SOUTHERN COMMUNITY FINANCIAL CORP - 10-Q Quarterly Report

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

Form 10-Q

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

For the quarterly period ended September 30, 2002

[ ] 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 (State or other jurisdiction of incorporation or organization)		56-2270620 (I.R.S. Employer Identification No.)


4701 Country Club Road Winston-Salem, North Carolina (Address of principal executive offices)		27104 (Zip Code)

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

Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, No Par Value

7.25% Convertible Junior Subordinated Debentures

Guarantee with respect to 7.25% Convertible Trust Preferred Securities

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

As of September 30, 2002, (the most recent practicable date), the registrant had outstanding 8,375,082 shares of Common Stock, no par value.

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			Page No.

Part I. FINANCIAL INFORMATION




Item 1 - Financial Statements (Unaudited)




	Consolidated Balance Sheets September 30, 2002 and December 31, 2001			3




	Consolidated Statements of Operations Three Months and Nine Months Ended September 30, 2002 and 2001			4




	Consolidated Statements of Stockholders’ Equity Nine Months Ended September 30, 2002 and 2001			5




	Consolidated Statements of Cash Flows Nine Months Ended September 30, 2002 and 2001			6




	Notes to Consolidated Financial Statements			7




Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations				15




Item 3 - Quantitative and Qualitative Disclosures about Market Risk				19




Item 4 - Controls and Procedures				19




Part II. Other Information




		Item 6. Exhibits and Reports on Form 8-K		20

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Part I. FINANCIAL INFORMATION

Item 1 — Financial Statements

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS


		September 30, 2002			December 31, 2001*
		(Unaudited)

		(Amounts in thousands,
		except share data)
Assets




Cash and due from banks		$	15,758		$	18,878




Federal funds sold			10,883			22,926




Investment securities (Note 3)




	Available for sale, at fair value		105,864			30,678




	Held to maturity, at amortized cost		31,776			34,529




Loans (Note 4)			410,578			360,288




Allowance for loan losses (Note 4)			(6,129	)		(5,400	)

Net Loans			404,449			354,888




Bank premises and equipment (Note 5)			15,127			12,111




Other assets			11,221			7,210

Total Assets		$	595,078		$	481,220

Liabilities And Stockholders’ Equity




Liabilities Deposits:




	Demand	$	40,619		$	36,202




	Money market and NOW		106,460			95,904




	Time (Note 6)		301,129			260,745

Total Deposits			448,208			392,851




Short-term borrowings (Note 7)			25,000			19,980




Long-term debt (Note 7)			55,000			25,000




Convertible Junior Subordinated Debentures			17,250			—




Other liabilities			3,027			938

Total Liabilities			548,485			438,769

Stockholders’ Equity (Note 10) Common stock, no par value, 30,000,000 shares authorized; 8,375,082 and 8,354,990 shares issued and outstanding			40,367			40,285




	Retained earnings		3,526			1,362




Accumulated other comprehensive income			2,700			804

Total Stockholders’ Equity			46,593			42,451

Commitments (Notes 4 and 5)
Total Liabilities and Stockholders’ Equity		$	595,078		$	481,220

• Derived from audited financial statements

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)


		Three Months Ended				Nine Months Ended
		September 30,				September 30,

		2002		2001		2002		2001

		(Amounts in thousands, except per share data)
Interest Income




	Loans	$	6,757	$	6,617	$	18,978	$	20,125




	Investment securities available for sale		1,431		625		3,437		1,805




	Investment securities held to maturity		436		762		1,847		1,497




	Federal funds sold		32		76		102		540

Total Interest Income			8,656		8,080		24,364		23,967

Interest Expense




	Money market and NOW deposits		370		636		1,061		1,752




	Time deposits		2,565		3,567		8,349		11,826




	Borrowings		1,020		361		2,514		581

Total Interest Expense			3,955		4,564		11,924		14,159

Net Interest Income			4,701		3,516		12,440		9,808




Provision for Loan Losses (Note 4)			400		625		1,180		1,500

Net Interest Income After Provision for Loan Losses			4,301		2,891		11,260		8,308

Non-Interest Income (Note 8)			1,009		784		2,654		2,617

Non-Interest Expense




	Salaries and employee benefits		2,102		1,493		5,469		4,168




	Occupancy and equipment		636		529		1,842		1,525




	Other (Note 8)		1,133		868		3,278		2,611

Total Non-Interest Expense			3,871		2,890		10,589		8,304

Income Before Income Taxes			1,439		785		3,325		2,621




Income Tax Expense			503		278		1,161		919

Net Income		$	936	$	507	$	2,164	$	1,702

Net Income Per Share (Note 10)




	Basic	$	.11	$	.06	$	.25	$	.20




	Diluted		.10		.06		.24		.19




Weighted Average Shares Outstanding




	Basic		8,793,836		8,761,508		8,789,307		8,687,026




	Diluted		9,069,622		9,038,393		9,070,110		8,965,797

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)


