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SCMF Southern Community Financial Corp. (MM)

3.33
0.00 (0.00%)
Pre Market
Last Updated: 01:00:00
Delayed by 15 minutes
Share Name Share Symbol Market Type
Southern Community Financial Corp. (MM) NASDAQ:SCMF NASDAQ Common Stock
  Price Change % Change Share Price Bid Price Offer Price High Price Low Price Open Price Shares Traded Last Trade
  0.00 0.00% 3.33 0 01:00:00

- Quarterly Report (10-Q)

10/05/2010 8:44pm

Edgar (US Regulatory)



U.S. Securities and Exchange Commission
Washington, D.C. 20549

Form 10-Q

x   Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2010

¨ Transition Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the transition period ended                                       

Commission File Number    000-33227   

Southern Community Financial Corporation
(Exact name of registrant as specified in its charter)

North Carolina
 
56-2270620
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
   
     
4605 Country Club Road
   
Winston-Salem, North Carolina
 
27104
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code (336) 768-8500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)
Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨    Accelerated filer ¨    Non-accelerated filer ¨     Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨ No  x

As of April 30, 2010 (the most recent practicable date), the registrant had outstanding 16,818,125 shares of Common Stock, no par value.

 
 

 

   
Page No.
     
Part I.
FINANCIAL INFORMATION
 
     
Item 1 -
Financial Statements (Unaudited)
 
     
 
Consolidated Statements of Financial Condition
 
 
March 31, 2010 and December 31, 2009
15
     
 
Consolidated Statements of Operations
 
 
Three Months Ended March 31, 2010 and 2009
16
     
 
Consolidated Statements of Comprehensive Income (Loss)
 
 
Three Months Ended March 31, 2010 and 2009
17
     
 
Consolidated Statement of Changes in Stockholders’ Equity
 
 
Three Months Ended March 31, 2010
18
     
 
Consolidated Statements of Cash Flows
 
 
Three Months Ended March 31, 2010 and 2009
19
     
 
Notes to Consolidated Financial Statements
20
     
 
Selected Financial Data
  3
     
Item 2 -
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  4
     
Item 3 -
Quantitative and Qualitative Disclosures about Market Risk
37
     
Item 4 -
Controls and Procedures
38
     
Part II.
Other Information
 
     
Item 1A -
Risk Factors
38
     
Item 6 -
Exhibits
38
     
Signatures
 
39

 
 

 

Part I. FINANCIAL INFORMATION
SELECTED FINANCIAL DATA

   
At or for the Quarter Ended
   
% Change March 31, 2010 from
 
   
March 31,
   
December 31,
   
March 31,
   
December 31,
   
March 31,
 
   
2010
   
2009
   
2009
   
2009
   
2009
 
   
(Amounts in thousands, except per share data)
             
Operating Data:
                             
Interest income
  $ 20,986     $ 22,092     $ 22,744       (5 ) %     (8 ) %
Interest expense
    7,739       8,701       10,285       (11 )     (25 )
Net interest income
    13,247       13,391       12,459       (1 )     6  
Provision for loan losses
    10,000       18,000       4,000       (44 )     150  
Net interest income (loss) after provision for loan losses
    3,247       (4,609 )     8,459       (170 )     (62 )
Non-interest income
    3,953       3,526       2,587       12       53  
Non-interest expense
    11,843       13,578       60,584       (13 )     (80 )
                                         
Income (loss) before income taxes
    (4,643 )     (14,661 )     (49,538 )     (68 )     (91 )
Benefit from income taxes
    (32 )     (3,944 )     (214 )     (99 )     (85 )
Net income (loss)
  $ (4,611 )   $ (10,717 )   $ (49,324 )     (57 )     (91 )
                                         
Effective dividend on preferred stock
    633       627       627                  
Net income (loss) available to common shareholders
  $ (5,244 )   $ (11,344 )   $ (49,951 )                
                                         
Net Income (Loss) Per Common Share:
                                       
Basic
  $ (0.31 )   $ (0.68 )   $ (2.98 )                
Diluted
    (0.31 )     (0.68 )     (2.98 )                
                                         
Selected Performance Ratios:
                                       
Return on average assets
    -1.10 %     -2.44 %  
NM
                 
Return on average equity
 
NM
   
NM
   
NM
                 
Net interest margin (1)
    3.41 %     3.28 %     3.01 %                
Efficiency ratio (2)
    68.85 %     80.26 %     73.66 %                
                                         
Asset Quality Ratios:
                                       
Nonperforming loans to period-end loans
    4.19 %     3.07 %     1.56 %                
Nonperforming assets to total assets (3)
    4.15 %     3.32 %     1.73 %                
Net loan charge-offs to average loans outstanding (annualized)
    1.20 %     2.92 %     1.09 %                
Allowance for loan losses to period-end loans
    2.98 %     2.41 %     1.49 %                
Allowance for loan losses to nonperforming loans
    0.71  X     0.79  X     0.95  X                
                                         
Capital Ratios:
                                       
Total risk-based capital
    12.80 %     12.92 %     13.69 %                
Tier 1 risk-based capital
    10.92 %     11.34 %     12.35 %                
Leverage ratio
    8.86 %     9.14 %     9.96 %                
Equity to assets ratio
    6.85 %     7.06 %     7.72 %                
                                         
Balance Sheet Data (End of Period):
                                       
Total assets
    1,707,180       1,728,608       1,789,734       (1 )     (5 )
Loans
    1,208,454       1,230,275       1,297,489       (2 )     (7 )
Deposits
    1,306,954       1,353,436       1,328,143       (3 )     (2 )
Short-term borrowings
    76,769       85,477       101,425       (10 )     (24 )
Long-term borrowings
    199,062       199,103       212,975       -       (7 )
Stockholders’ equity
    116,882       121,997       138,209       (4 )     (15 )
                                         
Other Data:
                                       
Weighted average shares
                                       
Basic
    16,806,292       16,789,045       16,780,058                  
Diluted
    16,806,292       16,789,045       16,780,058                  
Period end outstanding shares
    16,818,125       16,787,675       16,793,175                  
                                         
Number of banking offices
    22       22       22                  
Number of full-time equivalent employees
    321       331       341                  
 

(1)
Net interest margin is net interest income divided by average interest-earning assets.
(2)
Efficiency ratio is non-interest expense divided by the sum of net interest income and non-interest income.  This ratio for first quarter 2009 excludes the $49,501 goodwill impairment charge.
(3)
Nonperforming assets consist of nonaccrual loans, restructured loans and foreclosed assets, where applicable.
NM - Not meaningful

 
- 3 -

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates.  These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, technological factors affecting our operations, pricing, products and services, and other factors discussed in our filings with the Securities and Exchange Commission.

Summary of First Quarter

Total assets decreased $21.4 million, or 1.2%, during the first quarter as loans declined for the sixth consecutive quarter.  Loans outstanding decreased $21.8, million or 1.8%, due to the continued weak economic conditions and resulting slowdown in loan demand.  The allowance for loan losses increased $6.4 million, or 21.5% primarily attributable to elevated levels in our provision for loan losses resulting from increases in volume and loss impairment of nonperforming loans.  Foreclosed assets remained stable, increasing only $651 thousand.  Investment securities and cash and due from banks increased $11.8 million, or 3.7%, and $3.7 million, or 12.3%, respectively; while federal funds sold decreased $8.9 million as part of ongoing balance sheet management to maximize available yields on investments.  Total deposits were $1.31 billion at March 31, 2010, a decrease of $7.1 million, or 0.5%, from December 31, 2009.  The decrease in deposits was from time deposits and demand deposits which decreased $43.4 million, or 7.0%, and $5.1 million, or 4.3%, respectively; while interest bearing transaction deposits increased $41.4 million or 7.2%.  The decrease in time deposits was primarily attributed to declines in brokered deposits of $41.3 million.  Borrowings decreased $8.7 million, or 3.1%, from the prior quarter end continuing a trend of allowing borrowings to mature without renewal or replacement as loan demand has declined and deposit growth has been adequate to fund new loan requests.

Net interest income decreased $144 thousand, or 1.1%, for the first quarter compared to the fourth quarter 2009.  The interest rate environment remained relatively stable in the first quarter as the Federal Reserve maintained the federal funds target rate consistent with the fourth quarter.  Total interest income decreased by $1.1 million, or 5.0%; while the cost of funds decreased $1.0 million, or 11.1%, compared to the previous quarter.  Effective pricing of loans including the continued incorporation of interest rate floors on floating rate loans upon renewal and loan balances decreasing at a slower pace during the quarter minimized the reduction in interest income.  Interest expense declined primarily due to reduced levels of higher cost time deposits and borrowings and as deposits continued to reprice at lower rates during the quarter.  The net interest margin improved 13 basis points to 3.41% compared to 3.28% for the linked quarter and increased 40 basis points when compared to 3.01% for the first quarter of 2009.

The Company’s provision for loan losses of $10.0 million decreased from $18.0 million for the fourth quarter 2009 although it increased from $4.0 million reported in the first quarter of 2009.  This level of provision and net charge-offs are the continuation of our proactive efforts to resolve troubled loans.  This approach has led to an early identification of potential problem loans and their timely resolution, including the recognition of their loss exposure.   The impairment of $5.1 million on two loan relationships was a significant factor in the level of provision for loan losses during the quarter.  Annualized net charge-offs decreased to 1.20% of average loans in first quarter 2010 from 2.92% of average loans for fourth quarter 2009 and increased from 1.09% of average assets for the first quarter 2009.  Nonperforming loans increased to $50.6 million or 4.19% of loans at March 31, 2010 from $37.7 million or 3.07% of loans at December 31, 2009.  The $12.9 million increase in nonperforming loans reflects an increase of $6.7 million derived from one loan relationship as well as an increase in the volume of other new nonaccrual loans.  Nonperforming assets rose to $70.9 million or 4.15% of total assets at March 31, 2010 from $57.4 million, or 3.32% of total assets, at December 31, 2009 primarily due to the increase in nonaccrual loans during the quarter.  The activity for this quarter in net charge-offs, nonperforming loans and nonperforming assets continues to be predominately related to construction and development lending although commercial real estate was more of a factor.  The allowance for loan losses of $36.0 million at March 31, 2010 represented 2.98% of total loans and a 0.71% coverage of nonperforming loans at current quarter-end compared with 2.41% of total loans and a 0.79% coverage of nonperforming loans at December 31, 2009.  We believe the allowance is adequate for losses inherent in the loan portfolio at March 31, 2010.

 
- 4 -

 

Non-interest income was $4.0 million during the first quarter of 2010, compared to $3.5 million for the prior quarter and $2.6 million for the first quarter of 2009.  The increase in non-interest income was primarily due to a $1.4 million gain on the sale of investment securities and improved SBIC earnings of $176 thousand compared to a $218 thousand loss in the prior quarter.  All other categories decreased during the first quarter compared to the fourth quarter 2009. The decline in non-interest income during the first quarter also included a $186 thousand “other-than-temporary” impairment loss from the write-down of one equity investment security.  The increase in non-interest income compared to the first quarter of 2009 was also primarily due to a $1.4 million gain on the sale of investment securities and improved service charges of $113 thousand.

Non-interest expense of $11.8 million in the first quarter of 2010 decreased $1.7 million or 12.8% from the prior quarter, and grew by $766 thousand or 6.9% compared with the year ago period excluding the $49.5 million goodwill impairment charge.  The decrease from the fourth quarter of 2009 is primarily due to a $1.1 million reduction in write-downs on carrying values on foreclosed real estate.  Compared to the first quarter of 2009, significant increases were recognized in foreclosed asset related expenses and write-downs, FDIC deposit insurance premiums and the Company’s buyer incentive program.

