive change in the net interest margin was due in part to the repricing of certain relatively high priced deposits at the end of December 2001. Southern had utilized these deposits in 2000 and 2001 to attract funds to support growth and liquidity. Due to the sharp decline in market interest rates in the first nine months of 2001, these deposits adversely impacted Southern’s net interest margin during 2001. Southern’s net interest margin improved after December 31, 2001, when these deposits were repriced to market rates. The net interest margin was also positively impacted by higher levels of loans relative to other interest earning assets and by the decrease in interest rates in the economy, which reduced the yields paid by Southern on its other deposits and interest bearing liabilities more rapidly than the rates earned on Southern’s loans and investment securities.
Provision for Loan Losses. The provision for loan losses totaled $2,405,000 for the year ended December 31, 2002 and $2,351,000 in 2001. The amount of the provision for 2002 reflects the growth in Southern’s loan portfolio and the establishment of a new reserve at Southern’s new South Florida Bank.
Non-Interest Income. Non-interest income totaled $2.6 million for the year ended December 31, 2002 compared to $1.9 million for the year ended December 31, 2001. Non-interest income consists of service charges on deposit accounts, income from Southern’s mortgage origination business, income from Southern’s insurance agency and other fees and income. Customer service charges on deposit accounts totaled $624,000 in 2002, up from $372,000 in 2001, due to an increase in the average number of deposit accounts. The income from Southern’s mortgage origination business was $167,000 in 2002, up from $69,000 in 2001. The income from Southern’s insurance agency was $148,000 in 2002, up from $109,000 in 2001. Southern had a gain on sale of securities available for sale of $120,000 in 2002, compared to $642,000 in 2001. Earnings on bank owned life insurance totaled $204,000 in 2002, compared to $166,000 in 2001.
Non-Interest Expenses. Non-interest expenses for the year ended December 31, 2002 totaled $15.1 million, up from $10.4 million for the year ended December 31, 2001, and was comprised of the following:
•
Other non-interest expenses in 2002 totaled $4.0 million or 26% of total non-interest expenses, and $3.1 million or 29% in 2001. Other non-interest expenses included data processing, printing and office supplies, marketing and advertising, professional fees and other expenses. The increase in these amounts was primarily due to the opening of additional branches, organizational expense associated with the new South Florida Bank and the overall growth of Southern.
Income Taxes (Benefit). Income taxes (benefit) totaled $1.3 million for 2002 (effective rate of 36.7%) and $(295,000) in 2001 (effective rate of 33.7%).
Capital Expenditures
Southern’s capital expenditures are reviewed by its board of directors. Southern makes capital expenditures in order to expand its business and to improve Southern’s ability to provide quality services to its customers. Capital expenditures equaled $2.6 million in 2003, and $3.9 million for the year ended December 31, 2002. These expenditures were related to the purchase of real property as branch locations, and the purchase of leasehold improvements and furniture and equipment purchased for new banking facilities opened during 2003 and 2002. The expenses in 2002 are primarily related to the cost of construction of Southern’s new offices in Lake Mary, Florida and furnishing of other branches. The expense in 2003 primarily related to the new branches
in Palm Beach and West Palm Beach, Florida. Southern currently expects to have $3.6 million in capital expenditures in 2004.
Asset Quality and Credit Risk
Securities. Southern maintains a high quality investment portfolio, including U.S. government agencies, mortgage-backed securities and municipal bonds. Southern believes that these securities have very little risk of default. At December 31, 2003 and 2002, all of the securities held in the investment portfolio were rated “A” or better. All but one of these securities were classified “available for sale.” A rating of “A” or better means that the bonds are of “upper medium grade, with strong ability to repay, possibly with some susceptibility to adverse economic conditions or changing circumstances.” Ratings are assigned by independent rating agencies and are subject to the accuracy of reported information concerning the issuers and the subjective judgment and analysis of the rating agencies. They are not a guarantee of collectability.
At December 31, 2003, approximately 24% of these securities (not including mortgage-backed securities) were scheduled to mature in five years or less compared with 67% at December 31, 2002. As such, Southern is subject fluctuations in market value due to changes in the general level of interest rates.
The following table sets forth information regarding the composition and carrying amounts of the investment portfolio at December 31, 2003, 2002 and 2001 (in thousands):
Southern’s investment securities increased significantly in 2003 due to Southern’s decision to reallocate other liquid assets (such as cash and cash equivalents) into higher yielding investment securities. Investment securities also increased because Southern purchased investment securities from the proceeds of additional borrowings from the Federal Home Loan Bank.
Loans. Southern maintains a high quality portfolio of real estate, commercial and consumer loans. All loans over individual lending limits are reviewed and approved by Southern’s loan committee, which ensures that loans comply with applicable credit standards. In most cases, Southern requires collateral from borrowers. The type and amount of collateral varies, but may include residential or commercial real estate, deposits held by financial institutions, U.S. Treasury securities, other marketable securities and personal property. Southern’s monitors collateral values to ensure that they are maintained at proper levels.
At December 31, 2003, approximately $583.2 million or 79.8% of Southern’s loans were real estate loans secured by real estate in central and south Florida. This percentage increased from 74.4% at December 31, 2002. This level of concentration could present a potential credit risk because the ultimate collectability of these loans is susceptible to adverse changes in real estate market conditions in these markets. Southern seeks to address this risk by limiting most loans to a maximum of 75% of the appraised value of the underlying real estate and maximum amortization schedules of 20 years with maturity dates not exceeding 5 years.
The following table divides Southern’s loan portfolio into five categories. Most of the loans are short-term and may be renewed or rolled over at their maturity. At that time, Southern undertakes a complete review of the borrower’s credit worthiness and the value of any collateral. If these items are satisfactory, Southern will generally renew the loan at prevailing interest rates. In addition to outstanding loans, Southern enters into legally binding commitments to extend credit, letters of credit and unused line of credit. These commitments totaled $249.2 million at December 31, 2003, and $159.7 million at December 31, 2002.
Types of Loans
The following table sets forth information regarding the maturities of Southern’s loans. For purposes of the table, demand loans are shown as being payable in one year or less. The entire amount of a balloon loan is treated as maturing in the year that the balloon payment is due.
Maturities of Loans Based on Contractual Principal Repayments
Of the $533.0 million in loans due after one year, approximately 17% have fixed interest rates and 83% have adjustable rates.
Commercial Loans. Southern makes commercial loans to businesses located in its target markets. The credit risk associated with business lending is influenced by general economic conditions, deterioration in a borrower’s capital position resulting in increasing debt to equity ratios, deterioration in a borrower’s cash position resulting in a liquidity problem, and decreasing revenues due to inefficient operations of the borrower. These loans are generally secured by corporate assets, marketable securities or other liquid financial instruments. These loans totaled $127.9 million or 17.5% of total loans at December 31, 2003 and $117.6 million or 23.1% of total loans at December 31, 2002. The growth in commercial loans was primarily due to new loans originated in southeast Florida.
Real Estate Loans. Southern’s real estate loans totaled $583.2 million or 79.8% of total loans at December 31, 2003, and $378.8 million or 74.4% of total loans at December 31, 2002.