												Accumulated
				Common Stock				Additional				Other		Total
								Paid-in		Retained		Comprehensive		Stockholders'
				Shares		Amount		Capital		Earnings		Income		Equity

						(Amounts in thousands, except share data)
Balance at December 31, 2001					8,354,990	$	40,285	$	—	$	1,362	$	804	$	42,451




Comprehensive income:




	Net income				—		—		—		2,164		—		2,164




	Other comprehensive income:




		Net increase in fair value of securities available for sale, net of tax			—		—		—		—		1,032		1,032




		Net increase in fair value on cash flow hedging activities, net of tax			—		—		—		—		864		864

			Total comprehensive income												4,060

Common stock issued pursuant to:




	Stock options exercised				20,092		82		—		—		—		82

Balance at September 30, 2002					8,375,082	$	40,367	$	—	$	3,526	$	2,700	$	46,593

Balance at December 31, 2000					7,595,979	$	18,990	$	15,766	$	1,883	$	311	$	36,950




Comprehensive income:




	Net income				—		—		—		1,702		—		1,702




	Other comprehensive income:




		Net increase in fair value of securities available for sale, net of tax			—		—		—		—		693		693

			Total comprehensive income												2,395

Common stock issued pursuant to:




	Sale of common stock				344,118		860		1,951		—		—		2,811




	Stock options exercised				18,191		46		35		—		—		81

Balance at September 30, 2001					7,958,288	$	19,896	$	17,752	$	3,585	$	1,004	$	42,237

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See accompanying notes.

SOUTHERN COMMUNITY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


					Nine Months Ended
					September 30,

					2002			2001

					(Amounts in thousands)
Cash Flows from Operating Activities




		Net income			$	2,164		$	1,702




	Adjustments to reconcile net income to net cash provided by operating activities:




				Depreciation and amortization		956			737




				Provision for loan losses		1,180			1,500




				Gain on sale of securities available for sale		(69	)		—




				Gain on sale of bank premises and equipment		(3	)		—




				Gain on sale of foreclosed assets		(19	)		—




				Changes in assets and liabilities:




				Increase in other assets		(3,452	)		(2,186	)




				Increase (decrease) in other liabilities		2,089			(133	)

Net Cash Provided by Operating Activities						2,846			1,620

Cash Flows from Investing Activities




		Decrease in federal funds sold				12,043			17,916




		Purchases of:




			Available-for-sale investment securities			(111,771	)		(2,061	)




			Held-to-maturity investment securities			(23,251	)		(35,000	)




		Proceeds from maturities and calls of:




			Available-for-sale investment securities			17,054			7,622




			Held-to-maturity investment securities			26,000			11,996




		Proceeds from sales of available-for-sale securities				21,220			—




		Net increase in loans				(50,910	)		(50,350	)




		Proceeds from termination of interest rate swap agreement				208			—




		Purchases of bank premises and equipment				(3,922	)		(2,158	)




		Proceeds from disposal of bank premises and equipment				3			—




		Proceeds from sale of foreclosed assets				292			—




		Increase in other assets				(641	)		(2,000	)

Net Cash Used by Investing Activities						(113,675	)		(54,035	)

Cash Flows from Financing Activities




		Net increase in deposits				55,357			20,331




		Net increase in short-term borrowings				5,020			1,000




		Net increase in long-term debt				30,000			29,000




		Proceeds from issuance of convertible debentures				17,250			—




		Net proceeds from issuance of common stock				82			2,892

Net Cash Provided by Financing Activities						107,709			53,223

Net Increase (Decrease) in Cash and Due From Banks						(3,120	)		808




Cash and Due From Banks, Beginning of Year						18,878			11,197

Cash and Due From Banks, End of Period					$	15,758		$	12,005

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 1 — Basis of Presentation

The consolidated financial statements include the accounts of Southern Community Financial Corporation and its subsidiaries, Southern Community Capital Trust I, an issuer of the Company’s Convertible Trust Preferred Securities, and Southern Community Bank and Trust and its wholly owned subsidiaries, Southern Credit Services, Inc., which is engaged in the business of accounts receivable financing, Southeastern Acceptance Corporation, a consumer finance company, and VCS Management, LLC, the managing general partner for Venture Capital Solutions L.P., a Small Business Investment Company. All intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and nine month periods ended September 30, 2002 and 2001, in conformity with accounting principles generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2002.

The organization and business of Southern Community Financial Corporation (the “Company”), accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2001 annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.