Financial Condition at March 31, 2010 and December 31, 2009

During the three month period ending March 31, 2010, total assets declined $21.4 million or 1.2% to $1.71 billion.  The key drivers of the change in balance sheet mix were an emphasis on maintaining an adequate allowance for loan losses, actively managing the investment portfolio, maintaining both a high level of liquidity and our regulatory capital ratios in excess of the well capitalized level.  The allowance for loan losses was increased to 2.98% of period end loans compared to 2.41% at the end of the previous quarter and 1.49% at the end of the first quarter of 2009.  The allowance was increased by $10.0 million during the quarter while net charge offs totaled $3.6 million.  The investment portfolio was increased slightly during the quarter in order to fully utilize the increased liquidity caused by the lower loan balances.  Total deposits decreased $7.1 million during the quarter with time deposits declining $43.4 million while lower cost transaction accounts increased $36.3 million.  Virtually the entire decline in time deposits was brokered deposits which declined $41.3 million. Excess liquidity was also used to repay $8.7 million in borrowings.  The shift in the funding mix contributed to an improvement in the net interest margin during the first quarter.

Total loans decreased $21.8 million or 1.8% during the quarter with decreases in the following major categories:   $6.0 million, or 3.3%, for commercial and industrial loans, $5.9 million, or 1.3%, for commercial mortgage loans, $5.8 million, or 1.5%, for residential mortgage loans and $3.4 million, or 1.9%, for construction loans.  The decrease in loans outstanding during the quarter can be attributed to a continued slowdown in loan demand during these difficult economic times.  Loans held for sale decreased by $41 thousand or 1.4% from the prior year end.

Our capital position remains strong, with all of our regulatory capital ratios at levels that categorize us “well capitalized” under federal bank regulatory capital guidelines.  At March 31, 2010, our stockholders’ equity totaled $116.9 million, a decrease of $5.1 million compared to December 31, 2009.  The decrease is the result of the net loss for the quarter, $633 thousand in dividends on the preferred stock issued to the United States Treasury through the Capital Purchase Program, and a decrease of $7 thousand in other comprehensive income items.

Results of Operations for the Three Months Ended March 31, 2010 and 2009

Net Loss.   Our net loss from operations of $4.6 million and our net loss after preferred dividends of $5.2 million for the three months ended March 31, 2010 decreased $44.7 million from the same three month period in 2009 which included a $49.5 million goodwill impairment charge.  Net loss per share available to common shareholders was a $0.31 loss per share for both basic and diluted for the three months ended March 31, 2010 as compared with a $2.98 loss per share for both basic and diluted for the same period in 2009.  Net interest income for the first quarter of 2010 was $13.2 million, up $788 thousand, or 6.3%, compared with the first quarter 2009, due to an improvement in the net interest margin despite a decrease in interest earning assets.  The net interest margin of 3.41% improved 40 basis points from the year ago period.  The Federal Reserve did not change rates during the current quarter, although repricing of interest bearing assets and liabilities continued to have an effect on the current net interest income and margin.  The primary factor for the loss in the first quarter was the continued elevated level of asset quality costs, including a provision for loan losses of $10.0 million for the quarter.  Non-interest income was $4.0 million during the first quarter of 2010, which represents an increase of 52.8% from non-interest income of $2.6 million reported in the comparable period in 2009.  Excluding the $49.5 million goodwill impairment charge in first quarter 2009, non-interest expense increased $766 thousand, or 6.9%, compared with the same quarter a year ago.  The largest increases in non-interest expense resulted from increased OREO write-downs and other OREO expense totaling $630 thousand and an increased FDIC deposit insurance premium of $304 thousand from ongoing deposit insurance premium rate increases.

 
- 5 -

 

Net Interest Income.   During the three months ended March 31, 2010, our net interest income was $13.2 million, an increase of $788 thousand, or 6.3%, over the first quarter 2009.  Interest expense decreased $2.5 million from repricing of deposits and the reduction in the cost of borrowings.  This reduction in our cost of funds exceeded the $1.8 million decrease in interest income from declining outstanding balances and declining yields on interest earning assets.  This increase in net interest income was achieved in spite of the cost of carrying nonperforming assets with an average balance of $60.5 million whose annualized impact on our net interest margin is approximately nine basis points.

Our net interest margin has been impacted and will continue to be impacted in the near term by actions taken by the Federal Reserve Board with respect to interest rates and by competition in our markets.  During the first quarter of 2010, the Federal Reserve maintained the Federal Funds rate at the all time low of between zero and 25 basis points since December 2008.  The average prime rate for the first quarter of 2010 and 2009 remained at 3.25% at which it was since December 2008.  During the first half of 2008, we began to incorporate interest rate floors on most of our floating rate loans upon renewal.  We have continued this practice throughout 2009 and 2010 such that most of our floating rate loan portfolio now has interest rate floors.  Additionally, we have reinforced loan pricing discipline so we are adequately compensated for the risk of each loan.  These practices have resulted in a five basis point improvement in the average loan yield during the first quarter 2010 compared with the same period in 2009.  The average yield on interest-earning assets in the first quarter of 2010 decreased 8 basis points to 5.41% compared to the first quarter 2009 due to the decline in yields for investment securities and the shift in mix from loans to lower yielding securities.  The lower interest rate environment has also impacted our funding costs.  Deposits, such as money market and NOW accounts, are repriced at the discretion of management while time deposits can only be repriced as they mature.  Our cost of average interest bearing liabilities for the first quarter of 2010 decreased 57 basis points to 2.15% compared to the first quarter of 2009.  For the first quarter 2010, our net interest margin of 3.41% increased 40 basis points from 3.01% for the first quarter of 2009.  While the interest rate environment has been constant throughout 2010 in the prime rate and federal funds sold, market interest rates such as LIBOR have drifted lower in first quarter 2009 and moved slightly higher during the first quarter of 2010.  This has strengthened the Company’s net interest margin through the improvement in our cost of funds via continued downward repricing of time deposits and borrowings at current market rates.  During the past three quarters, we have seen more rational deposit pricing in our local markets in contrast with the first half of 2009 when some larger banks sought needed liquidity with above market, long term retail certificate offerings.

 
- 6 -

 

Average Yield/Cost Analysis

The following table contains information relating to the Company’s average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated.  Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.  The average loan portfolio balances include nonaccrual loans.

   
Three Months Ended March 31, 2010
   
Three Months Ended March 31, 2009
 
   
(Amounts in thousands)
 
   
Average
balance
   
Interest
earned/paid
   
Average
yield/cost
   
Average
balance
   
Interest
earned/paid
   
Average
yield/cost
 
Interest-earning assets:
                                   
Loans
  $ 1,222,594     $ 17,668       5.86 %   $ 1,310,679     $ 18,762       5.81 %
Investment securities available for sale
    310,150       3,192       4.17 %     315,765       3,642       4.68 %
Investment securities held to maturity
    10,655       122       4.64 %     27,864       332       4.83 %
Federal funds sold
    29,848       4       0.05 %     24,985       8       0.13 %
                                                 
Total interest earning assets
    1,573,247       20,986       5.41 %     1,679,293       22,744       5.49 %
Other assets
    130,943                       105,781                  
Total assets
  $ 1,704,190                     $ 1,785,074                  
                                                 
Interest-bearing liabilities:
                                               
Deposits:
                                               
NOW, Money Market, and Savings
  $ 594,152     $ 1,784       1.22 %   $ 469,447     $ 1,628       1.41 %
Time deposits greater than $100K
    177,408       622       1.42 %     181,416       1,425       3.19 %
Other time deposits
    410,898       2,756       2.72 %     519,969       4,251       3.32 %
Short-term borrowings
    78,102       388       2.01 %     101,425       565       2.26 %
Long-term borrowings
    199,076       2,189       4.46 %     263,699       2,416       3.72 %
                                                 
Total interest bearing liabilities
    1,459,636       7,739       2.15 %     1,535,956       10,285       2.72 %
                                                 
Demand deposits
    113,991                       101,747                  
Other liabilities
    8,619                       9,360                  
Stockholders' equity
    121,944                       138,011                  
                                                 
Total liabilities and stockholders' equity
  $ 1,704,190                     $ 1,785,074                  
                                                 
Net interest income and net interest spread
          $ 13,247       3.26 %           $ 12,459       2.78 %
Net interest margin
                    3.41 %                     3.01 %
Ratio of average interest-earning assets to average interest-bearing liabilities
    107.78 %                     109.33 %                

 
- 7 -

 

Provision for Loan Losses .   The Company recorded a $10.0 million provision for loan losses for the quarter ended March 31, 2010, representing an increase of $6.0 million from the $4.0 million provision for the first quarter of 2009.  The level of provision for the quarter is reflective of the trends in the loan portfolio, including levels of nonperforming loans and other loan portfolio quality measures, and analyses of impaired loans as well as the level of net charge-offs during the period.  The substantial increase in the provision for the first quarter of 2010 compared with the provision for loan losses for first quarter 2009 was based on certain loans identified as impaired and other specific loans currently identified with a greater than normal risk based on the current economic conditions.  Additional amounts are also required to properly recognize the loss potential inherent in riskier segments of the loan portfolio, particularly the residential construction and development loan segment based on the historic loss experience of each loan segment.  Nonperforming loans as a percentage of total loans increased to 4.19% at March 31, 2010 compared with 1.56% at March 31, 2009.  Provisions for loan losses are charged to income to bring our allowance for loan losses to a level deemed appropriate by management based on the factors discussed under “Asset Quality.”  On an annualized basis, our percentage of net loan charge-offs to average loans outstanding was 1.20% for the quarter ended March 31, 2010, compared with 1.09% for the quarter ended March 31, 2009.

Non-Interest Income.   For the three months ended March 31, 2010, non-interest income increased $1.4 million, or 52.8%, to $4.0 million from $2.6 million for the same period in 2009 primarily resulting from a $1.4 million increase in gains on sale of investment securities as part of ongoing portfolio management.  Service charges increased $113 thousand compared to the 2009 quarter as debit card income increased $86 thousand, other service charges increased $60 thousand and NSF charges decreased $33 thousand from decreased overdraft volume.  Mortgage banking income decreased $58 thousand or 13.9% from decreased customer transaction volume including refinance activity.  The Company recognized $176 thousand income from its investment in Small Business Investment Company (SBIC) during the first quarter 2010 compared to $238 thousand in the same period of the prior year.  The income generated during the quarter was from normal operations as no individual investments were harvested or written off during this quarter.  Investment brokerage income decreased $61 thousand compared to the first quarter of 2009 based on lower transaction volume.  During the first quarter of 2010, an “other-than-temporary” impairment charge of $186 thousand was recognized on one equity investment while the write-off of our equity position in the failed Silverton Bank totaling $404 thousand was recognized during the first quarter of 2009.