Southern makes real estate loans secured by commercial real estate, including loans to acquire or refinance office buildings, warehouses and apartments. These loans totaled $269.2 million or 36.8% of total loans at December 31, 2003 and $208.6 million or 41.0% of total loans at December 31, 2002. Most of these loans have a maturity of five years or less. At December 31, 2003 and 2002, almost all of these loans were collateralized by real property located in central and south Florida. These loans generally require a loan-to-collateral value of not more than 75%. The growth in commercial real estate loans was primarily due to new loans originated in southeast Florida. Risks associated with commercial real estate mortgage loans include reliability of appraisals, deterioration of market values, environmental contamination, and accelerated depreciation of property due to deferred maintenance.
Residential real estate loans totaled $72.3 million or 9.9% of total loans at December 31, 2003 and $49.0 million, or 9.6% of total loans at December 31, 2002. Residential real estate loans are predominately adjustable rate home mortgages which generally require a loan-to-collateral value of not more than 90% and equity credit lines which generally limit the loan-to-collateral value to not more than 90%. Most loans have a maximum term of five years. At December 31, 2002, almost all of the residential real estate loans were collateralized by residences in central and south Florida. Risks associated with residential real estate mortgage loans include reliability of appraisals, deterioration of market values, environmental contamination, and accelerated depreciation of property due to deferred maintenance.
Construction loans totaled $241.8 million or 33.1% of loans at December 31, 2003 compared to $121.2 million or 23.8% of loans at December 31, 2002. The growth in construction loans was attributable to strong demand in Southern’s primary markets and interest rates that continue to favor new development. Southern primarily makes construction loans on property located in central and south Florida. Risks associated with construction loans include the solvency of both the builder and the property owner during the construction period and the reliability of commitments for permanent financing at the completion of construction, in addition to the real estate-related risks present with both commercial and residential real estate loans described above. At December 31, 2003, almost all construction loans were collateralized by property in central and south Florida.
Consumer Loans and Other. Southern offers consumer loans and personal and secured loans. The security for these loans ordinarily consists of automobiles, consumer goods, marketable securities, certificates of deposit and similar items. These loans totaled $19.4 million or 2.7% of total loans at December 31, 2003 and $12.4 million or 2.5% of total loans at December 31, 2002. Risks associated with customer loans include loss of employment of borrowers, declines in the financial condition of borrowers resulting in delinquencies, and rapid depreciation of loan collateral.
Non-Performing Assets and Past Due Loans
Non-performing assets consist of non-accrual loans and properties or assets acquired in partial or total satisfaction of problem loans which are known as “foreclosed assets.” Past due loans are loans that are delinquent 30 days or more which are still accruing interest.
Southern’s credit review and approval process is critical to its ability to minimize non-performing assets on a long-term basis. In addition to the negative impact on interest income, non-performing assets also increase operating costs due to the expense of collection efforts. It is Southern’s policy to place all loans which are past due 90 days or more on non-accrual status, subject to exceptions made on a case by case basis.
Southern had $1.7 million in loans which were nonperforming (nonaccrual) at December 31, 2003, or 0.24% of total loans. Southern also had $133,000 in accruing loans which were past due more than 90 days on December 31, 2003. Southern had $3.2 million in loans which were nonperforming (nonaccrual) at December 31, 2002, or 0.62% of total loans. Southern also had $126,000 in accruing loans which were past due more that 90 days on December 31, 2002.
Non-performing loans at December 31, 2003 principally consisted of commercial and residential real estate loans. Southern believes that its non-performing loans are generally well secured and are unlikely to result in any material losses.
The following table sets forth certain information regarding nonaccrual loans and foreclosed assets, including the ratio of such loans and foreclosed assets to total assets as of the dates indicated:
To date, Southern has incurred only a modest level of loan losses, primarily due to its short operating history. Southern expects that its level of loan losses will increase in the future as Southern’s loan portfolio matures. However, Southern believes that its allowance for loan losses will be sufficient to absorb these loan losses.
Allowance and Provision for Loan Losses
Southern evaluates the adequacy of its allowance for loan losses as part of Southern’s on-going credit review and approval process. The review process is intended to identify, as early as possible, customers who may be facing financial difficulties. Once identified, the extent of the client’s financial difficulty is carefully monitored by Southern’s credit administrator, who recommends to the directors’ loan committee the portion of any credit that needs a specific reserve allocation or should be charged off. Other factors considered by the loan committee in evaluating the adequacy of the allowance include overall loan volume, historical net loan loss experience, the level and composition of nonaccrual and past due loans, local economic conditions, and value of any collateral. From time to time, specific amounts of the reserve are designated for certain loans in connection with the loan review officer’s analysis of the adequacy of the allowance for loan losses.
While a portion of this allowance is typically intended to cover specific loan losses, it is considered a general reserve which is available for all credit-related purposes. The allowance is not a precise amount, but is derived based upon the above factors and represents management’s best estimate of the amount necessary to adequately cover probable losses from current credit exposures. The provision for loan losses is a charge against current earnings and is determined by management as the amount needed to maintain an adequate allowance.
Southern believes that the overall credit quality of its loan portfolio is strong, as evidenced by the fact that it has had only $1.9 million and $3.3 million in nonaccrual and accruing loans past due more than ninety days at December 31, 2003 and 2002, respectively. To date, Southern has sought to maintain its allowance for loan losses in excess of 1% of total loans. At December 31, 2003, its allowance was $8.9 million or 1.22% of total loans and $6.3 million or 1.23% of total loans at December 31, 2002.
Interest income that would have been recorded under the original terms of nonaccrual loans and the interest income actually recognized are summarized below:
The following table sets forth information with respect to activity of Southern’s allowance for loan losses for the periods indicated:
The following table further summarizes the allocation of the allowance for loan losses by type of loan at December 31, 2003, 2002, 2001, 2000 and 1999.
Allocation of Allowance for Loan Losses
The following table displays loan originations by type of loan and principal reductions during the years ended December 31, 2003, 2002, 2001, 2000 and 1999.
Loan Originations and Principal Reductions
Southern’s Financial Condition
Southern’s goal is to maintain a high quality and liquid balance sheet. Southern seeks to achieve this objective through a high quality portfolio of investment securities with short to medium term maturities, and a high quality portfolio of real estate, commercial and consumer loans.
Cash and Cash Equivalents. Southern had cash and cash equivalents of $30.4 million at December 31, 2003, compared to $35.7 million at December 31, 2002. This decrease was primarily the result of Southern’s strategy to expand its loan portfolio and redeploy excess cash into investment securities.
Securities. In 2003, securities averaged $107.7 million or 14.4% of total earning assets, as compared to $58.0 million, or 11.0% in 2002. Southern’s strategy for its investment account is to maintain a high quality portfolio with generally short to medium term maturities. Securities were $112.4 million at December 31, 2003, and $93.1 million at December 31, 2002. This increase was largely attributable to Southern’s efforts to invest excess cash and cash equivalents into higher yielding securities. Southern is seeking to reduce its level of securities through loan growth. The following tables set forth information regarding the investment portfolio at December 31, 2003 ($ in thousands):
Remaining Maturity and Average Yield of Investment Securities
December 31, 2003
Loans. Loans averaged $623.2 million in 2003 and $420.0 million in 2002. Net loans grew from $352.2 million at December 31, 2001, to $500.3 million at December 31, 2002 and to $719.0 million at December 31, 2003.