Note 2 — Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 2 — Comprehensive Income (Continued)

The components of comprehensive income and related tax effects are as follows:


					Three Months Ended						Nine Months Ended
					September 30,						September 30,

					2002			2001			2002			2001

								(Amounts in thousands)
Net income					$	936		$	507		$	2,164		$	1,702

Other comprehensive income:




	Securities available for sale:




		Reclassification of gains (losses) recognized in net income				—			—			(70	)		—




		Unrealized holding gains on available for sale securities				1,258			780			1,760			1,130




		Tax effect				(484	)		(302	)		(658	)		(437	)

		Net of tax amount				774			478			1,032			693

	Cash flow hedging activities:




		Unrealized holding gains on cash flow hedging activities				1,085			—			1,311			—




		Reclassification of (gains) losses Recognized in net income				(19	)		—			(19	)		—




			Tax effect			(341	)		—			(428	)		—

			Net of tax amount			725			—			864			—

				Total other comprehensive income		1,499			478			1,896			693

Comprehensive income					$	2,435		$	985		$	4,060		$	2,395

Note 3 — Investment Securities

The following table summarizes the amortized cost, gross unrealized gains and losses and the resulting market value of securities at the dates indicated:


					Gross		Gross
		Amortized			Unrealized		Unrealized		Market
		Cost			Gains		Losses		Value

September 30, 2002				(Amounts in thousands)
Securities available for sale:




	U.S. Government agencies	$	26,436		$	904	$	—	$	27,340




	Mortgage-backed		71,600			2,095		—		73,695




	Other		4,829			—		—		4,829

		$	102,865		$	2,999	$	—	$	105,864

Securities held to maturity:




	U.S. Government agencies	$	31,000		$	332	$	51	$	31,281




	Mortgage-backed		525			21		—		546




	Municipal		251			11		—		262

		$	31,776		$	364	$	51	$	32,089

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 3 — Investment Securities (Continued)


					Gross		Gross
		Amortized			Unrealized		Unrealized		Market
		Cost			Gains		Losses		Value

December 31, 2001				(Amounts in thousands)
Securities available for sale:




	U.S. Government agencies	$	22,172		$	1,162	$	—	$	23,334




	Mortgage-backed		4,271			147		—		4,418




	Other		2,926			—		—		2,926

		$	29,369		$	1,309	$	—	$	30,678

Securities held to maturity:




	U.S. Government agencies	$	33,500		$	664	$	2	$	34,162




	Mortgage-backed		1,029			34		—		1,063

		$	34,529		$	698	$	2	$	35,225

Note 4 — Loans

Following is a summary of loans at each of the balance sheet dates presented:


	September 30, 2002					December 31, 2001

			Percent					Percent
	Amount		of Total			Amount		of Total

			(Amounts in thousands)
Residential mortgage loans	$	105,946		25.8	%	$	105,357		29.2	%




Commercial mortgage loans		136,158		33.1	%		89,354		24.8	%




Construction loans		63,081		15.4	%		61,558		17.1	%




Commercial and industrial loans		76,022		18.5	%		77,820		21.6	%




Loans to individuals		29,371		7.2	%		26,199		7.3	%

Subtotal		410,578		100.0	%		360,288		100.0	%

Less: Allowance for loan losses		6,129					5,400

Net loans	$	404,449				$	354,888

Loan commitments at September 30, 2002 include commitments to extend credit of $36.3 million and amounts available under home equity credit lines, other credit lines and standby letters of credit of $34.6 million, $33.0 million and $11.5 million, respectively.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 4 — Loans (Continued)

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


	Three Months Ended						Nine Months Ended
	September 30,						September 30,

	2002			2001			2002			2001

				(Amounts in thousands)
Balance at beginning of period	$	5,976		$	4,761		$	5,400		$	4,283

Provision charged to operations		400			625			1,180			1,500

Charge-offs		(249	)		(409	)		(494	)		(832	)




Recoveries		2			2			43			28

Net charge-offs		(247	)		(407	)		(451	)		(804	)

Balance at end of period	$	6,129		$	4,979		$	6,129		$	4,979

Note 5 — Commitments to Acquire Property and Equipment

The Company has committed to the construction of a new corporate headquarters. The new headquarters will be a 27,000 square foot facility to be built at a construction cost to the Company of approximately $2.8 million on land for which the Company paid $400,000, and will be located at 4605 Country Club Road, Winston-Salem, North Carolina. As of September 30, 2002, the Company has paid $2.0 million of this contract with estimated completion in the first quarter of 2003.

Note 6 — Time Deposits

Time deposits in denominations of $100,000 or more were approximately $132.3 million and $111.5 million at September 30, 2002 and December 31, 2001, respectively.

Note 7 — Borrowings

Advances from the Federal Home Loan Bank of Atlanta outstanding at September 30, 2002 are as follows:


	Interest			December 31,
Maturity	Rate			2001

				(Amounts in thousands)
2003		4.84	%	$	10,000




2004		5.35	%		10,000




2005		3.74	%		5,000




2006		—			—




2007	2.15% to 4.09%				20,000




Thereafter	3.24% to 4.43%				20,000

				$	65,000

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 7 — Borrowings (Continued)

At December 31, 2001, FHLB advances with original maturities of one year or more amounted to $25.0 million and have interest rates ranging from 4.43% to 5.35%.