Non-Interest Expense .   For the three months ended March 31, 2010, our non-interest expense decreased $48.7 million, or 80.5%, over the same period in 2009 primarily due to recognizing a $49.5 million goodwill impairment charge in first quarter 2009.  Excluding goodwill, our non-interest expense increased $766 thousand or 6.9% compared to the first quarter of 2009.  The Company’s FDIC deposit insurance premium increased $304 thousand as the FDIC increased the ongoing deposit insurance premium rates to maintain adequate balances in the Deposit Insurance Fund to protect depositors during this time of unusually high number of bank failures.  Management decreased discretionary spending as advertising and promotion expense decreased $156 thousand and travel and entertainment decreased $33 thousand.  Foreclosed asset write-downs were $484 thousand during the first quarter of 2010 with the continued devaluation of properties held; this compared to none in the first quarter of 2009.  OREO expenses were $360 thousand for the current quarter compared to $214 thousand in the first quarter last year due to the $9.5 million increase in the balances of foreclosed assets, the increased cost of acquiring, holding and maintaining foreclosed properties.  The Company started a new program during 2009 to help builders sell their bank-financed inventory of houses that had been on the market for 12 months or more.  The cost for this program totaled $173 thousand to incent home buyers to purchase 17 homes during the first quarter of 2010 compared to $100 thousand in the first quarter of 2009.  While this program has been successful in encouraging sales of slow moving houses since inception, it is expected to be discontinued after the second quarter of 2010.  These increased expenses were offset by gains on sales of OREO property which increased $94 thousand year over year.  Salaries and employee benefits decreased $61 thousand year over year as total employee benefits decreased $147 thousand primarily due to a reduction in the Company’s 401(k) match.  The employer 401(k) match was decreased during the third quarter of 2009 from a 100% match on the first 6% of employee compensation contributed to 50%.  This employee benefit cost reduction was partially offset by a net increase in salary expense of $97 thousand.  The movement in salary expense was impacted by a reduction in staffing amounting to 20 full-time equivalents and the imposition of a Company-wide salary freeze effective August 1, 2009.  Occupancy and equipment expense decreased $118 thousand compared to the first quarter of 2009 due to decreases in software depreciation and maintenance.

 
- 8 -

 

Provision for Income Taxes .   The Company recorded an income tax benefit of $32 thousand for the quarter ending March 31, 2010 compared to income tax benefit of $214 thousand for first quarter 2009.  The unusually low effective tax rate, especially for first quarter 2010, is reflective of the impact of tax exempt interest income and income from bank owned life insurance for both years and a $2.0 million valuation allowance increase related to the ability of the Company to realize its net deferred tax assets.  The non-deductible goodwill impairment charge was the most significant factor for the unusually low rate for 2009.  A $2.0 million valuation allowance related to the deferred tax asset for the allowance for loan losses was also recognized in the fourth quarter of 2009 resulting in a total valuation allowance of $4.0 million at March 31, 2010.

Liquidity and Capital Resources

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity.  This confidence is significantly dependent on our ability to maintain sound asset quality and sufficient levels of capital resources to generate appropriate earnings and to maintain a consistent dividend policy.

Liquidity is defined as our ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis.  Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of funds and demands for funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities, unpledged investments available for sale, loan repayments, loan sales, deposits, and borrowings from the Federal Home Loan Bank, the Federal Reserve and from correspondent banks under overnight federal funds credit lines.  In addition to deposit and borrowing withdrawals and maturities, the Company’s primary demand for liquidity is anticipated funding under credit commitments to customers.

We believe our liquidity is adequate to fund expected loan demand and current deposit and borrowing maturities.  Investment securities totaled $335.5 million at March 31, 2010, an increase of $11.8 million from $323.7 million at December 31, 2009.  Government agencies increased $38.0 million and mortgage backed securities decreased $28.5 million during this three month period, while municipal securities increased $1.6 million.  Supplementing customer deposits as a source of funding, we have available lines of credit from various correspondent banks to purchase federal funds on a short-term basis of approximately $107.0 million.  We also have the credit capacity from the Federal Home Loan Bank of Atlanta (FHLB) to borrow up to $425.7 million, as of March 31, 2010, with lendable collateral value of $326.8 million.  Borrowings with the FHLB were $104.4 million at March 31, 2010.  At March 31, 2010, we had funding of $80.0 million in the form of term repurchase agreements with maturities from two to eight years under repurchase lines of credit aggregating $100.0 million from various institutions.  The repurchases must be adequately collateralized.  We also had short-term repurchase agreements with total outstanding balances of $14.5 million and $14.9 million at March 31, 2010 and December 31, 2009, respectively, $4.5 million of which were done as accommodations for our deposit customers.  Securities sold under agreements to repurchase generally mature within ninety days from the transaction date and are collateralized by U.S. government agency obligations.  At March 31, 2010, our outstanding commitments to extend credit consisted of loan commitments of $163.7 million and amounts available under home equity credit lines, other credit lines and letters of credit of $99.0 million, $12.4 million and $9.4 million, respectively.  Given the amount of our unpledged collateral of $107.1 million, we believe that our combined aggregate liquidity position from all sources is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

Historically, we have relied heavily on certificates of deposits as a source of funds.  While the majority of these funds are from our local market area, the Bank has utilized brokered and out-of-market certificates of deposits to diversify and supplement our deposit base.  In recent years, the Bank has emphasized initiatives to increase lower cost transaction accounts and other core deposit accounts to improve our funding mix.  Time deposits of $573.2 million at March 31, 2010 decreased $43.4 million, or 7.0%, compared to December 31, 2009.  Certificates of deposits represented 43.9% of our total deposits at March 31, 2010, a decrease from 46.9% at December 31, 2009.  Deposit growth shifted from time deposits to money market, savings and NOW accounts in the first quarter of 2010 with growth of $36.3 million, or 5.2%.  Savings grew $18.8 million during the quarter from the introduction of our new Ready Saver account which is available only on the internet.

 
- 9 -

 

Under the United States Treasury’s Capital Purchase Program (CPP), the Company issued $42.75 million in Cumulative Perpetual Preferred Stock, Series A, on December 5, 2008.  In addition, the Company provided warrants to the Treasury to purchase 1,623,418 shares of the Company’s common stock at an exercise price of $3.95 per share.  These warrants are immediately exercisable and expire ten years from the date of issuance.  The preferred stock is non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years and 9% per annum thereafter.  The preferred shares are redeemable at the option of the Company subject to regulatory approval.

As a condition of the CPP, the Company must obtain consent from the United States Department of the Treasury to repurchase its common stock or to increase its cash dividend on its common stock from the September 30, 2008 quarterly level of $0.04 per common share.  The Company has agreed to certain restrictions on executive compensation, including limitations on amounts payable to certain executives under severance arrangements and change in control provisions of employment contracts and clawback provisions in compensation plans, as part of the CPP.  Under the American Recovery and Reinvestment Act of 2009, the Company is limited to using restricted stock as the form of payment to the top five highest compensated executives under any incentive or bonus compensation programs.

At March 31, 2010, our leverage ratio (Tier I capital to average quarterly assets) was 8.86%, and all of our capital ratios exceeded the minimums established for a well-capitalized bank by regulatory measures.  Our Tier I risk-based capital ratio and total risk-based capital ratio at March 31, 2010 were 10.92% and 12.80%, respectively.

Through July 2006, the Company authorized the repurchase up to 1.9 million shares of its common stock.  Through December 5, 2008 (the date of our participation in the Treasury’s Capital Purchase Plan), the Company had repurchased 1,858,073 shares at an average price of $6.99 per share under the three plans.  During the first quarter in 2010, there were no repurchases.  Under the provisions of the Treasury’s Capital Purchase Program, the Company may not repurchase any of its common stock without the consent of the Treasury as long as the Treasury invests in our preferred stock.

On March 24, 2009, the Company announced that its Board of Directors voted to suspend payment of a quarterly cash dividend to common shareholders.  The Board will continue to evaluate the payment of a quarterly cash dividend on a periodic basis.

Asset Quality

We consider asset quality to be of primary importance.  We employ a formal internal loan review process to ensure adherence to the Lending Policy as approved by the Board of Directors.  It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated.  Credit Administration, through the loan review process, validates the accuracy of the initial and any revised risk grade assessment.  In addition, as a given loan’s credit quality improves or deteriorates, it is the loan officer’s responsibility to change the borrower’s risk grade accordingly.  Our policy in regard to past due loans normally requires a charge-off to the allowance for loan losses within a reasonable period after collection efforts and a thorough review have been completed.  Further collection efforts are then pursued through various means including legal remedies.  Loans carried in a nonaccrual status and probable losses are considered in the determination of the allowance for loan losses.

Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis.  We account for loans on a nonaccrual basis when we have serious doubts about the collectability of principal or interest.  Generally, our policy is to place a loan on nonaccrual status when the loan becomes past due 90 days.  We also place loans on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement.  At March 31, 2010 and December 31, 2009, our nonaccrual loans included $12.0 million and $10.0 million, respectively, of loans past due less than 90 days.  Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected.  If a borrower brings their loan current, our policy is to keep this loan in a nonaccrual status until this loan has remained current for six months.  Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition.  We record interest on restructured loans at the restructured rates, as collected, when we anticipate that no loss of original principal will occur.  Management also considers potential problem loans in the evaluation of the adequacy of the Bank’s allowance for loan losses.  Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans as shown above, but about which we have doubts as to the borrower’s ability to comply with present repayment terms.  Because these loans are at a heightened risk of becoming past due, reaching nonaccrual status or being restructured, they are being monitored closely.

 
- 10 -

 

Nonperforming loans increased to $50.6 million or 4.19% of total loans at March 31, 2010, compared to $37.7 million or 3.07% of loans at December 31, 2009.  Approximately 62% of these nonperforming loans at March 31, 2010 were related to construction and development lending.  Of the $12.9 million increase in nonperforming loans on a linked quarter basis, $10.3 million, or 80% of the increase, was related to construction and development lending.  In addition to the financial strength of each borrower and cash flow characteristics of each project, the repayment of construction and development loans are particularly dependent on the value of the real estate collateral.  Repayment of such loans is generally considered subject to greater credit risk than residential mortgage loans.  Regardless of the underwriting criteria the Company utilizes, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of the real estate collateral and problems affecting the credit of our borrowers.  Due to the above mentioned factors, we consider certain segments of our residential construction and development loan portfolio to represent higher risk loans.  These higher risk loans are speculative construction loans and land acquisition and development loans, including lot inventory loans.

In the tables and discussion below, the credit metrics for the current quarter and their sequential changes are illustrated: 1) significant increase in nonperforming loans related to construction development lending; 2) significant increase in classified assets; and 3) increase in loan delinquencies.  While the impairment of two loan relationships had a significant impact on these credit metrics, the continued deterioration of the construction and development portfolio has also had a significant impact.  (See further discussion on potential problem loans below).

The following table sets forth a breakdown of nonperforming loans and foreclosed assets as of March 31, 2010, by nature of the property.

   
March 31,
   
December 31,
 
Nonperforming loans
 
2010
   
2009
 
   
(Amounts in thousands)
 
Residential Construction:
           
Speculative construction
  $ 9,049     $ 4,210  
Land acquisition and development
    17,462       11,997  
Total residential construction
    26,511       16,207  
Commercial real estate
    18,671       16,344  
Commercial and industrial
    4,177       3,432  
Consumer
    1,249       1,749  
Total nonperforming loans
  $ 46,431     $ 37,732  

   
March 31,
   
December 31,
 
Foreclosed assets
 
2010
   
2009
 
   
(Amounts in thousands)
 
Residential construction, land development and other land
  $ 12,679     $ 11,101  
Commercial construction
    2,142       2,206  
1 - 4 family residential properties
    3,330       4,272  
Nonfarm nonresidential properties
    1,749       1,670  
Multi family properties
    160       160  
Equipment
    225       225  
Total foreclosed assets
  $ 20,285     $ 19,634  

 
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The following table illustrates the quarterly trends in the outstanding balances of these higher risk loan segments.