Interest-Bearing Liabilities. Interest-bearing liabilities primarily consist of deposits and federal funds purchased. Total interest-bearing liabilities increased from $400.0 million at December 31, 2001, to $535.5 million at December 31, 2002 and $747.0 million at December 31, 2003. Total interest-bearing liabilities averaged $652.9 million in 2003 and $458.2 million in 2002. The growth in Southern’s deposits reflects Southern’s marketing efforts to obtain deposits in southeast Florida for the South Florida Bank and the opening of additional branches.
Advances from the Federal Home Loan Bank and other borrowings increased $37.0 million, to $38.4 million at December 31, 2003, from $1.4 million at December 31, 2002. Southern utilized these funds to purchase investment securities which had a higher current yield than the interest payable on the borrowed funds and to fund loan growth. The Federal Home Loan Bank borrowings bear interest at rates of 2.26% to 2.66% per year. These loans are secured by a pledge of the mortgage-backed securities purchased with the proceeds, and are payable in monthly installments including principal and interest over a 5 year period with final maturities in April and May, 2008. Other borrowings also included $7.9 million in overnight Federal funds and bank repurchase transactions at December 31, 2003, up from $1.4 million at December 31, 2002. These borrowings, at an average interest rate of approximately 1.17%, are utilized by Southern as needed to manage its liquidity position as efficiently as possible.
During 2003, the Central Florida Bank also borrowed $13.0 million through the issuance of subordinated debentures. These debentures bear interest at a floating rate equal to the prime rate, with a minimum of 5.0% per year and a maximum of 12.0% per year. Interest only is payable semiannually. The principal amount of the debentures and all accrued interest is due in full in 2011. Subject to required reductions during the last 5 years prior to maturity, the debentures qualify as Tier 2 capital of the Central Florida Bank.
The following table sets forth information regarding Southern’s average deposits for 2003, 2002 and 2001.
Average Deposits
The following table summarizes the maturity of time deposits over $100,000 at December 31, 2003.
Summary of Time Deposits over $100,000 by Maturity
(in thousands)
The following table sets forth the net deposit flows during the year ended December 31, 2003, 2002 and 2001:
Net Deposit Flows
(in thousands)
Liquidity and Rate Sensitivity
The principal functions of asset and liability management are to provide for adequate liquidity, to manage interest rate exposure by maintaining a prudent relationship between rate sensitive assets and liabilities and to manage the size and composition of the balance sheet so as to maximize net interest income.
Liquidity is the ability to provide funds at minimal cost to meet fluctuating deposit withdrawals or loan demand. These demands are met by maturing assets and the capacity to raise funds from internal and external sources. Southern primarily utilizes cash and federal funds sold to meet its liquidity needs. Although not utilized in managing daily liquidity needs, the sale of investment securities provides a secondary source of liquidity.
Fluctuating interest rates, increased competition and changes in the regulatory environment continue to significantly affect the importance of interest-rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or a different proportion than that of interest rates on liabilities. The primary objective of interest-rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates.
Regular monitoring of assets and liabilities that are rate sensitive within 30 days, 90 days and one year is an integral part of Southern’s rate-sensitivity management process. It is Southern’s policy to maintain a reasonable balance of rate-sensitive assets and liabilities on a cumulative one-year basis, thus minimizing net interest income exposure to changes in interest rates. A ratio of 1.0 represents perfect matching of interest-earning assets and interest-bearing liabilities. Southern’s sensitivity position at December 31, 2001, 2002 and 2003 was such that net interest income would increase modestly if there were an increase in short-term interest rates.
Southern monitors the interest rate risk sensitivity with traditional gap measurements. The gap table has certain limitations in its ability to accurately portray interest sensitivity; however, it does provide a static reading of Southern’s interest rate risk exposure.
The following tables show the repricing structure of Southern’s balance sheet at December 31, 2003, 2002 and 2001 with each maturity interval referring to the earliest repricing opportunity for each asset and liability. The earliest repricing opportunity is the earlier of scheduled contractual maturities or the next reset date. Liability sensitive means interest sensitive liabilities subject to repricing exceeded interest sensitive assets subject to repricing on a 365-day basis. Southern was liability sensitive to the extent of $100.7 million and $37.9 million at December 31, 2003 and 2002, respectively. This negative gap at December 31, 2003 and 2002 was 11.2% and 5.8%, respectively of total assets. Southern’s target gap position is in the range of negative 20% to positive 20%. Southern measures its gap position as a percentage of its total assets. The change in Southern’s gap position reflects a shift in deposits, particularly certificates of deposits to shorter maturities as well as increase in savings and NOW deposits.
While the absolute level of gap is a measurement of interest rate risk, the quality of the assets and liabilities in the balance sheet must be analyzed in order to understand the degree of interest rate risk taken by Southern. Southern does not invest in any derivative products in order to manage or hedge its interest rate risk.
Interest Rate Sensitivity & Gap Report
December 31, 2003
($ in Thousands)
Notes to Preceding Table
(1)
In preparing the above table, adjustable-rate loans are included in the period in which the interest rates are next scheduled to adjust rather than in the period in which the loans mature. Fixed-rate loans are scheduled, including repayment, according to their maturities.
(2)
Includes interest-earning deposits and federal funds sold, which reprice daily and Federal Home Loan Bank Stock, which reprices quarterly.
(3)
Savings, NOW and money-market deposits are regarded as readily accessible withdrawable accounts. Time deposits are scheduled according to their respective maturity dates.
Capital
One of Southern’s primary objectives is to maintain a strong capital position to merit the confidence of customers, bank regulators and shareholders. A strong capital position helps Southern to withstand unforeseen adverse developments and to take advantage of attractive lending and investment opportunities when they raise.
Southern’s tier one capital was 7.96% and the total capital was 10.53% of risk-based assets at December 31, 2003. These risk-based capital ratios were well in excess of the minimum requirements of 4.0% for tier one and 8.0% for total risk-based capital ratios. Southern’s leverage ratio (tier one capital to total average quarterly assets) of 7.72% at December 31, 2003, was also in excess of the minimum 4.0% requirement.
Southern’s goal is to increase the capital of its banks so that each of them is “well capitalized” under applicable federal banking regulations. At December 31, 2003, all of the banks had achieved this objective.
During 2003, Southern sold 323,253 shares of its common stock at a price of $14.00 per share in a private placement transaction. Southern received gross proceeds of $4.5 million from this offering. Southern contributed $4.0 million of this amount to increase the capital of the Southwest Florida Bank, which will utilize the funds for general working capital purposes, including making loans and purchasing investment securities. The balance was retained by Southern’s holding company for general working capital purposes.
During the second half of 2003, the Central Florida Bank issued $13.0 million of subordinated debentures to institutional investors. The Central Florida Bank utilized the proceeds from the sale of the debentures for general working capital purposes, including making loans and purchasing investment securities.
Southern anticipates that it will need to continue to increase its capital in order to maintain its planned growth. Southern intends to increase its capital through a combination of earnings from operations, loans from third parties and the sale of securities. In this connection, Southern intends to establish a revolving line of credit with SunTrust Bank N.A., in the amount of $5.0 million. Amounts advanced under the line will bear interest at LIBOR plus 1.85%, with interest payable quarterly, and the entire balance due 364 days after closing.