In addition to the above advances, the Bank has lines of credit of $27.0 million from various correspondent banks to purchase federal funds sold on a short-term basis, with no outstanding balance at September 30, 2002, and $100.0 million in available lines of credit under repurchase agreements, with $15.0 million outstanding at September 30, 2002.

Aggregate borrowings at September 30, 2002 amounted to $80.0 million, including $25.0 million that is due within one year and classified as short-term borrowings and $55.0 million due after one year that is classified as long-term debt in the accompanying balance sheet.

Under collateral agreements with the Federal Home Loan Bank at September 30, 2002, advances are secured both by loans with a market value of $51.2 million and pledged investment securities with a market value of $63.0 million.

In February of 2002, the Company issued 1,725,000 shares of Cumulative Convertible Junior Subordinated Debentures, generating total proceeds of $17.3 million. These debentures have a distribution rate of 7.25% per annum payable at the end of each calendar quarter.

Note 8 — Non-Interest Income and Other Non-Interest Expense

The major components of non-interest income are as follows:


	Three Months Ended					Nine Months Ended
	September 30,					September 30,

	2002			2001		2002		2001

			(Amounts in thousands)
Service charges and fees on deposit accounts	$	277		$	225	$	810	$	630




Income from mortgage operations		366			235		781		764




Investment brokerage fees		102			77		185		144




SBIC management fees		138			139		414		426




Income from non-hedge derivative		—			—		—		383




Other		126			108		464		270

	$	1,009		$	784	$	2,654	$	2,617

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SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 8 — Non-Interest Income and Other Non-Interest Expense (Continued)

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


	Three Months Ended					Nine Months Ended
	September 30,					September 30,

	2002			2001		2002		2001

			(Amounts in thousands)
Postage, printing and office supplies	$	85		$	74	$	243	$	258




Advertising and promotion		144			110		419		367




Data processing and other outsourced services		350			186		954		677




Professional services		46			70		164		208




Other		508			428		1,498		1,101

	$	1,133		$	868	$	3,278	$	2,611

Note 9 — Nonperforming Assets

The table sets forth, for the dates indicated, information with respect to nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans), and total nonperforming assets.


		September 30,			December 31,
		2002			2001

		(Amounts in thousands)
Nonaccrual loans		$	2,185		$	894




Restructured loans			—			—

	Total non-performing loans		2,185			894




Real estate owned			248			347

	Total non-performing assets	$	2,433		$	1,241

Accruing loans past due 90 days or more		$	236		$	—




Allowance for loan losses			6,129			5,400




Nonperforming loans to period end loans			.59	%		.25	%




Allowance for loan losses to period end loans			1.49	%		1.50	%




Nonperforming assets to total assets			.41	%		.26	%

Note 10 — Net Income Per Share

Basic and diluted net income per share is computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for a 5% stock dividend declared September 19, 2002, which was distributed on October 15, 2002. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income of the Company.

- 12 -

SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 10 — Net Income Per Share (Continued)

Basic and diluted net income per share have been computed based upon net income as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,

	2002		2001		2002		2001

Weighted average number of common shares used in computing basic net income per share		8,793,836		8,761,508		8,789,307		8,687,026




Effect of dilutive stock options		275,786		276,885		280,803		278,771

Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share		9,069,622		9,038,393		9,070,110		8,965,797

Note 11 — Derivatives

The Company utilizes interest rate swaps in the management of interest rate risk. Interest rate swaps are contractual agreements between two parties to exchange a series of cash flows representing interest payments. A swap allows both parties to alter the repricing characteristics of assets or liabilities without affecting the underlying principal positions. Through the use of a swap, assets and liabilities may be transformed from fixed to floating rates, from floating rates to fixed rates, or from one type of floating rate to another. Swap terms generally range from one year to ten years depending on the need. At September 30, 2002, derivatives with a total notional value of $35.0 million, with terms ranging up to three years, were outstanding.

The net interest payable or receivable on interest rate swaps that are designated as hedges is accrued and recognized as an adjustment to the interest income or expense of the related asset or liability. Gains and losses from early terminations of derivatives are deferred and amortized as yield adjustments over the shorter of the remaining term of the hedged asset or liability or the remaining term of the derivative instrument. Upon disposition or settlement of the asset or liability being hedged, deferral accounting is discontinued and any gains or losses are recognized in income. Derivative financial instruments that fail to qualify as a hedge are carried at fair value with gains and losses recognized in current earnings.

- 13 -

SOUTHERN COMMUNITY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements

Note 11 — Derivatives (Continued)

The following table sets forth certain information concerning the Company’s interest rate swaps at September 30, 2002:


				Notional Amount

				(Amounts in thousands)
			Type




Receive fixed swaps				$	35,000




Receive rate					6.44	%




Pay rate (daily average prime)					4.75	%




Fair value				$	1,108




	Year-to-date Activity




Balance, December 31, 2001				$	—




Additions					50,000




Maturities/amortizations					—




Sales/terminations					(15,000	)

Balance, September 30, 2002				$	35,000

		Maturity Schedule




One to five years				$	35,000

The $35.0 million notional amount of derivatives used in interest rate risk management are used to hedge prime-rate based commercial loans. The Company does not utilize derivatives for trading purposes.