   
March 31,
   
December 31,
   
September 30,
   
June 30,
   
March 31,
 
   
2010
   
2009
   
2009
   
2009
   
2009
 
   
(Amounts in millions)
 
Residential construction:
                             
Speculative Residential Construction
  $ 53.0     $ 53.3     $ 64.5     $ 75.1     $ 87.7  
Land Acquisition and Development
    56.2       58.3       62.3       62.3       66.5  
Lot Inventory
    28.0       29.5       32.0       32.3       33.5  
Total
  $ 137.2     $ 141.1     $ 158.8     $ 169.7     $ 187.7  

Furthermore, we monitor certain performance and credit metrics related to these higher risk loan segments, including the aging of the underlying loans in these segments.  As of March 31, 2010, speculative construction loans on our books more than twelve months amounted to $31.7 million or 59.8% of the total speculative residential construction loan portfolio.  Land acquisition and development loans on our books for more than twenty-four months at March 31, 2010 amounted to $48.3 million or 85.9% of that portfolio segment.

We also monitor credit risk migration and delinquency trends in the ongoing evaluation and assessment of credit risk exposure in the overall loan portfolio.  The following table presents quarterly trends in loan delinquencies, nonaccrual loans and in loans classified substandard or doubtful.

   
March 31,
   
December 31,
   
September 30,
   
June 30,
   
March 31,
 
   
2010
   
2009
   
2009
   
2009
   
2009
 
   
(Amounts in millions)
 
   
$
   
% of
Total
Loans
   
$
   
% of
Total
Loans
   
$
   
% of
Total
Loans
   
$
   
% of
Total
Loans
   
$
   
% of
Total
Loans
 
Loans classified substandard or doubtful
  $ 137.3       11.36 %   $ 83.6       6.80 %   $ 60.8       4.87 %   $ 56.7       4.53 %   $ 41.4       3.19 %
                                                                                 
Loans delinquencies 30 days or more past due
  $ 37.3       3.09 %   $ 29.7       2.42 %   $ 25.8       2.07 %   $ 24.0       1.92 %   $ 32.9       2.54 %
                                                                                 
Nonperforming Loans
  $ 50.6       4.19 %   $ 37.7       3.07 %   $ 22.7       1.82 %   $ 17.9       1.43 %   $ 20.3       1.56 %

The $53.7 million, or 64%, increase in classified loans from December 31, 2009 to March 31, 2010, was due to the impact of two loan relationships totaling $15.0 million combined with a significant downgrading of credit risk grades resulting from our regular quarterly review of watch and criticized loans.  Total loan delinquencies (including nonaccrual loans) increased by $7.6 million from December 31, 2009 to March 31, 2010; while the 30 to 89 day delinquencies increased $10.4 million during the same period.

The following is a summary of nonperforming assets at the periods presented:

   
March 31,
   
December 31,
   
March 31,
 
   
2010
   
2009
   
2009
 
   
(Amounts in thousands)
 
                   
Nonaccrual loans
  $ 45,249     $ 35,535     $ 20,251  
Restructured loans - nonaccruing
    4,341       2,197       -  
Restructured loans - accruing
    1,018       -       -  
Total nonperforming loans
    50,608       37,732       20,251  
                         
Foreclosed assets
    20,285       19,634       10,798  
                         
Total nonperforming assets
  $ 70,893     $ 57,366     $ 31,049  

 
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The largest nonaccrual balance of any one borrower at March 31, 2010 was $6.9 million, with the average balance for the one hundred fifty-two nonaccrual loans being $329 thousand.  At December 31, 2009, the largest nonaccrual balance of any one borrower was $7.0 million, with the average balance for the one hundred twenty-eight nonaccrual loans being $295 thousand.

In addition to nonperforming loans, there were loans totaling $87.7 million at March 31, 2010, for which management has concerns regarding the ability of the borrowers to meet existing repayment terms.  While we have seen some increased credit deterioration in the commercial real estate portfolio, the largest increase in potential problem loans remain related to residential construction and development lending.  Potential problem loans are primarily classified as substandard for regulatory purposes and reflect the distinct possibility, but not the probability, that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement.  Although these loans have been identified as potential problem loans, they may never become delinquent, nonperforming or impaired.  Additionally, these loans are generally secured by residential real estate or other assets, thus reducing, to some extent given current real estate market trends, the potential for loss should they become nonperforming.  Potential problem loans are considered in the determination of the adequacy of the allowance for loan losses.

Foreclosed assets consist of real estate acquired through foreclosure and repossessed assets.  At March 31, 2010, foreclosed assets totaled $20.3 million, or 1.19% of total assets, and consisted of seventy-three properties compared to $19.6 million, or 1.14% of total assets, and seventy-one properties at December 31, 2009.  The largest dollar value of a foreclosed property was $2.9 million at March 31, 2010 and December 31, 2009.  We recorded write-downs in the value of foreclosed assets of $484 thousand during the first quarter of 2010 and $1.6 million during the fourth quarter of 2009.  We have reviewed recent appraisals of these properties and believe that the fair values, less estimated costs to sell, equal or exceed their carrying value.

Our allowance for loan losses (“ALLL”) is established through charges to earnings in the form of a provision for loan losses.  We increase our allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off and we reduce our allowance by loans charged off.  In evaluating the adequacy of the allowance, we consider the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, trends in past dues and classified assets, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors derived from our history of operations.  The methodology and assumptions used to determine the allowance are continually reviewed as to their appropriateness given the most recent losses realized and other factors that influence the estimation process.  The model assumptions and resulting allowance level are adjusted accordingly as these factors change.

The Bank’s format for the calculation of ALLL begins with the evaluation of individual loans considered impaired.  For the purpose of evaluating loans for impairment, loans are considered impaired when it is considered probable that all amounts due under the contractual terms of the loan will not be collected when due (minor shortfalls in amount or timing excepted).  The Bank has established policies and procedures for identifying loans that should be considered for impairment.  Loans are reviewed through multiple means such as delinquency management, credit risk reviews, watch and criticized loan monitoring meetings and general account management.  Loans that are outside of the Bank’s established criteria for evaluation may be considered for impairment testing when management deems the risk sufficient to warrant this approach.  For loans determined to be impaired, the specific allowance is based on the most appropriate of the three measurement methods: present value of expected future cash flows, fair value of collateral, or the observable market price of a loan method.  While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations.  Once a loan is considered individually impaired, it is not included in other troubled loan analysis, even if no specific allowance is considered necessary.  See Note 4 to the Financial Statements for further discussion.

 
- 13 -

 

The Bank also utilizes various other factors to further evaluate the portfolio for risk to determine the appropriate level of allowance to provide for probable losses in the loan portfolio.  During the third quarter of 2009, we made some enhancements to our methodology for the calculation of ALLL in regards to loans that are not evaluated individually.  The major change was to apply loss factors based on the credit risk grading of these loans segmented by major loan types of residential construction and development, commercial real estate, consumer and other loans.  These loss factors were based on an appropriate loss history for each major loan type adjusted by credit grade migration factors and other risk factors.  While similar to other risk factors related to economic and portfolio trends used in prior quarters, we focused on risk factors pertinent to the underlying risks in each major loan type such as changes in sales activity and pricing for sales of newly constructed homes for residential construction and changes in vacancy levels and collateral value for commercial real estate.  These enhancements place a greater emphasis on the credit risk grading of the loan portfolio and allow us to focus on the relative risk and the pertinent factors for the major loan segments of the Company.

Management is continuing to closely monitor the value of real estate serving as collateral for our loans, especially lots and land under development, due to continued concern that the low level of real estate sales activity will continue to have a negative impact on the value of real estate collateral.  In addition, depressed market conditions have adversely impacted, and may continue to adversely impact, the financial condition and liquidity position of certain of our borrowers.  Additionally, the value of commercial real estate collateral may come under further pressure from weak economic conditions and prevailing unemployment levels.

Throughout our history, growth in loans outstanding has been the primary reason for increases in our allowance for loan losses and the resultant provisions for loan losses.  Although at the end of the last four quarters loans outstanding have decreased, the allowance for loan losses has continued to increase due to increased nonperforming loans and increasing levels of net charge-offs.  The provision for loan losses increased to $10.0 million for the first quarter of 2010 as compared to $4.0 million for the same period last year due principally to an increase in nonperforming loans.  The allowance for loan losses at March 31, 2010 was $36.0 million and represented 2.98% of total loans which increased from 2.41% from year end and provided coverage of 71% of nonperforming loans.  This level of allowance has increased a net of $6.4 million from $29.6 million, or 2.41% of total loans at December 31, 2009, which provided coverage for 79% on nonperforming loans.  At March 31, 2009, the allowance was $19.4 million, which represented 1.49% of total loans and coverage of 0.95% of nonperforming loans.  As a percentage of loans outstanding, the allowance increased both sequentially and year-over-year as a result of increased nonperforming loans and is based on the model described above.  We believe that the Company’s allowance is adequate to absorb probable future losses inherent in our loan portfolio.  No assurance can be given, however, that adverse economic circumstances or other events, including additional and continued loan review, future regulatory examination findings or changes in borrowers’ financial conditions, will not result in increased losses in the loan portfolio or in the need for increases in the allowance for loan losses.

 
- 14 -

 

Item 1 - Financial Statements

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)


   
March 31,
   
December 31,
 
   
2010
   
2009 *
 
             
   
(Amounts in thousands, except share data)
 
Assets
           
Cash and due from banks
  $ 33,885     $ 30,184  
Federal funds sold
    22,352       31,269  
Investment securities
               
Available for sale, at fair value
    325,311       312,780  
Held to maturity, at amortized cost
    10,207       10,919  
Federal Home Loan Bank stock
    9,794       9,794  
                 
Loans held for sale
    2,984       3,025  
                 
Loans
    1,208,454       1,230,275  
Allowance for loan losses
    (36,007 )     (29,638 )
Net Loans
    1,172,447       1,200,637  
                 
Premises and equipment, net
    42,058       42,630  
Foreclosed assets
    20,285       19,634  
Other assets
    67,857       67,736  
                 
Total Assets
  $ 1,707,180     $ 1,728,608  
Liabilities and Stockholders’ Equity
               
Deposits
               
Non-interest bearing demand
  $ 113,292     $ 118,372  
Money market, NOW and savings
    620,433       579,027  
Time
    573,229       616,671  
Total Deposits
    1,306,954       1,314,070  
                 
Short-term borrowings
    76,769       85,477  
Long-term borrowings
    199,062       199,103  
Other liabilities
    7,513       7,961  
                 
Total Liabilities
    1,590,298       1,606,611  
                 
Stockholders’ Equity
               
Senior cumulative preferred stock (Series A), no par value, 1,000,000 shares authorized; 42,750 shares issued and outstanding  at March 31, 2010 and December 31, 2009
    41,158       41,060  
Common stock, no par value, 30,000,000 shares authorized; issued and outstanding 16,818,125 shares at March 31, 2010 and 16,787,675 shares at December 31, 2009
    119,320       119,282  
Retained earnings (accumulated deficit)
    (46,674 )     (41,430 )
Accumulated other comprehensive income
    3,078       3,085  
Total Stockholders’ Equity
    116,882       121,997  
                 
Commitments and contingencies
               
                 
Total Liabilities and Stockholders' Equity
  $ 1,707,180     $ 1,728,608  
* Derived from audited consolidated financial statements

See accompanying notes.