The following table sets forth Southern’s required and actual capital amounts and percentages at December 31, 2002 and 2003 ($ in thousands):
Unrealized Loss on Securities Available for Sale
Due to the combined effects of the growth in Southern’s available for sale investment securities and the rise in long-term interest rates during the second half of 2003, Southern’s comprehensive income for 2003 was reduced by $3.2 million as a result of the unrealized loss in the market value of its investment securities that are available for sale, compared to an unrealized gain of $1.3 million in the value of the securities portfolio during 2002. The net change in unrealized income attributable to the portfolio is a function of both the growth of $19.5 million, or 21.7%, in the volume of Southern’s securities available for sale, including primarily U.S. government agency and mortgage-backed securities, and the decline in market value of those securities resulting from rising long-term interest rates in the third quarter. As a result of this change, which would affect Southern’s net income only in the event of the sale of these securities, Southern’s accumulated other comprehensive income was $957,000 at December 31, 2002, compared to a loss of $1,138,000 at December 31, 2003.
Sale of Daytona Beach Bank Charter
In August 2003, the Daytona Beach Bank transferred substantially all of its assets to the Central Florida Bank. In consideration for the transfer of the assets, the Central Florida Bank assumed all of the liabilities of the Daytona Beach Bank and paid the Daytona Beach Bank a cash amount equal to the difference between the book value of the transferred assets and the assumed liabilities. The Central Florida Bank also hired all of the former employees of the Daytona Beach Bank. Since that time, the Central Florida Bank has continued to operate all of the facilities of the Daytona Beach Bank.
At the same time as the asset transfer, Southern entered into an agreement with an unaffiliated bank based outside of Florida to acquire the Daytona Beach Bank corporate shell and its charter. This transaction was completed immediately following the transfer of the Daytona Beach Bank’s assets and liabilities to the Central Florida Bank. In consideration for this transaction, the purchaser paid Southern an amount equal to the capital accounts of the Daytona Beach Bank at the time of the merger and a premium of $1.0 million. The purchaser acquired the Daytona Beach Bank in order to be able to establish branch offices in Florida. Southern recorded a $1.0 million pretax gain from this transaction. Except for the receipt of the $1.0 million premium from the purchaser, the transaction did not affect Southern’s consolidated assets, liabilities or stockholders’ equity.
Dissolution of Mortgage Company
In 2001, the Central Florida Bank and an unaffiliated company, American Heritage Mortgage Affiliates, Inc. (“American Heritage Affiliates”), formed Southern Community Banc Mortgage, LLC (the “Mortgage Company”), to originate residential mortgage loans for customers of the Central Florida Bank and others. The Central Florida Bank and American Heritage Affiliates each held 50% in the Mortgage Company. American Heritage Affiliates, through an agreement with its parent company, American Heritage Mortgage Corporation (“American Heritage Mortgage”), provided the staffing and administrative services required for the operations of the Mortgage Company. In the fall of 2003, American Heritage Mortgage was acquired by another unaffiliated company, First Horizon Home Loan Corporation (“First Horizon”). In connection with its acquisition of American Heritage Mortgage, First Horizon agreed to pay $500,000 to American Heritage Affiliates if the Mortgage Company were dissolved, with $250,000 to be paid to the Central Florida Bank upon dissolution of the Mortgage Company. The dissolution of the Mortgage Company was completed in November 2003. Since the dissolution of the Mortgage Company, the Central Florida Bank has originated residential mortgage loans for its customers directly.
Branch Activities
On July 14, 2003, the South Florida Bank opened a branch office in leased facilities in Palm Beach, Florida. In July, 2003, the South Florida Bank also purchased a site in West Palm Beach where it intends to construct a new branch facility. The purchase price for the West Palm Beach branch site was $1.2 million. Pending construction of the planned permanent facility, the West Palm Beach branch will operate from an adjacent leased facility. Construction of the permanent facility is expected to be completed in mid-2005 at a cost of approximately $800,000. On June 14, 2003, the
South Florida Bank entered into a lease agreement for a proposed branch office to be located on PGA Boulevard in Palm Beach Gardens, Florida. The PGA branch office opened in January 2004.
Purchase of Bank Branch. In December 2003, the Southwest Florida Bank purchased a branch of Harris Bank, N.A. located in Ft. Myers, Florida. As part of the transaction, the Southwest Florida Bank acquired $4.0 million in loans and $1.3 million in premises and equipment. The Southwest Florida Bank paid for branch assets by assuming $4.9 million in deposits and making a cash payment of $450,000.
Impact of Inflation and Changing Prices
The financial statements and related data presented in this report have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of Southern’s assets and liabilities of are monetary in nature. As a result, interest rates have a more significant impact on Southern’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
Future Accounting Requirements
Recent Pronouncements. In November 2002, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others” (“FIN 45”), which expands previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires the Company to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability is applied on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a material effect on Southern’s consolidated financial statements.
In January 2003, the FASB issued (Revised in December 2003) FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”) which addresses consolidation by business enterprises of variable interest entities. FIN 46 applies to variable interest entities created after January 31, 2003. The Company has no variable interest entities, therefore FIN 46 had no effect on Southern’s consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 provides guidance on the recognition and measurement of liabilities for costs associated with exit or disposal activities. SFAS No. 146 is effective for exit and disposal activities that are initiated after December 31, 2002. The adoption of this Statement had no effect on Southern’s consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this Statement had no effect on Southern’s consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement had no effect on Southern’s consolidated financial statements.
Critical Accounting Policies
Southern’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. (see Summary of Significant Accounting Policies in Southern’s consolidated financial statements). Southern believes that of its significant accounting policies, those described below involve a high degree of judgment and complexity. These critical accounting policies require estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in the consolidated financial statements. Due to their nature, estimates involve judgment based upon available information. Actual results or amounts could differ from estimates and the difference could have a material impact on the consolidated financial statements. Therefore, understanding these policies is important in understanding the reported results of operations and the financial position of Southern.
Loan Portfolio. A variety of factors impact the carrying value of Southern’s loan portfolio, including the calculation of the allowance for loan losses, valuation of underlying collateral, the timing of loan charge-offs and the amount and amortization of loan fees and deferred origination costs.
Southern believes that the determination of the allowance for loan losses represents a critical accounting policy. The allowance for loan losses is maintained at a level management considers to be adequate to absorb probable loan losses inherent in the portfolio, based on evaluations of the collectibility and historical loss experience of loans. Credit losses are charged and recoveries are credited to the allowance. Provisions for loan losses are based on Southern’s review of the historical loan loss experience and such factors which, in management’s judgment, deserve consideration under existing economic conditions in estimating probable credit losses. The allowance is based on ongoing assessments of the probable estimated losses inherent in the loan portfolio. Southern’s methodology for assessing the appropriate allowance level consists of several key elements described below.
Large commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on Southern’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources
of cash flows, and available legal options. Included in the review of individual loans are those that are impaired as provided in Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” as amended. Any specific reserves for impaired loans are measured based on the fair market value of the underlying collateral. Southern evaluates the collectibility of both principal and interest when assessing the need for a special reserve. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as installment and residential mortgage loans, are not individually reviewed by management. Reserves are established for each pool of loans based on the expected net charge-offs. Loss rates are based on the average net charge-off history by loan category.