Although off-balance sheet derivative financial instruments do not expose the Company to credit risk equal to the notional amount, such agreements generate credit risk to the extent of the fair value gain in an off-balance sheet derivative financial instrument if the counterparty fails to perform. Such risk is minimized through the creditworthiness of the counterparties and the consistent monitoring of these agreements. The counterparties to these arrangements were primarily large commercial banks and investment banks. Where appropriate, master netting agreements are arranged or collateral is obtained in the form of rights to securities. At September 30, 2002, the Company’s interest rate swaps reflected an unrealized gain of $1.3 million, which included unrealized gains from the early termination of derivatives in the amount of $189,000. This gain is being amortized into income over the life of the original contract term.

Other risks associated with interest-sensitive derivatives include the effect on fixed rate positions during periods of changing interest rates. Indexed amortizing swaps’ notional amounts and maturities change based on certain interest rates indices. Generally, as rates fall the notional amounts decline more rapidly, and as rates increase notional amounts decline more slowly. At September 30, 2002, the Company had no indexed amortizing swaps outstanding. Under unusual circumstances, financial derivatives also increase liquidity risk, which could result from an environment of rising interest rates in which derivatives produce negative cash flows while being offset by increased cash flows from variable rate loans. Such risk is considered insignificant due to the relatively small derivative positions held by the Company.

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

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

Financial Condition at September 30, 2002 and December 31, 2001

During the nine-month period ending September 30, 2002, our total assets increased by $113.9 million, or 23.7%, to $595.1 million. This asset growth was funded by increases in various liabilities. Deposits increased $55.4 million, or 14.1%. In addition, during the nine-month period ending September 30, 2002, we successfully completed a public offering of trust preferred securities, generating $17.3 million in the form of Convertible Junior Subordinated Debentures. Short-term borrowings and long-term debt combined rose $35.0 million to a total of $80.0 million at period end.

Consistent with prior periods, a substantial portion of our growth resulted from strong loan demand. At September 30, 2002, loans totaled $410.6 million, an increase of $50.3 million or 14.0% during the nine months. This growth was spread primarily to our commercial mortgage loans, which increased by $46.8 million, or 52.4%. We also generated growth of $1.5 million and $3.2 million, respectively, in construction loans and consumer loans. Offsetting this growth was a moderate decrease among our commercial and industrial loans, which decreased $1.8 million, or 2.3%.

Our total liquid assets, defined as cash and due from banks, federal funds sold and investment securities, increased by $57.3 million during the nine months, to $164.3 million at September 30, 2002 versus $107.0 million at the beginning of the period. Our composition of liquid assets has shifted to take advantage of the more favorable interest rates that are being paid on investment securities as compared to overnight investments. We decreased our investment in federal funds sold from $22.9 million at December 31, 2001 to $10.9 million at September 30, 2002. We have chosen to invest more heavily in investment securities available for sale, which we increased by $75.2 million to $105.9 million at September 30, 2002 versus $30.7 million at December 31, 2001. As a result of the activity during the period, our portfolio of held to maturity investments declined from $34.5 million to $31.8 million.

Customer deposits continue to be our primary funding source. At September 30, 2002, deposits totaled $448.2 million, an increase of $55.4 million or 14.1% from year-end 2001. In February of 2002, we completed our trust preferred securities offering which provided $17.3 million of additional funding in the form of Convertible Junior Subordinated Debentures. We increased our short-term borrowings through an increase in repurchase lines of credit in the amount of $5.0 million. We have also increased long-term debt by $30.0 million, utilizing the lower interest rates being offered by the Federal Home Loan Bank of Atlanta. We will utilize various funding sources, as necessary, to support balance sheet management and growth. However, we believe that as our branch network grows and matures, the volume of core deposits will become a relatively larger portion of our funding mix, which should contribute to a reduction in our overall funding cost.

Our capital position remains strong, with all of our regulatory capital ratios at levels that make us “well capitalized” under federal bank regulatory capital guidelines. At September 30, 2002, our stockholders’ equity totaled $46.6 million, an increase of $4.1 million from the December 31, 2001 balance. Increases included net income from operations during the period of $2.1 million, proceeds from the issuance of common stock in the amount of $82,000, net unrealized gains on investment securities available for sale of $1.0 million, net of tax, and unrealized gains on cash flow hedging activities in the amount of $864,000, net of tax. Our regulatory capital was supplemented during the period by issuance of the Convertible Junior Subordinated Debentures discussed above.