 
- 15 -

 

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
   
(Amounts in thousands, except per
 
   
share and share data)
 
Interest Income
           
Loans
  $ 17,668     $ 18,762  
Investment securities available for sale
    3,192       3,642  
Investment securities held to maturity
    122       332  
Federal funds sold
    4       8  
                 
Total Interest Income
    20,986       22,744  
Interest Expense
               
Money market, NOW and savings deposits
    1,784       1,628  
Time deposits
    3,378       5,676  
Borrowings
    2,577       2,981  
                 
Total Interest Expense
    7,739       10,285  
                 
Net Interest Income
    13,247       12,459  
                 
Provision for Loan Losses
    10,000       4,000  
                 
Net Interest Income After Provision for Loan Losses
    3,247       8,459  
                 
Non-Interest Income
               
Service charges and fees on deposit accounts
    1,557       1,444  
Income from mortgage banking activities
    358       416  
Investment brokerage and trust fees
    235       296  
Net impairment loss recognized in earnings
    (186 )     (404 )
Other
    1,989       835  
Total non-interest income
    3,953       2,587  
                 
Non-Interest Expense
               
Salaries and employee benefits
    5,469       5,530  
Occupancy and equipment
    1,916       2,034  
Goodwill impairment
    -       49,501  
Other
    4,458       3,519  
                 
Total Non-Interest Expense
    11,843       60,584  
                 
Income (Loss) Before Income Taxes
    (4,643 )     (49,538 )
                 
Income Tax (Benefit) Expense
    (32 )     (214 )
                 
Net Income (Loss)
    (4,611 )     (49,324 )
                 
Effective Dividend on Preferred Stock
    633       627  
                 
Net Income (Loss) Available to Common Shareholders
  $ (5,244 )   $ (49,951 )
                 
Net Income (Loss) Per Common Share
               
Basic
  $ (0.31 )   $ (2.98 )
Diluted
    (0.31 )     (2.98 )
                 
Weighted Average Common Shares Outstanding
               
Basic
    16,806,292       16,780,058  
Diluted
    16,806,292       16,780,058  

See accompanying notes.

 
- 16 -

 

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
             
   
(Amounts in thousands)
 
             
Net income (loss)
  $ (4,611 )   $ (49,324 )
                 
Other comprehensive income (loss):
               
Securities available for sale:
               
Unrealized holding gains (loss) on available for sale securities
    1,400       1,489  
Tax effect
    (540 )     (573 )
Reclassification of gains recognized in net income
    (1,354 )     (1 )
Tax effect
    523       -  
Reclassification of impairment on equity securities
    186       404  
Tax effect
    (72 )     (156 )
Net of tax amount
    143       1,163  
Cash flow hedging activities:
               
Unrealized holding gains (losses) on cash flow hedging activities
    (319 )     257  
Tax effect
    123       (99 )
Reclassification of gains (losses) recognized in net income (loss), net:
               
Reclassified into income
    75       (166 )
Tax effect
    (29 )     -  
Acquisition premium on interest rate cap contract, net of amortization
    -       (405 )
Tax effect
    -       156  
Net of tax amount
    (150 )     (257 )
                 
Total other comprehensive income (loss)
    (7 )     906  
                 
Comprehensive income (loss)
  $ (4,618 )   $ (48,418 )

See accompanying notes.

 
- 17 -

 

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

   
Preferred Stock
   
Common Stock
   
Retained
Earnings
   
Accumulated
Other
   
Total
 
   
Shares
   
Amount
   
Shares
   
Amount
   
(accumulated
deficit)
   
Comprehensive
Income (loss)
   
Stockholders'
Equity
 
               
(Amounts in thousands, except share data)
 
                                           
Balance at December 31, 2009
    42,750     $ 41,060       16,787,675     $ 119,282     $ (41,430 )   $ 3,085     $ 121,997  
Net income (loss)
    -       -       -       -       (4,611 )     -       (4,611 )
Other comprehensive income, net of tax
    -       -       -       -       -       (7 )     (7 )
Restricted stock issued
    -       -       30,450       -       -       -       -  
Stock-based compensation
    -       -       -       38       -       -       38  
Preferred stock dividend
    -       -       -       -       (535 )     -       (535 )
Preferred stock accretion of discount
    -       98       -       -       (98 )     -       -  
                                                         
Balance at March 31, 2010
    42,750     $ 41,158       16,818,125     $ 119,320     $ (46,674 )   $ 3,078     $ 116,882  

See accompanying notes.

 
- 18 -

 

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
   
(Amounts in thousands)
 
Cash Flows from Operating Activities
           
Net loss
  $ (4,611 )   $ (49,324 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    1,029       907  
Provision for loan losses
    10,000       4,000  
Net proceeds from sales of loans held for sale
    36,048       28,507  
Originations of loans held for sale
    (35,649 )     (33,819 )
Gain from mortgage banking
    (358 )     (416 )
Stock-based compensation
    38       43  
Net increase in cash surrender value of life insurance
    (265 )     (340 )
Realized gain on sale of available for sale securities, net
    (1,354 )     (1 )
Realized loss on impairment of investment securities available for sale
    186       -  
Realized loss of equity investment in Silverton Bank
    -       404  
Realized loss on sale of premises and equipment
    -       1  
Realized gain on sale of loans
    -       (1 )
Gain (loss) on economic hedges
    (31 )     22  
Deferred income taxes
    (89 )     (743 )
Realized gain on sale of foreclosed assets
    (100 )     (6 )
Oreo writedown
    484       -  
Goodwill impairment
    -       49,501  
Changes in assets and liabilities:
               
Increase in other assets
    (60 )     (1,247 )
Decrease in other liabilities
    (417 )     (1,080 )
Total Adjustments
    9,462       45,732  
                 
Net Cash Provided by (Used in) Operating Activities
    4,851       (3,592 )
                 
Cash Flows from Investing Activities
               
Increase (decrease) in federal funds sold
    8,917       (15,711 )
Purchase of:
               
Available-for-sale investment securities
    (85,984 )     (71,530 )
Proceeds from maturities and calls of:
               
Available-for-sale investment securities
    21,015       29,697  
Held-to-maturity investment securities
    715       10,265  
Proceeds from sale of:
               
Available-for-sale investment securities
    53,677       11,897  
Purchase of Federal Home Loan Bank stock
    -       (421 )
Net (increase) decrease in loans
    14,651       7,158  
OREO capitalized cost
    (16 )     (172 )
Purchases of premises and equipment
    (245 )     (1,423 )
Proceeds from sale of foreclosed assets
    2,520       1,753  
                 
Net Cash Provided by (Used in) Investing Activities
    15,250       (28,487 )
                 
Cash Flows from Financing Activities
               
Net increase in transaction accounts and savings accounts
    36,326       595  
Net increase (decrease) in time deposits
    (43,442 )     94,436  
Net decrease in short-term borrowings
    (8,708 )     (43,772 )
Repayment of long-term borrowings
    (41 )     (15,041 )
Preferred dividends paid
    (535 )     (415 )
Cash dividends paid
    -       (671 )
                 
Net Cash Provided by (Used in) Financing Activities
    (16,400 )     35,132  
                 
Net Increase in Cash and Due From Banks
    3,701       3,053  
Cash and Due From Banks, Beginning of Period
    30,184       25,215  
                 
Cash and Due From Banks, End of Period
  $ 33,885     $ 28,268  
                 
Supplemental Cash Flow Information:
               
Transfer of loans to foreclosed assets
  $ 3,539     $ 6,628  

See accompanying notes.

 
- 19 -

 

Southern Community Financial Corporation
Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Basis of Presentation

The consolidated financial statements include the accounts of Southern Community Financial Corporation (the “Company”), and its wholly-owned subsidiary, Southern Community Bank and Trust (the “Bank”).  All intercompany transactions and balances have been eliminated in consolidation.  In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three-month period ended March 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.

The preparation of the consolidated financial statements and accompanying notes requires management of the Company to make estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period.  Actual results could differ significantly from those estimates and assumptions.  Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.  To a lesser extent, significant estimates are also associated with the valuation of securities, intangibles and derivative instruments, determination of stock-based compensation and income tax assets or liabilities, and accounting for acquisitions.  Operating results for the three-month period ended March 31, 2010 is not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.

The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2009 annual report on Form 10-K.  This quarterly report should be read in conjunction with the annual report.

Recently issued accounting pronouncements

The Company has adopted new disclosures about derivative and hedging activities, including the underlying derivative instruments.  These disclosures include a description of the objectives including how and why derivative instruments are used.  Other disclosures include how derivative instruments and related hedged items are accounted for and how derivatives and related hedged items affect an entity’s financial position, financial performance and cash flows.  Cross-referencing is provided within the footnotes to improve the reader’s ability to locate information about derivative instruments.  For additional information, see Note 10 (Derivatives) to Financial Statements.

The Company has adopted ASC Topic 860, Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140 .  Topic 860 improves all aspects of transfers of financial assets including the transferor’s continuing involvement, if any, in transferred financial assets.  Topic 860 eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets.  This pronouncement was effective after the beginning of fiscal years beginning after November 15, 2009.  The Company does not anticipate that the adoption of this statement will have a material impact on its consolidated financial statements.

The Company has adopted ASC Topic 810, Amendments to FASB Interpretation No. 46(R).  The Company has not invested and does not anticipate investing in any Variable Interest Entities.   This pronouncement was effective after the beginning of fiscal years beginning after November 15, 2009.  The Company does not anticipate that the adoption of this statement will have a material impact on its consolidated financial statements.

 
- 20 -

 

The Company has adopted Accounting Standards Update No. 2010-06, Fair Value Measurements Disclosures, which   requires new disclosures for fair value measurements and clarifies existing disclosures requirements.  Fair value measurements must now be disclosed separately for each class of assets and liabilities based on the nature and risks of the assets and liabilities, their classification in the fair value hierarchy and the level of disaggregated information already required for specific assets and liabilities under other applicable pronouncements.  Disclosure is also required of the amounts of significant transfers between level 1 and level 2 in the fair value hierarchy and the reasons for the transfers.  The entity’s policy regarding the timing of recognizing transfers and specific information such as the actual date of the event or change in circumstances causing the transfer must also be disclosed.  The reconciliation of the beginning and ending balances in level 3 fair value measurements now also requires separate disclosure of gains and losses for the period recognized in other comprehensive income and separate disclosure is now required for purchases, sales, issuances and settlements.  Valuation techniques applied and inputs used to determine observable inputs (level 2) and significant unobservable inputs (level 3) must also be disclosed.  The new disclosure requirements are effective for interim and annual reporting periods beginning after December 15, 2009.  The requirements to disclose separately purchases, sales issuances and settlements in the level 3 reconciliation are effective for fiscal years beginning after December 15, 2010.  The adoption of this pronouncement in the first quarter 2010 did not have a material impact on the consolidated financial statements, other than adding expanded disclosures.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards.  Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards.  Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

Note 2 – Net Income (Loss) Per Common Share

Basic and diluted net income (loss) per common share is computed based on the weighted average number of shares outstanding during each period.  Diluted net income per share reflects the potential dilution that could occur if stock options or warrants were exercised, resulting in the issuance of common stock that then shared in the net income of the Company.

Basic and diluted net income per share have been computed based upon the weighted average number of common shares outstanding or assumed to be outstanding as summarized below.

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
             
Weighted average number of common shares used in computing basic net income per share
    16,806,292       16,780,058  
                 
Effect of dilutive stock options
    -       -  
                 
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share
    16,806,292       16,780,058  
                 
Net income (loss) Available to Common
               
Shareholders (in thousands)
  $ (5,244 )   $ (49,951 )
Basic
    (0.31 )     (2.98 )
Diluted
    (0.31 )     (2.98 )

For the three months ended March 31, 2010 and 2009, net loss for determining net loss per common share was reported as net income (loss) less the dividend on preferred stock.  Options and warrants to purchase shares that have been excluded from the determination of diluted earnings per share because they are antidilutive (the exercise price is higher than the current market price) amount to 661,867 and 731,201 shares for the three months ended March 31, 2010 and 2009, respectively.  Unvested shares of restricted stock and all other common stock equivalents were excluded from the determination of diluted earnings per share for the three months ended March 31, 2010 due to the Company’s loss position for those periods.