Historical loss rates for commercial and consumer loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions or loss recognition. Factors which management considers in the analysis include the effects of the local economy, trends in the nature and volume of loans (delinquencies, charge-offs, nonaccrual and problem loans), changes in the internal lending policies and credit standards, collection practices, and examination results from bank regulatory agencies and Southern’s internal credit review function.
An unallocated reserve is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans.
Specific reserves on individual loans and historical loss rates are reviewed throughout the year and adjusted as necessary based on changing borrower and collateral conditions and actual collection and charge-off experience.
Based on the procedures discussed above, management believes that allowance for loan losses was adequate to absorb estimated loan losses associated with the loan portfolio at December 31, 2003. Actual results could differ from these estimates. However, since the allowance is affected by management’s judgment and uncertainties, there is the likelihood that materially different amounts would be reported under different conditions or assumptions. To the extent that the economy changes, collateral values change, reserve factors change, or the nature and volume of problem loans change, Southern may need to adjust its provision for loan losses. Material additions to Southern’s provision for loan losses would result in a decrease in net earnings and capital.
The allowance for loan losses is also discussed in Note 3 to Southern’s consolidated financial statements. The significant accounting policies are discussed generally in Note 1 to Southern’s consolidated financial statements.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Southern is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit and construction loans and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the consolidated balance sheet. The contract or notional
amounts of those instruments reflect the extent of Southern’s involvement in particular classes of financial instruments.
Southern’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, unused lines of credit and construction loans and standby letters of credit is represented by the contractual amount of those instruments. Southern uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed-expiration dates or other termination clauses and may require payment of a fee. Since certain commitments expire without being drawn upon, the total committed amounts do not necessarily represent future cash requirements. Southern evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by Southern upon extension of credit, is based on management’s credit evaluation of the counter party.
Standby letters of credit are conditional commitments issued by Southern to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
The following is a summary of Southern’s contractual obligations, including certain on-balance sheet obligations, at December 31, 2003 (in thousands):
ITEM 7A
ITEM 7A QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and rates. Southern’s market risk arises primarily from interest rate risk inherent in Southern’s lending and deposit taking activities. Southern has little or no risk related to trading accounts, commodities or foreign exchange.
Southern actively monitors and manages its interest rate risk exposure. The primary objective in managing interest-rate risk is to limit, within established guidelines, the adverse impact of changes in interest rates on its net interest income and capital, while adjusting its asset-liability structure to obtain the maximum yield-cost spread on that structure. Management relies primarily on its asset-liability structure to control interest rate risk. However, a sudden and substantial increase in interest rates could adversely impact Southern’s earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Attached hereto and filed as part of this Form 10-K are Southern’s consolidated financial statements required by Regulation S-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
Southern maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that Southern files or submits under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of December 31, 2003, the Chief Executive Officer and Chief Financial Officer of Southern concluded that Southern’s disclosure controls and procedures were adequate.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information required by Item 10 regarding executive officers is set forth at the end of the Part I of this Annual Report on Form 10-K.
Information set forth in the 2004 Proxy Statement under the caption “Directors” is incorporated by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth in the 2004 Proxy Statement under the caption “Executive Compensation” is incorporated by reference.
ITEM 12.
ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption “Principal Shareholders and Security Ownership of Management” in the 2004 Proxy Statement is incorporated by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption “Transactions with Management and Others” in the 2004 Proxy Statement is incorporated by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information set forth under the caption “Ratification of Appointment of Independent Accountants” in the 2004 Proxy Statement is incorporated by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
3.1
Articles of Incorporation, as amended, of Registrant. (a)
3.2
Bylaws of Registrant. (a)
4.1
Specimen Common Stock Certificate of Registrant. (a)
10.1
Employees’ Incentive Stock Option Plan of Registrant. (a)
10.2
Directors’ Statutory Stock Option Plan of Registrant. (a)
10.3
Amended and Restated Employee Stock Purchase Plan of Registrant. (a)
10.4
Salary Continuation Agreement between the Registrant and Charlie W. Brinkley, Jr. dated February 23, 1999.(a)
10.5
Salary Continuation Agreement between the Registrant and John G. Squires dated February 23, 1999. (a)
10.6
Salary Continuation Agreement between the Registrant and Dennis Bedley dated February 26, 2003. (d)
10.7
Salary Continuation Agreement between the Registrant and Richard Garner dated July 11, 2003. (d)
10.8
Salary Continuation Agreement between the Registrant and Joel Whittenhall dated July 11, 2003. (d)
10.9
Lease Agreement dated April 22, 1998 between Marx Realty and Improvement Co., Inc. and Registrant.(a)
10.10
Lease Agreement dated November 30, 1998 between Patrick J. Armstrong and Registrant. (a)
10.11
Restricted Stock Agreement made effective as of January 1, 1999 between the Registrant and Charlie W. Brinkley, Jr. (a)
10.12
2001 Equity Incentive Plan. (d)
10.13
Agreement regarding Termination Benefits dated as of November 17, 2000 between the Registrant and Charlie Brinkley. (d)
10.14
Agreement regarding Termination Benefits dated as of November 20, 2000 between the Registrant and John Squires. (d)
10.15
Agreement regarding Termination Benefits dated as of June 6, 2002 between the Registrant and Dennis Bedley. (d)
10.16
Agreement regarding Termination Benefits dated as of June 6, 2002 between the Registrant and Richard Garner. (d)
10.17
Agreement regarding Termination Benefits dated as of June 6, 2002 between the Registrant and Joel Whittenhall. (d)
10.18
Merger Agreement, dated as of March 19, 2004, between First National Bankshares of Florida, Inc. and Southern. (e)
10.19
Peninsula Directors Stock Option Plan.*
10.20
Peninsula Employees Stock Option Plan.*
10.21
Agreement between Southern and CSI.*
10.22
Loan Agreement between Southern and SunTrust Bank, N.A.*
10.23
Promissory Note issued by Southern in favor of SunTrust Bank, N.A.*
10.24
Advances, Specific Collateral, Pledge and Security Agreement between Southern and the Federal Home Loan Bank.*
10.25
Form of Subordinated Debenture.*
14.1
Code of Ethics.*
21.1
List of Subsidiaries of Registrant.*
24.1
Power of Attorney.*
31.1
Certification of Chief Executive Officer, pursuant to Rule 13a - 14(a).*
31.2
Certification of Chief Financial Officer, pursuant to Rule 13a - 14(a).*
32.1
Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2
Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
SIGNATURES
In accordance with Section 13(a) or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Index to Consolidated Financial Statements
All schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements and related Notes.
Independent Auditors’ Report
Southern Community Bancorp
Orlando, Florida:
We have audited the accompanying consolidated balance sheets of Southern Community Bancorp and subsidiaries (the “Company”) at December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
HACKER, JOHNSON & SMITH PA
Orlando, Florida
January 14, 2004, except for Note 23 as to
which the date is March 19, 2004
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Balance Sheets
($ in thousands, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Statements of Operations
($ in thousands, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2003, 2002 and 2001
($ in thousands)
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity, Continued
Years Ended December 31, 2003, 2002 and 2001
($ in thousands)
See accompanying Notes to Consolidated Financial Statements.
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
(In thousands)
See accompanying Notes to Consolidated Financial Statements.
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002 and For Each of the
Years in the Three-Year Period Ended December 31, 2003
(1) Summary of Significant Accounting Policies
Organization. Southern Community Bancorp (the “Holding Company”) is a multi-bank holding company and owns 100% of the outstanding common stock of Southern Community Bank of Central Florida (formerly known as Southern Community Bank prior to its name change in 2003), Southern Community Bank of Southwest Florida, and Southern Community Bank of South Florida (collectively, the “Banks”). Southern Community Bank of South Florida was formed in June 2002 and commenced operations on August 5, 2002. Southern Community Bank of Southwest Florida was formed in 2000 and commenced operations on January 2, 2001. The Holding Company acquired Southern Community Bank, Atlantic on April 30, 2001 in connection with its acquisition of Peninsula Bancorp, Inc. (See Note 20). Southern Community Bank, Atlantic, was known as Peninsula Bank, prior to its name change in January 2002. During 2003, Southern Community Bank of Central Florida acquired all of the assets and assumed all of the liabilities of Southern Community Bank, Atlantic and the charter for Southern Community Bank, Atlantic was sold to a third party for $1.0 million. Southern Community Bank of Central Florida owns 100% of the outstanding common stock of Southern Community Insurance Agency, Inc. (the “Insurance Agency”). In January 2001, Southern Community Bank of Central Florida and a third party formed Southern Community Bank Mortgage LLC (the “Mortgage Company”). Each of them held a 50% equity interest in the Mortgage Company. On October 1, 2003, Southern Community Bank of Central Florida agreed to liquidate the Mortgage Company in exchange for $250,000. The Mortgage Company originated, processed and closed residential loans in central Florida.
The Holding Company’s only business activity is the ownership of the Banks. The Banks are state (Florida) chartered commercial banks. The Banks offer a variety of financial services to individual and corporate customers through their eighteen banking offices located in Orange, Seminole, Volusia, Lee, Collier, Broward and Palm Beach Counties, Florida. The deposits of the Banks are insured by the Federal Deposit Insurance Corporation. The Insurance Agency refers customers of the Banks to insurance agencies for the purchase of insurance products. Southern Community Bank of Central Florida formed 1600 East Robinson Street, Inc. in 2001 for the purpose of holding certain foreclosed assets and was dissolved after selling these assets in 2002.
Basis of Presentation. The accompanying consolidated financial statements include the accounts of the Holding Company and its subsidiaries (collectively, the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. The accounting and reporting practices of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following summarizes the more significant of these policies and practices:
Use of Estimates. In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and deferred tax assets.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Cash and Cash Equivalents. For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks and federal funds sold, all of which mature within ninety days.
The Banks are required by law or regulation to maintain cash reserves in the form of vault cash or in a noninterest-earning account with the Federal Reserve Bank or in noninterest-earning accounts with other qualified banks. These reserve requirements at December 31, 2003 and 2002 were approximately $3.6 million and $1.2 million, respectively.
Securities. The Company may classify its securities as either trading, held to maturity or available for sale. Trading securities are held principally for resale and recorded at their fair values. Unrealized gains and losses on trading securities are included immediately in operations. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Available-for-sale securities consist of securities not classified as trading securities nor as held-to-maturity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are excluded from operations and reported in other comprehensive income (loss). Gains and losses on the sale of available-for-sale securities are recorded on the trade date and are determined using the specific-identification method. Premiums and discounts on securities are recognized in interest income using the interest method over the period to maturity.
Loans. Loans that management has the intent and the Company has the ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.
Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan.
The accrual of interest on loans is discontinued at the time the loan is ninety days delinquent unless the loan is well collateralized and in process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to operations. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Allowance for Loan Losses, Continued. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial, construction and commercial real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Foreclosed Assets. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of fair value or the loan balance at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.
Premises and Equipment. Land is carried at cost. Buildings, leasehold improvements and furniture and equipment are carried at cost, less accumulated depreciation and amortization computed principally using the straight-line method over the estimated useful lives of the assets. The Company amortizes leasehold improvements over the lease term, which could include lease renewal periods, if it is the intent of management to exercise the renewal option on the lease. The Company capitalizes interest during the construction period of major capital projects such as the construction of office facilities. Interest costs capitalized were approximately $44,000 and $103,000 during the years ended December 31, 2002 and 2001, respectively. No interest costs were capitalized during the year ended December 31, 2003.
Goodwill. Goodwill resulted from the purchase of Peninsula Bancorp, Inc. in 2001 and represents the excess of the acquisition cost over the fair value of the net assets acquired. Prior to January 1, 2002, goodwill was amortized on the straight-line method over twenty years.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Goodwill, Continued. In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 requires goodwill to be tested for impairment on an annual basis and between annual tests in certain circumstances, and written down when impaired, rather than being amortized as previous accounting standards required. Furthermore, SFAS 142 requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite. SFAS 142 is effective for fiscal years beginning after December 15, 2001. In accordance with SFAS 142, the Company ceased amortizing goodwill totaling $971,000 as of January 1, 2002. Based on the impairment tests performed, there was no impairment of goodwill in 2002 or 2003. There can be no assurance that future goodwill impairment tests will not result in a charge to earnings.
The following table presents the impact of SFAS 142 on net loss had the accounting standard been in effect for the year ended December 31, 2001 (in thousands):
The effect on basic and diluted loss per share in 2001 was not material.
Transfer of Financial Assets. Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Income Taxes. Deferred income tax assets and liabilities are recorded to reflect the tax consequences on future years of temporary differences between revenues and expenses reported for financial statement and those reported for income tax purposes. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. Valuation allowances are provided against assets which are not likely to be realized.
The Holding Company and its subsidiaries file a consolidated income tax return. Income taxes are allocated to the Holding Company and the subsidiaries as though separate income tax returns were filed.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Organizational and Preopening Costs. Preopening and organizational costs associated with Southern Community Bank of South Florida totaled approximately $83,000 in both 2002 and 2001 (net of tax benefits of approximately $50,000 for both periods) and were charged to expense as incurred during the organizational period during those years.
Stock Compensation Plans. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure (collectively “SFAS No. 123”) encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date, and under APB No. 25 no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in APB No. 25. The following table illustrates the effect on net earnings (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts).
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Stock Compensation Plans, Continued. In order to calculate the fair value of the options, it was assumed that the average risk-free interest rate was 4.17% for 2003, 4.46% for 2002 and 5.68% for 2001, there would be no dividends paid by the Company over the exercise period, the expected life of the options would be the entire exercise period and stock volatility would be zero due to the lack of an active trading market for the stock. For purposes of pro forma disclosures, the estimated fair value is treated as expense during the vesting period. The following information summarizes the fair value of options granted under the plans (in thousands, except per share amounts):
Off-Balance Sheet Instruments. In the ordinary course of business, the Company has entered into off-balance-sheet instruments consisting of commitments to extend credit, standby letters of credit, undisbursed loans in process and unused lines of credit. Such financial instruments are recorded in the consolidated financial statements when they are funded.
Fair Values of Financial Instruments. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument or may not necessarily represent the underlying fair value of the Company. The following methods and assumptions were used by the Company in estimating fair values of financial instruments disclosed herein:
Cash and Cash Equivalents. The carrying amounts of cash and cash equivalents approximate their fair value.
Securities. Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.