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Results of Operations for the Three Months Ended September 30, 2002 and 2001

Net Income. Our net income for the three months ended September 30, 2002 was $936,000, an increase of $429,000 from the same three-month period in 2001. Net income per share was $.11 basic and $.10 diluted for the three months ended September 30, 2002, as compared with $.06 basic and diluted for the same period in 2001. We have continued to experience strong growth, with total assets averaging $558.9 million during the current three-month period as compared to $443.4 million in the prior period, an increase of 26.0%. Our interest rate spread and net yield on average interest-earning assets increased 48 basis points and 23 basis points, respectively. Our growth in net interest income of 33.7%, as compared with the same period in 2001, a decrease in our loan loss provision in the amount of $225,000 and an increase in our non-interest income in the amount of $225,000 were partially offset by an increase in non-interest expenses of 33.9%. Our expense growth included the costs of new branches, additional branch personnel, and personnel costs associated with expansion of our business. While these expenses represent investments in building our franchise, they initially create a drag on earnings.

Net Interest Income. During the three months ended September 30, 2002, our net interest income increased by $1.2 million or 33.7% to $4.7 million. Our total interest income benefited from strong growth in the level of average earning assets, which offset lower asset yields caused by the decline in interest rates from period to period. The rates earned on a significant portion of our loans adjust immediately when index rates such as our prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Because rates have stabilized at a lower level during 2002, downward repricings of our interest-bearing liabilities have been larger than our downward repricings of our interest-earning assets. Average total interest-earning assets increased $104.5 million, or 25.1%, during the three months ended September 30, 2002 as compared to the same period in 2001. Our average yields on total interest-earning assets decreased by 111 basis points from 7.70% to 6.59%. Our average total interest-bearing liabilities increased by $105.7 million, or 28.4%, consistent with the increase in interest-earning assets. Our average cost of total interest-bearing liabilities decreased by 158 basis points from 4.86% to 3.28%. For the three months ended September 30, 2002, our net interest spread was 3.32% and our net interest margin was 3.58%. For the three months ended September 30, 2001, our net interest spread was 2.84% and our net interest margin was 3.35%.

Provision for Loan Losses. Our provision for loan losses for the three months ended September 30, 2002 was $400,000, representing a decrease of $225,000 from the $625,000 provision we made for the three months ended September 30, 2001. We have continued to increase the level of our allowance for loan losses in response to the growth in our loan portfolio. In evaluating the allowance for loan losses, we consider factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. We have decreased our provision during the current three-month period in part because of the lower level of net loan charge-offs, which totaled $247,000 during the three months ended September 30, 2002, down from $407,000 during the three months ended September 30, 2001. On an annualized basis, our percentage of net loan charge-offs to average loans outstanding was .25% and .50% for the three months ended September 30, 2002 and 2001, respectively. Non-performing assets increased to $2.4 million, or 0.41% of total assets at September 30, 2002 from $1.3 million, or 0.27% of total assets at December 31, 2001. The increase is primarily the result of a single relationship with which the bank has a secured position. At September 30, 2002, the allowance for loan losses stood at $6.1 million. We believe that the allowance is adequate to absorb losses inherent in our loan portfolio.

Non-Interest Income. For the three months ended September 30, 2002, non-interest income increased by $225,000 or 28.7% to $1.0 million from $784,000 for the same period the prior year. Increases for the three months ended September 30, 2002 include an increase of $52,000, or 23.1%, in service charges and fees on deposit accounts as a result of deposit growth, increases of $131,000, or 55.7%, in mortgage origination operations as the level of mortgage refinancings has increased due to the favorable interest rate market for such loans. Other operational income increased by $42,000, or 13.0%.

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our growth. From 1998 forward through the current three-month period, we have consistently maintained our ratio of non-interest expenses to average total assets below 3%. Because of our growth we have consistently seen increases in every major component of our non-interest expenses. For the three months ended September 30, 2002, our non-interest expense increased $981,000, or 33.9% over the same period in 2001. Salaries and employee benefit expense increased $609,000, or 40.8%, and reflects the addition of personnel in our new branches as well as additions of personnel to expand our business, and, to a lesser degree, normal salary increases. Occupancy and equipment expense increased $107,000, or 20.2%. Other expenses increased $265,000, or 30.5%, reflecting the increased volume of business activity, principally increases in lending and growth in deposit accounts. For the three months ended September 30, 2002, on an annualized basis, our ratio of non-interest expenses to average total assets increased to 2.77% as compared with 2.61% for the same three months in 2001.

Provision for Income Taxes. Our provision for income taxes, as a percentage of income before income taxes, was 35.0% and 35.4%, respectively, for the three months ended September 30, 2002 and 2001.

Results of Operations for the Nine Months Ended September 30, 2002 and 2001

Net Income. Our net income for the nine-months ended September 30, 2002 was $2.2 million, an increase of $462,000 from the same nine-month period in 2001. Net income per share was $.25 basic and $.24 diluted for the nine months ended September 30, 2002, as compared with $.20 basic and $.19 diluted for the same period in 2001. We have continued to experience strong growth, with total assets averaging $537.2 million during the current nine-month period as compared to $414.6 million in the prior period, an increase of 29.6%. Because of the downward trend in interest rates from period to period, resulting in dramatically lower yields during the current nine month period as compared with the same period in 2001, our increase in net interest income over the nine month period was slightly lower in comparison with our average asset growth. Our growth in net interest income of 26.8%, as compared with the same period in 2001, and a decrease in our loan loss provision in the amount of $320,000 were primarily offset by an increase in non-interest expenses of 27.5%. Our expense growth included the costs of new branches, additional branch personnel, as well as personnel costs associated with expansion of our business. While these expenses represent investments in building our franchise, they initially create a drag on earnings.