 
- 21 -

 

Note 3 – Investment Securities

The following is a summary of the securities portfolio by major classification at the dates presented.

   
March 31, 2010
 
   
Amortized Cost
   
Gross Unrealized
Gains
   
Gross Unrealized
Losses
   
Fair Value
 
   
(Amounts in thousands)
 
                         
Securities available for sale:
                       
U. S. government agencies
  $ 95,163     $ 249     $ 139       95,273  
Mortgage-backed securities
    148,919       4,828       104       153,643  
Municipals
    67,186       1,445       108       68,523  
Trust preferred securities
    4,252       -       1,057       3,195  
Common stocks and mutual funds
    3,232       280       31       3,481  
Other
    1,000       196       -       1,196  
    $ 319,752     $ 6,998     $ 1,439     $ 325,311  
                                 
Securities held to maturity:
                               
U. S. government agencies
  $ 2,500     $ 6     $ -       2,506  
Mortgage-backed securities
    1,104       53       -       1,157  
Municipals
    6,603       158       5       6,756  
    $ 10,207     $ 217     $ 5     $ 10,419  
                                 
   
December 31, 2009
 
   
Amortized Cost
   
Gross Unrealized
Gains
   
Gross Unrealized
Losses
   
Fair Value
 
   
(Amounts in thousands)
 
                                 
Securities available for sale:
                               
U. S. government agencies
  $ 57,441     $ 407     $ 560     $ 57,288  
Mortgage-backed securities
    176,543       5,813       256       182,100  
Municipals
    64,797       1,564       102       66,259  
Trust preferred securities
    4,252       -       1,376       2,876  
Common stocks and mutual funds
    3,418       141       295       3,264  
Other
    1,000       -       7       993  
    $ 307,451     $ 7,925     $ 2,596     $ 312,780  
                                 
Securities held to maturity:
                               
U. S. government agencies
  $ 2,500     $ 35     $ -     $ 2,535  
Mortgage-backed securities
    1,175       44       -       1,219  
Municipals
    7,244       185       3       7,426  
    $ 10,919     $ 264     $ 3     $ 11,180  

Sales of securities available for sale for the three months ended March 31, 2010 produced $53.7 million in proceeds and resulted in gross realized gains of $1.4 million and no realized losses.

 
- 22 -

 

Note 3 – Investment Securities (continued)

The following table shows the gross unrealized losses and fair values for our investments and length of time that the individual securities have been in a continuous unrealized loss position.

   
March 31, 2010
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair Value
   
Unrealized
losses
   
Fair Value
   
Unrealized
losses
   
Fair  Value
   
Unrealized
losses
 
   
(Amounts in thousands)
 
                                     
Securities available for sale:
                                   
U. S. government agencies
  $ 35,059     $ 139     $ -     $ -     $ 35,059     $ 139  
Mortgage-backed securities
    8,718       104       -       -       8,718       104  
Municipals
    9,624       103       109       5       9,733       108  
Trust preferred securities
    2,040       960       1,155       97       3,195       1,057  
Common stocks and mutual funds
    -       -       468       31       468       31  
                                                 
Total temporarily impaired securities
  $ 55,441     $ 1,306     $ 1,732     $ 133     $ 57,173     $ 1,439  
                                                 
Securities held to maturity:
                                               
Municipals
  $ 495     $ 5     $ -     $ -     $ 495     $ 5  
                                                 
   
December 31, 2009
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
   
Fair Value
   
Unrealized
losses
   
Fair Value
   
Unrealized
losses
   
Fair Value
   
Unrealized
losses
 
   
(Amount in thousands)
 
                                                 
Securities available for sale:
                                               
U. S. government agencies
  $ 27,131     $ 560     $ -     $ -     $ 27,131     $ 560  
Mortgage-backed securities
    15,414       256       -       -       15,414       256  
Municipals
    6,881       102       -       -       6,881       102  
Trust preferred securities
    1,770       1,230       1,106       146       2,876       1,376  
Common stocks and mutual funds
    69       198       403       97       472       295  
Other
    993       7       -       -       993       7  
                                                 
Total temporarily impaired securities
  $ 52,258     $ 2,353     $ 1,509     $ 243     $ 53,767     $ 2,596  
                                                 
Securities held to maturity:
                                               
Municipals
  $ 497     $ 3     $ -     $ -     $ 497     $ 3  

In evaluating investment securities for “other-than-temporary impairment” losses, management considers, among other things, (i) the length of time and the extent to which the investment is in an unrealized loss position, (ii) the financial condition and near term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a sufficient period of time to allow for any anticipated recovery of unrealized loss.  At March 31, 2010, there were four investment securities with aggregate fair values of $1.7 million in an unrealized loss position for at least twelve months.  The trust preferred securities had one investment security in an unrealized loss position for less than 12 months due to changes in the level of market interest rates and to the lack of an active market in these securities.  The security has a variable rate based on LIBOR which had declined steadily throughout 2009.  The fair value of this security improved during the first quarter of 2010 although the unrealized loss remained significant.  Based on the nature of these securities, we believe the decline in value to be solely due to changes in interest rates and the general economic
 
- 23 -

  
 Note 3 – Investment Securities (continued)

conditions and not deterioration in their credit quality.  We have the intention and ability to hold these securities for a period of time sufficient to allow for their recovery in value or maturity.  The unrealized losses are reflected in other comprehensive income.  The common stock and mutual funds category had one equity security with an unrealized loss of $31 thousand for more than twelve months at March 31, 2010.  Due to the amount of the loss and the ability of the security to recover its value in the near future the Company did not consider this investment “other-than-temporarily” impaired.  For the three months ended March 31, 2010, the Company determined one marketable equity security was “other-than-temporarily” impaired and recognized a $186 thousand write-down on the investment.  The investment had been carried at a basis of $268 thousand.  The fair value of the investment at March 31, 2010 is $82 thousand.  The Company recorded a loss of $404 thousand in the first quarter of 2009 to write-off its equity investment in Silverton Bank, N.A.

The amortized cost and fair values of securities available for sale and held to maturity at March 31, 2010 by contractual maturity are shown below.  Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligation.

   
March 31, 2010
 
   
Securities Available for Sale
   
Securities Held to Maturity
 
   
Amortized
Cost
   
Fair Value
   
Amortized
Cost
   
Fair Value
 
   
(Amount in thousands)
 
                         
Due within one year
  $ 2,116     $ 2,116     $ 3,375     $ 3,383  
Due after one but through five years
    29,026       29,287       1,440       1,492  
Due after five but through ten years
    46,755       46,765       1,756       1,825  
Due after ten years
    84,452       85,628       2,532       2,562  
Mortgage-backed securities
    148,919       153,643       1,104       1,157  
Trust preferred securities
    4,252       3,195       -       -  
Common stocks and mutual funds
    3,232       3,481       -       -  
Other
    1,000       1,196       -       -  
                                 
    $ 319,752     $ 325,311     $ 10,207     $ 10,419  

Federal Home Loan Bank Stock

As disclosed separately on our statements of financial condition, the Company has an investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock of $9.8 million at March 31, 2010 and December 31, 2009.  The Company carries its investment in FHLB at its cost which is the par value of the stock.  In prior years, member institutions of the FHLB system have been able to redeem shares in excess of their required investment level at par on a voluntary basis daily.  On March 6, 2009, FHLB announced changes in the calculation of member stock requirements (that had the impact of requiring increased member stock ownership) and changes in its policy toward the repurchase of excess stock held by members.  Prior to the announcement the FHLB automatically repurchased excess stock on a daily basis.  Subsequently, the FHLB will evaluate on a quarterly basis whether to repurchase excess capital stock from its members.  The FHLB announced that it will not repurchase excess stock outstanding at March 31, 2010 and will continue to evaluate their decision on a quarterly basis.  These steps were taken as capital preservation measures reflecting a conservative financial management approach in the face of continued volatility in the financial markets and regulatory pressures.  After not paying a cash dividend for the fourth quarter 2008 and first quarter 2009, FHLB paid a cash dividend for the second, third and fourth quarters at an annualized rate of 0.84%, 0.41% and 0.27%, respectively.  At December 31, 2009 (the most recent date available), the FHLB was in compliance with all of its regulatory capital requirements as its total regulatory capital-to-assets ratio was 6.07% exceeding the 4% requirement, and its leverage capital ratio was 9.11%, exceeding its 5.0% requirement.  Management believes that our investment in FHLB stock was not impaired as of March 31, 2010.  There can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of the Company’s investment in FHLB stock.

 
- 24 -

 

Note 4 – Loans

Following is a summary of loans:

   
At   March   31,
   
At   December   31,
 
   
2010
   
2009
 
   
Amount
   
Percent
of   Total
   
Amount
   
Percent
of   Total
 
   
(Amounts in thousands)
 
Residential mortgage loans
  $ 389,760       32.3 %   $ 395,586       32.2 %
Commercial mortgage loans
    449,327       37.2 %     455,268       37.0 %
Construction loans
    174,859       14.5 %     178,239       14.5 %
Commercial and industrial loans
    177,286       14.7 %     183,319       14.9 %
Loans to individuals
    17,222       1.3 %     17,863       1.4 %
                                 
Subtotal
    1,208,454       100.0 %     1,230,275       100.0 %
                                 
Less: Allowance for loan losses
    (36,007 )             (29,638 )        
                                 
Net loans
  $ 1,172,447             $ 1,200,637          

An analysis of the allowance for loan losses is as follows:

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
   
(Amounts in thousands)
 
             
Balance at beginning of period
  $ 29,638     $ 18,851  
                 
Provision for loan losses
    10,000       4,000  
                 
Charge-offs
    (4,017 )     (3,596 )
Recoveries
    386       59  
                 
Net charge-offs
    (3,631 )     (3,537 )
                 
Balance at end of period
  $ 36,007     $ 19,314  

The following is a summary of nonperforming assets at the periods presented:

   
March 31,
   
December 31,
   
March 31,
 
   
2010
   
2009
   
2009
 
   
(Amounts in thousands)
 
                   
Nonaccrual loans
  $ 45,249     $ 35,535     $ 20,251  
Restructured loans - nonaccruing
    4,341       2,197       -  
Restructured loans - accruing
    1,018       -       -  
Total nonperforming loans
    50,608       37,732       20,251  
                         
Foreclosed assets
    20,285       19,634       10,798  
                         
Total nonperforming assets
  $ 70,893     $ 57,366     $ 31,049  

 
- 25 -

 

Note 4 – Loans (continued)

Management estimates the allowance for loan losses required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors.  The allowance consists of several components.  One component is for loans that are individually classified as impaired which may result in a need for specific valuation allowances.  The other components are for collective loan impairment which generates a general valuation allowance.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

At March 31, 2010, the Company had loans with a book value of $51.4 million that have been individually evaluated for impairment.  A corresponding valuation allowance of $18.3 million has been provided for these loans with determined to be impaired an outstanding balance of $42.9 million.  Based upon extensive analyses of the credits, including collateral position, loss exposure, guaranties, or other considerations, no additional specific valuation allowance credits were deemed necessary.

Note 5 – Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.  Goodwill impairment testing is performed annually or more frequently if events or circumstances indicate possible impairment.  An impairment loss is recorded to the extent that the carrying value of goodwill exceeds its implied fair value.