Federal Home Loan Bank Stock. Fair value of the Company’s investment in Federal Home Loan Bank (“FHLB”) stock is based on its redemption value, which is its cost of $100 per share.
Loans. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for certain fixed-rate mortgage (e.g. one-to-four family residential), commercial real estate and commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Fair Values of Financial Instruments, Continued.
Deposit Liabilities. The fair values disclosed for demand, NOW, money-market and savings deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities of time deposits.
Accrued Interest. The carrying amounts of accrued interest approximate their fair values.
Other Borrowings. The carrying value of borrowings related to customer repurchase agreements and federal funds purchased approximate fair value.
Advances from Federal Home Loan Bank and Subordinated Debentures. The fair value for advances from Federal Home Loan Bank and subordinated debentures are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance-Sheet Instruments. Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.
Advertising. The Company expenses all media advertising as incurred.
Earnings (Loss) Per Share. Basic earnings (loss) per share is computed on the basis of the weighted-average number of common shares outstanding. For 2003 and 2002, diluted earnings per share is computed based on the weighted-average number of shares outstanding plus the effect of outstanding stock options, computed using the treasury stock method. For 2001, such options were antidilutive. Earnings (loss) per common share have been computed based on the following:
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Comprehensive Income (Loss). Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net earnings (loss). Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated balance sheets, such items along with net earnings (loss), are components of comprehensive income (loss). The components of other comprehensive income and related tax effects are as follows (in thousands):
Reclassifications. Certain reclassifications have been made to prior period balances in order to conform to the current year presentation.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Summary of Significant Accounting Policies, Continued
Recent Pronouncements. In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others” (“FIN 45”), which expands previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires the Company to recognize an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability is applied on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 did not have a material affect on the Company’s consolidated financial statements.
In January 2003, the FASB issued (Revised in December 2003) FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”) which addresses consolidation by business enterprises of variable interest entities. FIN 46 applies to variable interest entities created after January 31, 2003. The Company has no variable interest entities, therefore FIN 46 had no effect on the Company’s consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 provides guidance on the recognition and measurement of liabilities for costs associated with exit or disposal activities. SFAS No. 146 is effective for exit and disposal activities that are initiated after December 31, 2002. The adoption of this Statement had no effect on the Company’s consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This Statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this Statement had no effect on the Company’s consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this Statement had no effect on the Company’s consolidated financial statements.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Securities
Securities have been classified according to management’s intent. The carrying amount of securities and their approximate fair value are summarized as follows (in thousands):
The following summarizes sales of securities available for sale (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Securities, Continued
The scheduled maturities of securities at December 31, 2003 are as follows (in thousands):
At December 31, 2003 and 2002, the Company had pledged securities with carrying values of approximately $3.7 million and $3.3 million, respectively, for public deposits and approximately $2.9 million and $3.6 million, respectively, had been pledged as collateral for borrowings under customer repurchase agreements. In addition, the Company had pledged securities with carrying values of approximately $31.9 million as collateral for advances from Federal Home Loan Bank at December 31, 2003.
(3) Loans
The components of loans were as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Loans, Continued
The following is a summary of the activity in the allowance for loan losses (in thousands):
The following summarizes the amounts of impaired loans, all of which are collateral dependent (in thousands):
The average net investment in impaired loans and interest income recognized and received on impaired loans was as follows (in thousands):
Nonaccrual and past due loans were as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Premises and Equipment
Premises and equipment were as follows (in thousands):
The Company purchased land in West Palm Beach and intends to begin construction of a new branch facility during 2004. The Company expects to expend approximately $1.8 million in construction and equipment costs.
The Company leases certain office facilities under operating leases. Some of the leases contain escalation clauses and expense pass-throughs and have renewal options ranging from 5 to 15 years. Rent expense under operating leases for the years ended December 31, 2003, 2002 and 2001 was approximately $1,024,000, $855,000 and $606,000, respectively. Future minimum rental commitments under noncancelable leases are approximately as follows (in thousands):
(5) Deposits
The aggregate amount of time deposits with a minimum denomination of $100,000, were approximately $157.0 million and $124.7 million at December 31, 2003 and 2002, respectively.
At December 31, 2003, the scheduled maturities of time deposits were as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Other Borrowings
The Company enters into repurchase agreements with customers. These agreements require the Company to pledge securities as collateral for borrowings under these agreements. At December 31, 2003 and 2002, the outstanding balance of such borrowings totaled approximately $1.9 million and $1.4 million and the Company pledged securities with carrying values of approximately $2.9 million and $3.6 million, respectively, as collateral for these agreements. At December 31, 2003, other borrowings also include federal funds purchased totaling $6.0 million.
(7) Advances from Federal Home Loan Bank
Advances from the Federal Home Loan Bank (“FHLB”) were as follows ($ in thousands):
These advances require monthly interest payments and have required principal payments as follows (in thousands):
At December 31, 2003, pursuant to the collateral agreement with the FHLB, advances are collateralized by the Company’s FHLB stock and securities available for sale with a carrying value of approximately $31.9 million.
(8) Subordinated Debentures
During 2003, the Company issued $13.0 million of uncollateralized subordinated debentures. The subordinated debentures bear interest at prime rate subject to a minimum rate of 5% and a maximum rate of 12%. Interest is payable semi-annually and principal is due in 2011.
(9) Benefit Agreements
The Company has entered into Salary Continuation Agreements (the “Agreements”) with certain officers which require the Company to provide salary continuation benefits to these officers upon retirement. The Agreements require the Company to pay annual benefits for up to twenty years following their normal retirement ages. The Company has purchased life insurance policies on these officers which although not formerly linked, have future cash values that exceed the estimated future benefits. The Company recognized expenses of approximately $160,000, $116,000 and $61,000 during the years ended December 31, 2003, 2002 and 2001, respectively and has accrued liabilities of approximately $440,000 and $280,000 at December 31, 2003 and 2002, respectively, relating to these Agreements.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Financial Instruments
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are commitments to extend credit, standby letters of credit, undisbursed loans in process and unused lines of credit and may involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract amounts of these instruments reflect the extent of involvement the Company has in these financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the counterparty.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved is essentially the same as that involved in extending loans to customers.
The estimated fair values of the Company’s financial instruments were as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Financial Instruments, Continued
Commitments to extend credit, standby letters of credit, undisbursed loans in process and unused lines of credit typically result in loans with a market interest rate when funded. A summary of the contractual amounts of the Company’s financial instruments with off-balance-sheet risk at December 31, 2003, follows (in thousands):
(11) Credit Risk
The Company grants real estate, commercial and consumer loans to customers primarily in the State of Florida with the majority of such loans in Orange, Seminole, Broward, Palm Beach, Collier, Volusia and Lee Counties. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy of these counties.
(12) Income Taxes
Allocation of Federal and state income taxes between current and deferred portions is as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(12) Income Taxes, Continued
The reasons for the differences between the statutory Federal income tax rate and the effective tax rate are summarized as follows ($ in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(13) Related Party Transactions
In the ordinary course of business, the Company has made loans, at terms and rates prevailing at the time, to the Company’s principal officers, directors and their affiliates. The following summarizes these loans to related parties (in thousands):
The following summarizes the Company’s other related party transactions (in thousands):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Stock Option Plans
In March 2001, the Company adopted the 2001 Equity Incentive Plan (the “2001 Plan”). Under the 2001 Plan, the Company is authorized to issue up to 2,000,000 shares of its common stock to employees and directors pursuant to stock options and restricted stock grants. Vesting periods will be determined as awards are granted. At December 31, 2003, there were 1,414,560 shares available to be issued in connection with future awards under the 2001 Plan.
In 1999, the Company adopted an employee incentive stock option plan (the “1999 Plan”). Under the 1999 Plan, the total number of shares which may be issued is 212,000. The option price shall not be less than the greater of the par value of the common stock or the fair market value at the date of grant and the options vest ratably over a five year period. At December 31, 2003, no options remained available for future grants under the 1999 Plan.
In 1999, the Company adopted a directors’ nonstatutory stock option plan (the “Director Plan”). Under the Director Plan, the total number of shares which may be issued is 140,000. The option price shall not be less than the greater of the par value of the common stock or the fair market value at the date of grant and all options are immediately exercisable when granted. At December 31, 2003, no options remained available for future grants under the Director Plan.
In connection with the acquisition of Peninsula discussed in Note 20, the Company assumed options to purchase 135,125 shares of common stock, of which 133,000 options were still outstanding at December 31, 2003.
A summary of stock option transactions follows ($ in thousands, except per share amounts):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(14) Stock Option Plans, Continued
All options granted under stock option plans have ten year lives. The weighted-average remaining contractual life of options outstanding at December 31, 2003, 2002 and 2001 was 6.7 years, 7.9 years and 8.6 years, respectively.
The options are exercisable as follows:
(15) Profit Sharing Plan
The Company has a 401(k) profit sharing plan (the “401(k) Plan”) which is available to all employees electing to participate after meeting certain length-of-service requirements. The Company’s annual matching contributions to the 401(k) Plan may be made in the form of the Company’s common stock or as directed by each participant and are discretionary. The Company’s expense in connection with the 401(k) Plan was $204,000, $128,000 and $45,000 during the years ended December 31, 2003, 2002 and 2001, respectively.
One of the investment choices available under the 401(k) Plan allows for participants to purchase the Company’s common stock. Participants electing to purchase stock defer salary each pay period and the Company issues shares after the end of the fiscal year. The total number of common shares allocated to the 401(k) Plan is 150,000, of which 41,612 were available for future issuances at December 31, 2003.
(16) Employee Stock Purchase Plan
The Company has a Employee Stock Purchase Plan (the “Stock Purchase Plan”) under which employees can elect to purchase the Company’s common stock through payroll deductions. Employees defer salary each pay period and the Company issues shares after the end of the fiscal year. The total number of common shares allocated to the Stock Purchase Plan is 100,000, of which 57,378 were available for future issuances at December 31, 2003.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Regulatory Matters
Banking regulations place certain restrictions on dividends and loans or advances made by the Banks to the Holding Company.
Each Bank is limited in the amount of cash dividends that may be paid. The amount of cash dividends that may be paid is based on the Banks net earnings of the current year combined with the Banks retained earnings of the preceding two years, as defined by state banking regulations. However, for any dividend declaration, the Company must consider additional factors such as the amount of current period net earnings, liquidity, asset quality, capital adequacy and economic conditions. It is likely that these factors would further limit the amount of dividends which the Banks could declare. In addition, bank regulators have the authority to prohibit banks from paying dividends if they deem such payment to be an unsafe or unsound practice.
The Company and the Banks are subject to various regulatory capital requirements administered by the regulatory banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s and the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Under the regulatory framework for prompt and corrective action the Banks must also meet specific capital guidelines. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and percentages (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2003 and 2002, the Company and the Banks met all capital adequacy requirements to which they were subject.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Regulatory Matters, Continued
As of December 31, 2003, the most recent notification from the regulatory authorities categorized the Banks as either well or adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage percentages as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Banks’ categories. The Company’s and the Banks’ actual capital amounts and percentages are also presented in the table ($ in thousands).
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(17) Regulatory Matters, Continued
(18) Legal Contingencies
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Holding Company Financial Information
The Holding Company’s financial information follows (in thousands):
Condensed Balance Sheets
Condensed Statements of Operations
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(19) Holding Company Financial Information, Continued
Condensed Statements of Cash Flows
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(20) Acquisitions
On April 30, 2001, the Holding Company acquired Peninsula Bancorp, Inc. (“Peninsula”). The Holding Company issued 623,913 shares of common stock in exchange for all of the outstanding shares of Peninsula. Peninsula was the parent company of Peninsula Bank of Central Florida (“Peninsula Bank”), a state bank with three offices in Volusia County, Florida. The Holding Company accounted for this transaction using the purchase method of accounting. The excess purchase price over fair market value of the net assets acquired of $1.0 million was allocated to goodwill. The consolidated financial statements include the results of Peninsula from the date of acquisition. The unaudited proforma results below assume the acquisition occurred at the beginning of the year ended December 31, 2001 (in thousands, except per share amounts).
In management’s opinion, the unaudited proforma combined results of operations are not indicative of the actual results that would have occurred had the acquisitions been consummated at the beginning of 2001 or of future operations of the combined entities under the ownership and management of the Company.
On December 1, 2003, the Company purchased a branch of Harris Bank, N.A located in Fort Myers, Florida. The Company paid approximately $449,000 in cash and assumed $4.9 million in deposits to acquire $4.0 million in loans and $1.3 million in premises and equipment related to this office. This transaction resulted in a core deposit intangible asset of $89,000. This intangible asset, which is included in other assets in the accompanying consolidated balance sheets, is being amortized over three years.
(21) Stock Dividend
The Company’s Board of Directors declared a two-for-one stock split, effected in the form of a 100% stock dividend, on August 6, 2001 to stockholders of record on October 19, 2001 which resulted in the issuance of 2,730,101 shares of common stock and corresponding decrease of $2,730,101 in additional paid-in capital. The stock split has been reflected in the accompanying consolidated financial statements and all per share information and stock option plan data has been restated to reflect this split.
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Selected Quarterly Results (Unaudited)
The following table presents summarized quarterly data (in thousands, except per share amounts):
(continued)
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(22) Selected Quarterly Results (Unaudited), Continued
(23) Definitive Agreement
On March 19, 2004, the Company entered into a definitive agreement with First National Bankshares of Florida, Inc. (“First National”) to sell all of the Company’s common stock to First National. The transaction is expected to be consummated in the third quarter of 2004 subject to regulatory and stockholder approvals.
Independent Auditors’ Report on Supplementary Information
Southern Community Bancorp
Orlando, Florida
We have audited the accompanying consolidated financial statements of Southern Community Bancorp and Subsidiaries at and for the year ended December 31, 2003, and have issued our report thereon dated January 14, 2004, except for Note 23, as to which the date is March 19, 2004. Our audit was conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidating information in the accompanying schedules is presented for purposes of additional analysis of the consolidated financial statements rather than to present the financial position and results of operations of the individual companies. The consolidating information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.
HACKER, JOHNSON & SMITH PA
Orlando, Florida
January 14, 2004
Schedule
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidating Balance Sheet
December 31, 2003
(In thousands)
(continued)
Schedule
SOUTHERN COMMUNITY BANCORP AND SUBSIDIARIES
Consolidating Statement of Earnings
Year Ended December 31, 2003
(In thousands)