Net Interest Income. During the nine months ended September 30, 2002, our net interest income increased by $2.6 million or 26.8% to $12.4 million. Our total interest income benefited from strong growth in the level of average earning assets, which offset lower asset yields caused by the decline in interest rates that occurred from period to period. The rates earned on a significant portion of our loans adjust immediately when index rates such as our prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Because rates have stabilized at a lower level during 2002, downward repricings of our interest-bearing liabilities have been larger than our downward repricings of our interest-earning assets. Average total interest-earning assets increased $114.9 million, or 29.4%, during the first nine months of 2002 as compared to the same period in 2001. Our average yield on total interest-earning assets decreased by 175 basis points from 8.19% to 6.44%. Our average total interest-bearing liabilities increased by $111.4 million, or 32.1%, consistent with the increase in interest-earning assets. Our average cost of total interest-bearing liabilities decreased by 198 basis points from 5.46% to 3.48%. For the nine months ended September 30, 2002, our net interest spread was 2.96% and our net interest margin was 3.29%. For the nine months ended September 30, 2001, our net interest spread was 2.74% and our net interest margin was 3.35%.

Provision for Loan Losses. Our provision for loan losses for the nine months ended September 30, 2002 was $1.2 million, representing a decrease of $320,000 from the $1.5 million provision we made for the nine months ended September 30, 2001. We have continued to increase the level of our allowance for loan losses in response to the growth in our loan portfolio. In evaluating the allowance for loan losses, we consider factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. We have decreased our provision during the current nine-month period in part because of the lower level of net loan charge-offs, which totaled $451,000 during the nine months ended September 30,

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2002, down from $804,000 during the nine months ended September 30, 2001. On an annualized basis, our percentage of net loan charge-offs to average loans outstanding was .16% and .35% for the nine months ended September 30, 2002 and 2001, respectively. Non-performing assets increased to $2.4 million, or 0.41% of total assets at September 30, 2002 from $1.3 million, or 0.27% of total assets at December 31, 2001. The increase is primarily the result of a single relationship with which the bank has a secured position. We consistently provide for our allowance for loan losses. Loss reserves of $6.1 million and $5.4 million represented 1.49% and 1.50% of total loans as of September 30, 2002, and December 31, 2001, respectively. We believe that the allowance is adequate to absorb losses inherent in our loan portfolio.

Non-Interest Income. For the nine months ended September 30, 2002, non-interest income increased by $37,000, or 1.4%, to $2.7 million. Although the core non-interest income components increased $226,000 and there were gains on sales of investment securities of $69,000 during the nine months ended September 30, 2002, the same period in 2001 included non-recurring income of $383,000 from an interest rate floor contract. Increases for the nine months ended September 30, 2002 include an increase of $180,000, or 28.6%, in service charges and fees on deposit accounts as a result of deposit growth, and an increase of $46,000 in other operational income.

Non-Interest Expense. We strive to maintain non-interest expenses at levels that we believe are appropriate given the nature of our operations and the investments in personnel and facilities that have been necessary to support and service our growth. From 1998 forward through the current nine-month period, we have consistently maintained our ratio of non-interest expenses to average total assets below 3%. Because of our growth, we have consistently seen increases in every major component of our non-interest expenses. For the nine months ended September 30, 2002, our non-interest expense increased $2.3 million, or 27.5% over the same period in 2001. Salaries and employee benefit expense increased $1.3 million, or 31.2%, and reflects the addition of personnel in our new branches as well as additions of personnel to expand our business, and, to a lesser degree, normal salary increases. Occupancy and equipment expense increased $317,000, or 20.8%. Other expenses increased $667,000, or 25.6%, reflecting the increased volume of business activity, principally increases in lending and growth in deposit accounts. For the nine months ended September 30, 2002, on an annualized basis, our ratio of non-interest expenses to average total assets improved to 2.63% as compared with 2.67% for the same nine months in 2001.

Provision for Income Taxes. Our provision for income taxes, as a percentage of income before income taxes, was 34.9% and 35.1%, respectively, for the nine months ended September 30, 2002 and 2001.

Liquidity and Capital Resources

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

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

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities; investment securities eligible for pledging to secure borrowings from dealers and customers pursuant to securities sold under repurchase agreements, investments available for sale, loan repayments, loan sales, deposits, and borrowings from the Federal Home Loan Bank and from correspondent banks under overnight federal funds credit lines. In addition to interest rate-sensitive deposits, the Company’s primary demand for liquidity is anticipated fundings under credit commitments to customers.