We completed our goodwill impairment testing as of March 31, 2009.  Given the substantial declines in our common stock price, declining operating results, asset quality trends, market comparables and the economic outlook for our industry, the results of impairment testing process indicated that the Company’s estimated fair value was less than book value.  After additional analysis, it was determined that the Company’s fair value did not support the goodwill recorded at the time of the acquisition of The Community Bank in January 2004; therefore, the Company recorded a $49.5 million goodwill impairment charge to write-off the entire amount of goodwill as of March 31, 2009.  This non-cash goodwill impairment charge to earnings was recorded as a component of non-interest expense on the consolidated statement of operations.

Note 6 – Borrowings

The following is a summary of our borrowings at March 31, 2010 and December 31, 2009:

   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(Amounts in thousands)
 
Short-term borrowings
           
FHLB advances
  $ 31,250     $ 31,250  
Repurchase agreements
    14,457       14,861  
Other borrowed funds
    31,062       39,366  
    $ 76,769     $ 85,477  
                 
Long-term borrowings
               
FHLB advances
  $ 73,185     $ 73,226  
Term repurchase agreements
    80,000       80,000  
Jr. subordinated debentures
    45,877       45,877  
    $ 199,062     $ 199,103  

 
- 26 -

 

Note 7 – Non-Interest Income and Other Non-Interest Expense

The major components of other non-interest income are as follows:
   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
   
(Amounts in thousands)
 
Gain on sale of investment securities
    1,354       -  
SBIC income and management fees
    176       238  
Increase in cash surrender value of life insurance
    266       340  
Loss and net cash settlement on economic hedges
    (31 )     (22 )
Other
    224       279  
                 
    $ 1,989     $ 835  

The major components of other non-interest expense are as follows:

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
   
(Amounts in thousands)
 
FDIC deposit insurance
  $ 547     $ 176  
Postage, printing and office supplies
    203       239  
Telephone and communication
    218       229  
Advertising and promotion
    131       287  
Data processing and other outsourced services
    226       186  
Professional services
    657       608  
Buyer incentive plan
    173       100  
Gain on sales of foreclosed assets
    (100 )     (6 )
Oreo Expense
    360       214  
Oreo Writedown
    484       -  
Other
    1,559       1,486  
                 
    $ 4,458     $ 3,519  

Note 8 – Cumulative Perpetual Preferred Stock

Under the United States Treasury’s Capital Purchase Program (CPP), the Company issued $42.75 million to the United States Treasury in Cumulative Perpetual Preferred Stock, Series A, on December 5, 2008.  In addition, the Company provided warrants to the Treasury to purchase 1,623,418 shares of the Company’s common stock at an exercise price of $3.95 per share.  These warrants are immediately exercisable and expire ten years from the date of issuance.  The preferred stock is non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years and 9% per annum thereafter.  The preferred shares are redeemable at the option of the Company subject to regulatory approval.

As a condition of the CPP, the Company must obtain consent from the United States Department of the Treasury to repurchase its common stock or to increase its cash dividend on its common stock from the September 30, 2008 quarterly level of $0.04 per common share.  Furthermore, the Company has agreed to certain restrictions on executive compensation.  Under the American Recovery and Reinvestment Act of 2009, the Company is limited to using restricted stock as the form of payment to the top five highest compensated executives under any incentive compensation programs.

 
- 27 -

 

Note 9 – Common Stock Repurchase Programs

Through July 2006, the Company authorized the repurchase up to 1.9 million shares of its common stock.  Through December 5, 2008 (the date of our participation in the Treasury’s Capital Purchase Plan), the Company had repurchased 1,858,073 shares at an average price of $6.99 per share under the three plans.  During the first quarter in 2010, there were no repurchases.  Under the provisions of the Treasury’s Capital Purchase Program, the Company may not repurchase any of its common stock without the consent of the United States Treasury as long as the Treasury holds an investment in our preferred stock.

Note 10 - Derivatives

Derivative Financial Instruments

The Company utilizes stand-alone derivative financial instruments, primarily in the form of interest rate swap and option agreements, in its asset/liability management program.  These transactions involve both credit and market risk.  The Company uses derivative instruments to mitigate exposure to adverse changes in fair value or cash flows of certain assets and liabilities.  Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.  Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

Fair value hedges are accounted for by recording the fair value of the derivative instrument and the fair value related to the risk being hedged of the hedged asset or liability on the balance sheet with corresponding offsets recorded in the income statement.  The adjustment to the hedged asset or liability is included in the basis of the hedged item, while the fair value of the derivative is recorded as a freestanding asset or liability.  Actual cash receipts or payments and related amounts accrued during the period on derivatives included in a fair value hedge relationship are recorded as adjustments to the income or expense on the hedged asset or liability.  Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the balance sheet as either a freestanding asset or liability, with a corresponding offset recorded in accumulated other comprehensive income within stockholders’ equity, net of tax.  Amounts are reclassified from accumulated other comprehensive income to the income statement in the period or periods the hedged transaction affects earnings.  Under both the fair value and cash flow hedge methods, derivative gains and losses not effective in hedging the change in fair value or expected cash flows of the hedged item are recognized immediately in the income statement.

The Company does not enter into derivative financial instruments for speculative or trading purposes.  For derivatives that are economic hedges, but are not designated as hedging instruments or otherwise do not qualify for hedge accounting treatment, all changes in fair value are recognized in non-interest income during the period of change.  The net cash settlement on these derivatives is included in non-interest income.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements.  The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and agreements that specify collateral levels to be maintained by the Company and the counterparties.  These collateral levels are based on the credit rating of the counterparties.

 
- 28 -

 

Note 10 – Derivatives (continued)

The Company currently has eleven derivative instrument contracts consisting of two interest rate caps, seven interest rate swaps and two foreign exchange contracts.  The primary objective for each of these contracts is to minimize risk, interest rate risk being the primary risk for the interest rate caps and swaps while foreign exchange risk is the primary risk for the foreign exchange contracts.  The Company’s strategy is to use derivative contracts to stabilize and improve net interest margin and net interest income currently and in future periods.  In order to acquire low cost, long term fixed rate funding without incurring currency risk, the Company entered into the foreign exchange contract to convert foreign currency denominated certificates of deposit into long term dollar denominated time deposits.  The interest rate on the underlying certificates of deposit with an original notional of $10.0 million is based on a proprietary index (Barclays Intelligent Carry Index USD ER) managed by the counterparty (Barclays Bank).  The currency swap is also based on this proprietary index.

The fair value of the Company’s derivative assets and liabilities and their related notional amounts is summarized below.

   
March 31, 2010
   
December 31, 2009
 
   
Fair Value
   
Notional
Amount
   
Fair Value
   
Notional
Amount
 
   
(Amounts in thousands)
 
Fair value hedges
                       
                         
Interest rate swaps associated with deposit activities:
Certificate of Deposit contracts
  $ 954     $ 65,000     $ 939     $ 65,000  
                                 
Currency Exchange Contracts
    (871 )     10,000       (847 )     10,000  
                                 
Cash flow hedges
                               
                                 
Interest rate swaps associated with borrowing activities:
Trust Preferred contracts
    (470 )     10,000       (402 )     10,000  
                                 
Interest rate cap contracts
    315       22,500       489       22,500  
                                 
    $ (72 )   $ 107,500     $ 179     $ 107,500  

See Note 12 for additional information on fair values of net derivatives.

 
- 29 -

 

Note 10 – Derivatives (continued)

The following table further breaks down the derivative positions of the Company:

 
For the Year Ended March 31, 2010
 
 
Asset Derivatives
 
Liability Derivatives
 
 
2010
 
2010
 
 
Balance Sheet
     
Balance Sheet
     
 
Location
 
Fair Value
 
Location
 
Fair Value
 
 
(Amounts in thousands)
 
Derivatives designated as
               
hedging instruments
               
     Interest rate options
Other Assets
  $ 315          
     Interest rate contracts
Other Assets
    954  
Other Liabilities
  $ 470  
                     
Derivatives not designated as
                   
hedging instruments
                   
     Interest rate contracts
Other Assets
    -  
Other Liabilities
    871  
                     
Total derivatives
    $ 1,269       $ 1,341  
                     
Net Derivative Asset (Liability)
              $ (72 )

 
For the Year Ended December 31, 2009
 
 
Asset Derivatives
 
Liability Derivatives
 
 
2009
 
2009
 
 
Balance Sheet
     
Balance Sheet
     
 
Location
 
Fair Value
 
Location
 
Fair Value
 
 
(Amounts in thousands)
 
Derivatives designated as
               
hedging instruments
               
     Interest rate options
Other Assets
  $ 489          
     Interest rate contracts
Other Assets
    939  
Other Liabilities
  $ 402  
                     
Derivatives not designated as
                   
hedging instruments
                   
     Interest rate contracts
Other Assets
    -  
Other Liabilities
    847  
                     
Total derivatives
    $ 1,428       $ 1,249  
                     
Net Derivative Asset (Liability)
              $ 179  
 
 
- 30 -

 

Note 10 – Derivatives (continued)

The tables below illustrate the effective portion of the gains (losses) recognized in other comprehensive income and the gains (losses) reclassified from accumulated other comprehensive income into earnings.
 
For the Three Months Ended March 31, 2010
         
Location of Gain or
   
Amount of Gain or (Loss)
 
   
Amount of Gain or (Loss)
   
(Loss) Reclassified from
   
Reclassified from
 
   
Recognized in OCI on
   
Accumulated OCI
   
Accumulated OCI into
 
Cash Flow Hedging
 
Derivative (Effective
   
into Income
   
Income (Effective
 
Relationships
 
Portion)
   
(Effective Portion)
   
Portion)
 
   
(Amounts in thousands)
 
                         
Interest rate contracts
  $ (319 )  
Interest Expense
    $ (75 )
 
For the Three Months Ended March 31, 2009
         
Location of Gain or
   
Amount of Gain or (Loss)
 
   
Amount of Gain or (Loss)
   
(Loss) Reclassified from
   
Reclassified from
 
   
Recognized in OCI on
   
Accumulated OCI
   
Accumulated OCI into
 
Cash Flow Hedging
 
Derivative (Effective
   
into Income
   
Income (Effective
 
Relationships
 
Portion)
   
(Effective Portion)
   
Portion)
 
   
(Amounts in thousands)
 
                         
Interest rate contracts
  $ (257 )  
Interest Expense
    $ -  

There was no gain or loss recognized in the income statement due to any ineffective portion of any cash flow hedging relationship for the three months ended March 31, 2010 or 2009.

 
- 31 -

 

Note 10 – Derivatives (continued)

The tables below show the location and amount of gains (losses) recognized in earnings for fair value hedges and other economic hedges.

For the Three Months Ended March 31, 2010
   
Location of Gain or
 
Amount of Gain or (Loss)
 
   
(Loss) Recognized in
 
Recognized in Income on
 
Description
 
Income on Derivative
 
Derivative
 
     
(Amounts in thousands)
 
Interest rate contracts - Not
         
designated as hedging instruments
 
  Other income (expense)
  $ (31 )
             
Interest Rate Contracts - Fair
           
value hedging relationships
 
Interest Income/(Expense)
  $ 579  

For the Three Months Ended March 31, 2009
   
Location of Gain or
 
Amount of Gain or (Loss)
 
   
(Loss) Recognized in
 
Recognized in Income on
 
Description
 
Income on Derivative
 
Derivative
 
     
(Amounts in thousands)
 
Interest rate contracts - Not
         
designated as hedging instruments
 
  Other income (expense)
  $ 66  
             
Interest Rate Contracts - Fair
           
value hedging relationships
 
Interest Income/(Expense)
  $ 46  

The maturity dates for the two interest rate cap contracts are November 23, 2010 and February 18, 2014.  The interest rate swap with borrowing activities on trust preferred securities has a maturity of September 6, 2012.  The currency exchange contracts have maturity dates of November 26, 2013 and December 26, 2013.  The interest rate swaps with deposit taking activities on certificates of deposit have maturity dates of February 26, 2024, June 25, 2029, July 9, 2029, July 28, 2024, July 28, 2024 and August 28, 2024.  No new derivative contracts were entered into during the first quarter of 2010.

Certain derivative liabilities were collateralized by securities, which are held by the counterparty or in safekeeping by third parties.  The fair value of these securities was $4.6 million and $4.2 million at March 31, 2010 and December 31, 2009, respectively.  Collateral calls can be required at any time that the market value exposure of the contracts is less than the collateral pledged.  The degree of overcollateralization is dependent on the derivative contracts to which the Company is a party.

As part of our banking activities, the Company originates certain residential loans and commits these loans for sale.  The commitments to originate residential loans and the sales commitments are freestanding derivative instruments and are generally funded within 90 days.  The fair value of these commitments was not significant at March 31, 2010.

 
- 32 -

 

Note 11 - Disclosures About Fair Values of Financial Instruments

Financial instruments include cash and due from banks, federal funds sold, investment securities, loans, bank-owned life insurance, deposit accounts and other borrowings, accrued interest and derivatives.  Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and due from banks, federal funds sold and other interest-bearing deposits

The carrying amounts for cash and due from banks, federal funds sold and other interest-bearing deposits approximate fair value because of the short maturities of those instruments.

Investment securities

Fair value for investment securities equals quoted market price if such information is available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans

For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.  The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  However, the values derived likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts ranging from 5% to 25%, depending upon the nature of the loans, were subtracted to reflect the illiquid and distressed conditions at March 31, 2010 and December 31, 2009.

Investment in bank-owned life insurance

The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

Deposits

The fair value of demand deposits is the amount payable on demand at the reporting date.  The fair value of time deposits is estimated based on discounting expected cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings

The fair values are based on discounting expected cash flows at the current interest rate for debt with the same or similar remaining maturities and collateral requirements.

Accrued interest

The carrying amounts of accrued interest approximate fair value.
 
 
- 33 -

 

Note 11 - Disclosures About Fair Values of Financial Instruments (Continued)

Derivative financial instruments

Fair values for interest rate swap and option agreements are based upon the amounts required to settle the contracts.  Fair values for commitments to originate loans held for sale are based on fees currently charged to enter into similar agreements.  Fair values for fixed rate commitments also consider the difference between current levels of interest rates and the committed rates.

The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, are as follows at March 31, 2010 and December 31, 2009:

   
March 31, 2010
   
December 31, 2009
 
   
Carrying
amount
   
Estimated
fair value
   
Carrying
amount
   
Estimated
fair value
 
   
(Amounts in thousands)
 
                         
Financial assets:
                       
Cash and due from banks
  $ 33,885     $ 33,885     $ 30,184     $ 30,184  
Federal funds sold and other interest-bearing deposits
    22,352       22,352       31,269       31,269  
Investment securities available for sale
    325,311       325,311       312,780       312,780  
Investment securities held to maturity
    10,207       10,419       10,919       11,180  
                                 
Loans
    1,172,447       1,194,130       1,200,637       1,226,248  
Market risk/liquidity adjustment
    -       (43,420 )     -       (34,055 )
Net loans
    1,172,447       1,150,710       1,200,637       1,192,193  
                                 
Investment in life insurance
    29,031       29,031       28,766       28,766  
Accrued interest receivable
    6,924       6,924       7,403       7,403  
                                 
Financial liabilities:
                               
Deposits
    1,306,954       1,321,502       1,314,070       1,334,468  
Short-term borrowings
    76,769       76,937       85,477       85,827  
Long-term borrowings
    199,062       216,177       199,103       203,987  
Accrued interest payable
    2,399       2,399       3,318       3,318  
                                 
On-balance sheet derivative financial instruments:
                               
Interest rate swap and option agreements:
                               
(Assets) Liabilities, net
    72       72       (179 )     (179 )
 
 
- 34 -

 

Note 12 – Fair Values of Assets and Liabilities

Effective January 1, 2008, the Company adopted the new requirement for optional reporting of financial assets and financial liabilities at fair value.   The effect of adopting the fair value reporting standards was not material to the financial statements.

The new standard defines fair value, establishes a framework for measuring fair value according to generally accepted accounting principles and expands disclosures about fair value measurements.  This pronouncement establishes a three level fair value hierarchy that is fully described below.  While this standard does not require any financial instruments to be measured at fair value, the provisions of the statement must be applied in situations where other accounting pronouncements either permit or require fair value measurement.  The Company reports fair value on a recurring basis for certain financial instruments, most notably for available for sale investment securities and certain derivative instruments.  The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis.  These include assets that are measured at the lower of cost or market that were recognized at fair value which was below cost at the end of the period.  Assets subject to nonrecurring use of fair value measurements could include loans held for sale, goodwill, and foreclosed assets.  At March 31, 2010 and December 31, 2009, the Company had certain impaired loans and foreclosed assets that are measured at fair value on a nonrecurring basis.

The Company groups financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:

 
·
Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.  Level 1 also includes U.S. Treasury securities that are traded by dealers or brokers in active markets.  Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 
·
Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets.  Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities.  Valuations are obtained from third party services for similar or comparable assets or liabilities.

 
·
Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies,  including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or brokered traded transactions.  Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
 
 
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Note 12 – Fair Values of Assets and Liabilities (continued)

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis.

   
March 31, 2010
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(Amounts in thousands)
 
                         
Securities available for sale:
                       
U. S. government agencies
  $ 95,273     $ -     $ 95,273     $ -  
Mortgage-backed securities
    153,643       -       153,643       -  
Municipals
    68,523       -       68,523       -  
Trust preferred securities
    3,195       -       3,195       -  
Common stocks and mutual funds
    3,481       550       -       2,931  
Other
    1,196       -       1,196       -  
Net Derivatives
    (72 )     -       799       (871 )

   
December 31, 2009
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(Amounts in thousands)
 
                         
Securities available for sale:
                       
U. S. government agencies
  $ 57,288     $ -     $ 57,288     $ -  
Mortgage-backed securities
    182,100       -       182,100       -  
Municipals
    66,259       -       66,259       -  
Trust preferred securities
    2,876       -       2,876       -  
Common stocks and mutual funds
    3,264       472       -       2,792  
Other
    993       -       993       -  
Net Derivatives
    179       -       1,026       (847 )

The table below presents reconciliation for the period of January 1, 2010 to March 31, 2010, for all Level 3 assets and liabilities that are measured at fair value on a recurring basis.

 
Fair Value Measurements Using Significant Unobservable Inputs
 
   
(Dollars in Thousands)
 
   
Securities
       
   
Available for Sale
   
Net Derivatives
 
Beginning Balance January 1, 2010
  $ 2,792     $ (847 )
Total realized and unrealized gains or losses:
               
Included in earnings
    -       (24 )
Included in other comprehensive income
    139       -  
Purchases, issuances and settlements
    -       -  
Transfers in and/or out of Level 3
    -       -  
Ending Balance
  $ 2,931     $ (871 )

The Company utilizes a third party pricing service to provide valuations on its securities portfolio.  Despite most of these securities being U.S. government agency debt obligations, agency mortgage-backed securities and municipal securities traded in active markets, third party valuations are determined based on the characteristics of a security (such as maturity, duration, rating, etc.) and in reference to similar or comparable securities.  Due to the nature and methodology of these valuations, the Company considers these fair value measurements as Level 2.  No securities were transferred between level 1 and level 2 during the first quarter of 2010.
 
 
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Note 12 – Fair Values of Assets and Liabilities (continued)

The Company records loans in the ordinary course of business and does not record loans at fair value on a recurring basis.  As previously discussed in “Asset Quality”, loans are considered impaired when it is determined to be probable that all amounts due under the contractual terms of the loan will not be collected when due.  A specific allowance is established for loans considered individually impaired if required based on the most appropriate of the three measurement methods: present value of expected future cash flows, fair value of collateral, or the observable market price of a loan method.  A specific allowance is required if the fair value of the expected repayments or the collateral is less than the recorded investment in the loan.  At March 31, 2010, loans with a book value of $50.6 million were evaluated for impairment.  Of this total, $42.9 million required a specific allowance totaling $17.6 million for a net fair value of $25.4 million.  The methods used to determine the fair value of these loans were considered level three.

Assets acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value less estimated cost to sell on the date of foreclosure.  Subsequent to foreclosure, valuations are periodically performed by management or outside appraisers and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell.  These valuations generally are based on market comparable sales data for similar type of properties.  The range of discounts in these valuations is specific to the nature, type, location, condition and market demand for each property.  The methods used to determine the fair value of these foreclosed assets were considered level three.

The table below presents the balances of assets and liabilities measured at fair value on a nonrecurring basis.

   
March 31, 2010
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(Amounts in thousands)
 
                         
Impaired loans
  $ 25,365     $ -     $ -     $ 25,365  
                                 
Foreclosed assets
    20,285       -       -       20,285  

   
December 31, 2009
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(Amounts in thousands)
 
                         
Impaired loans
  $ 19,322     $ -     $ -     $ 19,322  
                                 
Foreclosed assets
    19,634       -       -       19,634  

Note 13 – Subsequent Events

Management is not aware of any reportable events subsequent to March 31, 2010.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates.  This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

The Company’s market risk arises primarily from interest rate risk inherent in its lending, deposit-taking and borrowing activities.  The structure of the Company’s loan and liability portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income.  The Company does not maintain a trading account nor is the Company subject to currency exchange risk or commodity price risk.
 
 
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In reviewing the needs of our Bank with regard to proper management of its asset/liability program, we estimate future needs, taking into consideration investment portfolio purchases, calls and maturities in addition to estimated loan and deposit increases (due to increased demand through marketing) and forecasted interest rate changes.  We use a number of measures to monitor and manage interest rate risk, including net interest income simulations and gap analyses.  A net interest income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates.  Key assumptions in the model include prepayment speeds on mortgage-related assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing.  These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income.  Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.  The results of the most recent analysis indicated that the Company is relatively interest rate neutral.  Given the current level of market interest rates, it is not meaningful to use an assumed decrease in interest rates of more than 1%.  If interest rates decreased instantaneously by one percentage point, our net interest income over a one-year time frame could decrease by approximately 4%.  If interest rates increased instantaneously by two percentage points, our net interest income over a one-year time frame could increase by approximately 13%.

Item 4.  Controls and Procedures

The Company conducted an evaluation, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2010.  The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2010 at the reasonable assurance level.  However, the Company believes that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2010 that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.  The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.

Part II.     OTHER INFORMATION

Item 1A.  Risk Factors

There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 6.  Exhibits
 
(a)
Exhibits.

Exhibit3.2
Bylaws of Southern Community Financial Corporation

Exhibit31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)
 
Exhibit31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)
 
Exhibit32
Section 1350 Certification

 
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
SOUTHERN COMMUNITY FINANCIAL CORPORATION
   
Date:  May 10, 2010
By:
/s/ F. Scott Bauer                                                                      
   
F. Scott Bauer
   
Chairman and Chief Executive Officer
   
(principal executive officer)
   
Date:  May 10, 2010
By:
/s/ James Hastings                                                                    
   
James Hastings
   
Executive Vice President and Chief Financial Officer
   
(principal financial and accounting officer)
 
 
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