10-Q 1 community930_10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Mark One /X/ QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the quarter period ended September 30, 2002 / / TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT For the transition period from _______ to _______ Commission File Number: 33-81890 Community Bankshares, Inc. ---------------------------------- (Exact name of registrant as specified in its charter) Georgia 58-1415887 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 448 North Main Street, Cornelia, Georgia 30531 (Address of principal executive offices) (Zip Code) (706) 778-2265 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant has (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 APPLICABLE ONLY TO CORPORATE ISSUERS Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of November 1, 2002: 2,169,757 COMMUNITY BANKSHARES, INC. AND SUBSIDIARIES INDEX Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheet - September 30, 2002 and December 31, 2001 2 Consolidated Statements of Income and Comprehensive Income for Three Months Ended September 30, 2002 and 2001 and Nine Months Ended September 30, 2002 and 2001 3 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6 Item 3. Quantitative and Qualitative Disclosures about Market Risk 7 Item 4. Controls & Procedures PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8 - K 8 Signatures 9 Certifications 10 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS

COMMUNITY BANKSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION The consolidated financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in our opinion, necessary for a fair statement of results for the interim periods. The results of operations for the three and nine month periods ending September 30, 2002 are not necessarily indicative of the results to be expected for the full year. NOTE 2. RECENT DEVELOPMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement No. 141 (SFAS No. 141), "Business Combinations" and Statement No. 142 (SFAS No. 142), "Goodwill and Other Intangible Assets". SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. The impact of this change has resulted in a reduction of amortization expense of $2,000 per quarter. Goodwill was evaluated prior to June 30, 2002 and it was determined no write-down because of impairment was warranted. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. SFAS No. 141 was effective July 1, 2001 while the provisions of SFAS No. 142 were adopted effective January 1, 2002. NOTE 3. EARNINGS PER COMMON SHARE The following is a reconciliation of net income (the numerator) and weighted-average shares outstanding (the denominator) used in determining basic and diluted earnings per common share (EPS).

NOTE 4 SEGMENT INFORMATION Selected segment information by industry segment for the three and nine month periods ended September 30, 2002 and 2001 is as follows:

TOTAL ASSETS 2002 ------------ --------- Total assets for reportable segments $ 697,466 Non-reportable segment assets 5,591 Elimination of intersegment assets (22,943) --------- Total consolidated assets $ 680,113 COMMUNITY BANKSHARES, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Statements ---------------------------------------------- The following appears in accordance with the Securities Litigation Reform Act. These financial statements and discussion and analysis include forward looking statements that involve inherent risks and uncertainties. A number of important factors could cause actual results to differ materially from those in the forward looking statements. Those factors include fluctuations in interest rates, inflation, government regulations, economic conditions, and competition in the geographic business areas in which we conduct operations. Management's Discussion and Analysis ---------------------------------------------- The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements. Financial Condition As of September 30, 2002, we continue to experience moderate growth in total assets, total loans and total deposits as compared to December 31, 2001. Total assets, loans, and deposits increased by 5.25%, 5.23% and 4.65% respectively. The growth in all areas except for loans is slightly less than the same period last year but consistent with management's expectations. The growth in assets is attributable to growth in deposits and retention of earnings. Management expects the growth to continue in the future. Liquidity As of September 30, 2002, the liquidity ratio was 21.33% which is within our target range of 20 - 25%. The banks have available lines of credit to meet unexpected liquidity needs. Liquidity is measured by the ratio of net cash, short term and marketable securities to net deposits and short term liabilities. Interest Rate Risk Our overall interest rate risk was less than 3% of net interest income subjected to rising and falling rates of 200 basis points. We have positioned ourselves to minimize the affect of changes in rates in either direction. Capital Banking regulation requires the Company and the Banks to maintain capital levels in relation to our assets. At September 30, 2002, the Company's and banks' capital ratios were considered well capitalized based on regulatory minimum capital requirements. The minimum capital requirements and the actual capital ratios for the Company at September 30, 2002 were as follows:

Results of Operation Net interest income for the nine month period ended September 30, 2002 is up 6.41% over the same period for 2001, from $18,851,000 to $20,059,000 and is up 10.73% for the three month period ending September 30, 2002 from $6,263,000 to $6,935,000 for 2002. Interest income was down by 11.57% for the nine month period ending September 30, 2002 from $36,954,000 to $32,678,000 and down 9.29% for the three month period ending September 30, 2002 from $12,075,000 to $10,953,000. The decrease in interest income is the net effect of a decrease in the average prime rate from one year ago and an increase in earning assets of $42,655,000 from September 2001 to September 2002. This represents a 7.44% increase in earning assets and includes a 27.70% increase in investments of $28,075,000 and a 7.15% increase in total loans amounting to $31,988,000 for the 12 month period. Federal Funds sold declined by $17,450,000 during this 12 month period. Interest expense was down 30.29% or $5,484,000 for the nine month period ended September 30, 2002, over the same period in 2001 and down 30.87% or $1,794,000 for the three month period ending September 30, 2002, as compared to 2001. These decreases were related directly to the lower rate environment. The Company's net interest margin was 4.89% for the nine month period ended September 30, 2002 compared to 4.48% for the same period in 2001. Management plans for a stable net interest margin over the next twelve months. Any increase in rates would have a slight positive effect on our net interest margin, and conversly, any decrease in rates would have a slight negative effect on our net interest margin. The loan loss reserve is evaluated quarterly and adjusted to reflect the risk in the portfolio in the following manner. We use two different methods of measuring risk in the portfolio: (1) Risk in our watch list of loans and past due ratios, (2) Percentage of classified loans and 3) and Historical Charge-offs. We then compare results to reserve balances to assure all identified risk are covered. The following table furnishes information on the loan loss reserve for the current nine month reporting period and the same period for 2001. 2002 2001 ------- ------- Beginning Balance $ 6,652 $ 6,307 Less Charge Offs: Commercial Loans (167) (117) Real Estate Loans (618) (151) Consumer Loans (544) (726) (1,329) (994) ------- ------- Plus Recoveries Commercial Loans 19 14 Real Estate Loans 17 11 Consumer Loans 133 119 ------- ------- 169 144 ------- ------- Net Charge-offs (1,160) (859) ------- ------- Provision for loan loss 1,694 1,201 ------- ------- Ending Balance $ 7,186 $ 6,658 ======= ======= The majority of the real estate loan charge-offs for 2002 related to one loan and does not represent a general decline in the real estate portfolio. The provision for loan losses for the nine month period ended September 30, 2002 represented 127.5% of charge-offs for the same period, while the provision for the first nine months of 2001 represented 120% of the charge offs recorded in that period. The reserve at September 30, 2002 represented 180% of non-accrual loans while the reserve at September 30, 2001 represented 184% of non-accrual loans. Non-accrual loans have increased from $3,613,000 at September 30, 2001 to $3,997,000 as of September 30, 2002. Past due loans greater than 90 days and accruing interest have increased from $2,121,000 in 2001 to $2,367,000 in 2002. The level of non-accrual loans and past due loans is indicative of the overall state of the economy. Our net charged-off loans to total loan ratio was .24% for the nine month period ended September 30, 2002 compared to .19% for the same period in 2001. The loan loss reserve balance to total loan ratio at September 30, 2002 was 1.50% as compared to 1.49% at September 30, 2001. Management considered the loan loss reserve to be adequate to absorb any anticipated losses that may be incurred. The following table is a summary of Non Accrual, Past due and Restructured Debt

Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been included in the table above do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. These classified loans do not represent material credits about which management is aware of any information which causes management to have doubts concerning the collectibility of such credits. The banks place loans on non-accrual at such a time it is apparent that the collection of principal and interest is questionable and the loan is either past due 90 days or bankruptcy has been filed. Other income increased by 3.01% or $389,000 during the nine month period ended September 30, 2002 as compared to the same period for 2001 and the three month period ending September 30, 2002 showed a 49.31% or $1,674,000 increase over the same three month period of 2001. The increase during both the three month and nine month periods is attributed to amending FSI's contract to install banking pavilions for the Canadian Imperial of Commerce. Without the one time settlement other income decreased for the nine month period ended September 30, 2002. This decrease for the nine month period is primarily due to the decrease in activity associated with an agreement between Financial Supermarkets, Inc. (FSI), a nonbank subsidiary, and the Canadian Imperial Bank of Commerce ("CIBC") to establish banking pavilions in Florida. Due to slowing economic conditions, management anticipates fewer sales of supermarket bank units. Service charges on deposit accounts increased by $596,000 or 18.51% for the nine month period ended September 30, 2002, and increased $170,000 or 14.72% for the three month period ended September 30, 2002, as compared to the same periods in 2001. During the last two quarters of 2001, the banks started charging a daily overdraft fee on accounts that are overdrawn more than one day. During the nine and three month periods ended September 30, 2002, these fees totaled $487,000 and $196,000 respectively. Non-sufficient funds (NSF) charges increased $141,000 and $72,000 for the nine month period and the three month period ended September 30, 2002, respectively, compared to the same period in 2001. NSF charges increased primarily as a result of our continued growth in accounts in the totally free checking program. Other expenses increased by .38% or $89,000 for the nine month period ended September 30, 2002, and increased 5.39% or $400,000 for the three month period ending September 30, 2002 as compared to the same periods in 2001. Salaries and benefits increased by $497,000 or 3.97% during the nine month period ended September 30, 2002 compared to the same period in 2001. Full time equivalent employees increased only from 383 at the end of September 2001 to 387 at the end of September 2002. Other operating expenses reflected a reduction of 8.56% or $616,000 for the nine month period ending September 30, 2002 when compared to the nine month period ended September 30, 2001 and a 7.89% decrease for the three month period ending September 30, 2002 compared to the same period in 2001. In other operating expenses, travel expenses decreased 31.69% or $393,000 for the nine month period ended September 30, 2002, and 28.19% or $115,000 for the three month period ended September 30, 2002. These decreases are due to a slow down in non-bank subsidiary travel during the nine months ended September 30, 2002. In addition, legal fees decreased by 51.56% or $132,000 for the nine month period ended September 30, 2002 and 52.44% or $43,000 for the three month period ended September 30, 2002 when compared to the same periods in 2001. We incurred income tax expenses of $1,006,000 which represents an effective rate of 28.41% for the three month period ended September 30, 2002 as compared to $516,000 which represents an effective tax rate of 28.12% for the same period in 2001. In addition, we incurred income tax expenses of $2,259,000 which represents an effective rate of 28.16% for the nine month period ended September 30, 2002 as compared to $2,067,000 which represents an effective tax rate of 29.49% for the same period in 2001. Net income for the nine month period ended September 30, 2002, was $5,764,000 or an increase of 16.66% and for the three month period ended September 30, 2002, was $2,535,000 or an increase of 92.20% over the same periods for 2001. Our income fluctuated due to the timing of supermarket bank installations and the one time settlement for the contract amendment with CIBC in the third quarter. We are not aware of any other known trends, events or uncertainties, other than the effect of events as described above, that will have or that are reasonably likely to have a material effect on its liquidity, capital resources or operations. We are also not aware of any current recommendations by the regulatory authorities which, if they were implemented, would have such an effect. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed only to U.S. dollar interest rate changes and accordingly, the Company manages exposure by considering the possible changes in the net interest margin. The Company does not have any trading instruments nor does it classify any portion of the investment portfolio as held for trading. The Company does not engage in any hedging activities or enter into any derivative instruments with a higher degree of risk than mortgage backed securities, which are commonly pass through securities. Finally, the Company has no exposure to foreign currency exchange rate risk, commodity price risk, and other market risks. Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as "interest rate risk". The repricing of interest earning assets and interest-bearing liabilities can influence the changes in net interest income. As part of the Company's asset/liability management program, the timing of repriced assets and liabilities is referred to as Gap management. It is the policy of the Company to maintain Gap ratio in the one-year time horizon of .80 to 1.20. GAP management alone is not enough to properly manage interest rate sensitivity, because interest rates do not respond at the same speed or at the same level to market rate changes. For example, savings and money market rates are more stable than loans tied to a "Prime" rate and thus respond with less volatility to a market rate change. The Company uses a simulation model to monitor changes in net interest income due to changes in market rates. The model of rising, falling and stable interest rate scenarios allows management to monitor and adjust interest rate sensitivity to minimize the impact of market rate swings. The analysis of impact on net interest margins as well as market value of equity over a twelve-month period is subjected to a 200 basis point increase and decrease in rate. The September 2002 model reflects an increase of 2.61% in net interest income and a 15.53% decrease in market value equity for a 200 basis point increase in rates. The same model shows a 2.58% decrease in net interest income and an 8.8% increase in market value equity for a 200 basis point decrease in rates. The Company's policy is to allow no more than +-8% change in net interest income and no more than +-25% change in market value equity for these scenarios. Therefore, the Company is within its policy guidelines and is protected from any significant impact due to market rate changes. ITEM 4. CONTROLS & PROCEDURES Our management, including the chief executive and chief financial officers, supervised and participated in an evaluation of our disclosure controls and procedures (as defined in federal securities rules) within the 90 days before we filed this report. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures were effective as of the date of that evaluation. There were no significant changes in our 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 -------- 10.1 Amendment No. 1 to Consulting Agreement 99.1 Certification Pursuant to 18 U.S.C. Section 1350. 99.2 Certification Pursuant to 18 U.S.C. Section 1350. (b) Reports on Form 8-K -------------------- None SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COMMUNITY BANKSHARES, INC. DATE: November 14, 2002 BY: /s/ Harry L. Stephens Harry L. Stephens, Executive Vice President and Chief Financial Officer CERTIFICATION I, Harry L. Stephens, certify that: 1. I have reviewed this quarterly report on Form 10Q of Community Bankshares, Inc.; 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 period 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 officers 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 we 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 withih 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 officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): 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; and 6. The registrant's other certifying officers 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 14, 2002 /s/ Harry L. Stephens Harry L. Stephens Executive Vice-President and Chief Financial Officer CERTIFICATION I, J. Alton Wingate, certify that: 1. I have reviewed this quarterly report on Form 10Q of Community Bankshares, Inc.; 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 period 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 officers 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 we 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 officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): 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; and 6. The registrant's other certifying officers 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 14, 2002 /s/ J. Alton Wingate J. Alton Wingate President and Chief Executive Officer

COMMUNITY BANKSHARES INC /GA/ 10-Q