Because of our continued growth, we have maintained a relatively high position of liquidity in the form of interest-bearing bank deposits, federal funds sold, and investment securities. These aggregated $164.3 million at September 30, 2002 compared to $107.0 million at December 31, 2001. Supplementing customer deposits as a source of funding, we have available lines of credit in the amounts of $27.0 million and $100.0 million from various correspondent banks to purchase federal funds and repurchase agreements, respectively, on a short-term basis. We also have the ability to

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borrow up to $114.2 million from the Federal Home Loan Bank of Atlanta, with $65.0 million outstanding at September 30, 2002 and the ability to borrow up to $107.9 million from the Federal Reserve Bank of Richmond, with no outstanding balances at September 30, 2002. During the first quarter of 2002 we successfully completed a trust preferred securities offering which provided $17.3 million of additional funding in the form of Convertible Junior Subordinated Debentures. This subordinated debt obligation also supplements our regulatory capital. At September 30, 2002, our outstanding commitments to extend credit consisted of loan commitments of $36.3 million and amounts available under home equity credit lines, other credit lines and standby letters of credit of $34.6 million, $33.0 million and $11.5 million, respectively. We believe that our combined aggregate liquidity position is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

We have committed to the construction of a new corporate headquarters. The new headquarters will be built at a construction cost of approximately $2.8 million on land for which we paid $400,000, and will be located at 4605 Country Club Road, Winston Salem, North Carolina. As of September 30, 2002, we had paid $2.0 million in construction costs with estimated completion in the first quarter of 2003.

Throughout our six-year history, our loan demand has exceeded our growth in core deposits. We have therefore relied heavily on time deposits as a source of funds. Time deposits represented 67% of our total deposits at September 30, 2002, as compared with 66% at December 31, 2001. Certificates of deposit of $100,000 or more represented 30% of our total deposits at September 30, 2002 and 28% at December 31, 2001. A portion of these deposits is controlled by members of our Board of Directors and Advisory Board members, or otherwise come from customers considered to have long-standing relationships with our management. Based upon the nature of these relationships, management does not believe we are subject to significant liquidity risk related to these deposits. The Bank also utilizes brokered and out-of-market deposits which amounted to $116.5 million at September 30, 2002. Large time deposits are generally considered rate sensitive, however, we believe a portion of our large time deposits are relationship-oriented, and while we will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention.

At September 30, 2002, our Tier I capital to average quarterly asset ratio was 9.4%, and all of our capital ratios exceeded the minimums established for a well-capitalized bank by regulatory measures. Our Tier I risk-based capital ratio at September 30, 2002 was 11.2%.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking and borrowing activities. The structure of the Company’s loan and liability portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. The Company does not maintain a trading account nor is the Company subject to currency exchange risk or commodity price risk.

Management believes there has not been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2001.

Item 4. Controls and Procedures

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures within 90 days prior to the filing of this quarterly report, and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no significant

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changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Part II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K.

Two reports on Form 8-K were filed by the Company during the quarter ended September 30, 2002. One report was filed on July 24, 2002 to report financial results for the second quarter and six months ended June 30, 2002.

Another report was filed on September 27, 2002 to announce that the Board of Directors had declared a five percent stock dividend to common stock shareholders. The dividend was paid October 15, 2002 to shareholders of record on October 1, 2002.

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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:	November 13, 2002	By:	/s/ F. Scott Bauer

			F. Scott Bauer Chairman and Chief Executive Officer









Date:	November 13, 2002	By:	/s/ Richard M. Cobb

			Richard M. Cobb Executive Vice President, Chief Operating Officer and Chief Financial Officer

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CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, F. Scott Bauer, certify that:

(1) I have reviewed this quarterly report on Form 10-Q of Southern Community Financial Corporation, a North Carolina holding company (the “registrant”);

(2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this quarterly report;

(3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls;

(6) The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: November 13, 2002	By:	/s/ F. Scott Bauer

		F. Scott Bauer Chairman and Chief Executive Officer

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CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Richard M. Cobb, certify that:


Date: November 13, 2002	By:	/s/ Richard M. Cobb

		Richard M. Cobb Executive Vice President, Chief Operating Officer and Chief Financial Officer

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	(b)		Reports on Form 8-K.

			Two reports on Form 8-K were filed by the Company during the quarter ended September 30, 2002. One report was filed on July 24, 2002 to report financial results for the second quarter and six months ended June 30, 2002.

			Another report was filed on September 27, 2002 to announce that the Board of Directors had declared a five percent stock dividend to common stock shareholders. The dividend was paid October 15, 2002 to shareholders of record on October 1, 2002.

(1)		I have reviewed this quarterly report on Form 10-Q of Southern Community Financial Corporation, a North Carolina holding company (the “registrant”);

(2)		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this quarterly report;

(3)		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

(4)		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	(a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	(b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	(c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

	(a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	(b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls;