SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008 Commission File No. 000-22054
COMMUNITY BANKSHARES, INC.
-------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
South Carolina 57-0966962
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
102 Founders Court
Orangeburg, South Carolina 29118
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(Address of principal executive offices, zip code)
(803) 535-1060
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(Registrant's telephone number, including area code)
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 is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions 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]
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: Common Stock, no par
or stated value, 4,450,556 shares outstanding on July 15, 2008.
COMMUNITY BANKSHARES, INC.
FORM 10-Q
Index
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Changes in Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4T. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 6. Exhibits 28
SIGNATURES 29
2
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
COMMUNITY BANKSHARES, INC.
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
2008 2007
---- ----
(Dollars in thousands)
Assets
Cash and due from banks ................................................................. $ 23,860 $ 18,701
Federal funds sold ...................................................................... 7,631 6,985
--------- ---------
Total cash and cash equivalents .................................................. 31,491 25,686
Interest-bearing deposits with other banks .............................................. 364 911
Securities available-for-sale ........................................................... 78,463 57,868
Securities held-to-maturity (estimated fair value $1,650 for 2008
and $1,650 for 2007) ............................................................... 1,650 1,650
Other investments ....................................................................... 3,768 3,209
Loans held for sale ..................................................................... 5,392 3,509
Loans receivable ........................................................................ 446,268 464,039
Less, allowance for loan losses ..................................................... (5,939) (5,343)
--------- ---------
Net loans ........................................................................ 440,329 458,696
Premises and equipment - net ............................................................ 10,904 10,820
Accrued interest receivable ............................................................. 3,212 3,547
Net deferred income tax assets .......................................................... 2,079 1,357
Goodwill ................................................................................ 4,321 4,321
Core deposit intangible assets .......................................................... 2,222 2,345
Prepaid expenses and other assets ....................................................... 2,690 2,648
--------- ---------
Total assets ..................................................................... $ 586,885 $ 576,567
========= =========
Liabilities
Deposits
Noninterest bearing ................................................................. $ 59,342 $ 57,738
Interest-bearing .................................................................... 422,998 423,969
--------- ---------
Total deposits ................................................................... 482,340 481,707
Short-term borrowings ................................................................... 6,333 9,893
Long-term debt .......................................................................... 42,174 29,679
Accrued interest payable ................................................................ 1,193 1,501
Accrued expenses and other liabilities .................................................. 1,747 142
--------- ---------
Total liabilities
533,787 522,922
--------- ---------
Shareholders' equity
Common stock - no par value; 12,000,000 shares authorized; issued and
outstanding - 4,450,556 for 2008 and 4,446,456 for 2007 ............................. 30,399 30,505
Retained earnings ....................................................................... 23,773 22,812
Accumulated other comprehensive income .................................................. (1,074) 328
--------- ---------
Total shareholders' equity ....................................................... 53,098 53,645
--------- ---------
Total liabilities and shareholders' equity ....................................... $ 586,885 $ 576,567
========= =========
See accompanying notes to unaudited consolidated financial statements.
3
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Income
(Unaudited)
Period Ended June 30,
Three Months Six Months
------------ ----------
2008 2007 2008 2007
---- ---- ---- ----
(Dollars in thousands, except per share)
Interest and dividend income
Loans, including fees ..................................... $ 7,728 $ 8,628 $16,169 $16,785
Interest bearing deposits with other banks ................ 1 13 12 46
Debt securities ........................................... 929 984 1,675 2,000
Dividends ................................................. 63 46 122 93
Federal funds sold ........................................ 89 80 270 260
------- ------- ------- -------
Total interest and dividend income ................. 8,810 9,751 18,248 19,184
------- ------- ------- -------
Interest expense
Deposits
Time deposits $100M and over .......................... 1,055 1,080 2,298 2,073
Other deposits ........................................ 1,823 2,692 4,056 5,337
------- ------- ------- -------
Total interest expense on deposits ................. 2,878 3,772 6,354 7,410
Short-term borrowings ..................................... 29 187 88 303
Long-term debt ............................................ 461 475 952 912
------- ------- ------- -------
Total interest expense ............................. 3,368 4,434 7,394 8,625
------- ------- ------- -------
Net interest income ............................................ 5,442 5,317 10,854 10,559
Provision for loan losses ...................................... 540 175 1,010 550
------- ------- ------- -------
Net interest income after provision ............................ 4,902 5,142 9,844 10,009
------- ------- ------- -------
Noninterest income
Service charges on deposit accounts ....................... 892 939 1,819 1,830
Mortgage loan brokerage income ............................ 473 744 995 1,399
Net securities gains ...................................... - - 34 2
Gains on sales of other investments ....................... - 712 - 712
Other ..................................................... 332 372 616 649
------- ------- ------- -------
Total noninterest income ........................... 1,697 2,767 3,464 4,592
------- ------- ------- -------
Noninterest expenses
Salaries and employee benefits ............................ 2,918 3,084 5,765 6,018
Premises and equipment .................................... 578 619 1,201 1,181
Advertising ............................................... 188 138 349 281
Supplies .................................................. 97 110 194 235
Other ..................................................... 1,320 1,650 2,578 3,000
------- ------- ------- -------
Total noninterest expenses ......................... 5,101 5,601 10,087 10,715
------- ------- ------- -------
Income before income taxes ..................................... 1,498 2,308 3,221 3,886
Income tax expense ............................................. 571 838 1,193 1,411
------- ------- ------- -------
Net income ..................................................... $ 927 $ 1,470 $ 2,028 $ 2,475
======= ======= ======= =======
Per share
Net income ................................................ $ 0.21 $ 0.33 $ 0.46 $ 0.56
Net income - diluted ...................................... 0.20 0.32 0.45 0.55
Cash dividends declared ................................... 0.12 0.12 0.24 0.24
See accompanying notes to unaudited consolidated financial statements.
4
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
Common Stock
------------ Accumulated
Number of Retained Other Comprehensive
Shares Amount Earnings Income (Loss) Total
------ ------ -------- ------------- -----
(Dollars in thousands, except per share)
Balance, January 1, 2007 ................................ 4,441,220 $ 30,603 $ 22,382 $ (361) $ 52,624
----------
Comprehensive income
Net income .......................................... - - 2,475 - 2,475
----------
Unrealized holding gains and (losses)
on available-for-sale securities arising
during the period, net of income taxes of $174 ... - - - (351) (351)
Reclassification adjustment for losses (gains)
realized in income, net of income taxes of $1 .... - - - (1) (1)
----------
Total other comprehensive income (loss) ... ..... - - - - (352)
----------
Total comprehensive income .................... - - - - 2,123
----------
Share-based compensation ................................ - 27 - - 27
Proceeds of sale of common stock ........................ 500 8 - - 8
Exercise of employee stock options ...................... 41,836 406 - - 406
Cash dividends declared, $.24 per share ................. - - (1,075) - (1,075)
---------- ---------- ---------- ---------- ----------
Balance, June 30, 2007 .................................. 4,483,556 $ 31,044 $ 23,782 $ (713) $ 54,113
========== ========== ========== ========== ==========
Balance, January 1, 2008 ................................ 4,446,456 $ 30,505 $ 22,812 $ 328 $ 53,645
----------
Comprehensive income
Net income .......................................... - - 2,028 - 2,028
----------
Unrealized holding gains and (losses)
on available-for-sale securities arising
during the period, net of income taxes of $711 ... - - - (1,380) (1,380)
Reclassification adjustment for losses (gains)
realized in income, net of income taxes of $12 ... - - - (22) (22)
----------
Total other comprehensive income (loss) ......... - - - - (1,402)
----------
Total comprehensive income .................... - - - - 626
----------
Share-based compensation ................................ - 18 - - 18
Proceeds of sale of common stock ........................ 10,600 119 - - 119
Exercise of employee stock options ...................... 1,000 11 - - 11
Common stock repurchased and cancelled .................. (20,700) (254) - - (254)
Restricted stock grants to employees .................... 13,200 - - - -
Cash dividends declared, $.24 per share ................. - - (1,067) - (1,067)
---------- ---------- ---------- ---------- ----------
Balance, June 30, 2008 .................................. 4,450,556 $ 30,399 $ 23,773 $ (1,074) $ 53,098
========== ========== ========== ========== ==========
See accompanying notes to unaudited consolidated financial statements.
5
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
--------
2008 2007
----- ----
(Dollars in thousands)
Operating activities
Net income ............................................................................ $ 2,028 $ 2,475
Adjustments to reconcile net income to net
cash provided by operating activities
Provision for loan losses ...................................................... 1,010 550
Depreciation and amortization .................................................. 571 537
Net accretion of securities .................................................... (86) (15)
Net securities gains ........................................................... (34) (2)
Gains on sales of other investments ............................................ - (712)
Proceeds of sales of loans held for sale ....................................... 48,533 77,439
Originations of loans held for sale ............................................ (49,421) (75,926)
Gains on sales of loans held for sale .......................................... (995) (1,399)
Decrease in accrued interest receivable ........................................ 335 284
(Increase) decrease in other assets ............................................ (94) 868
Gains on sales of foreclosed assets ............................................ (101) (48)
Decrease in accrued interest payable ........................................... (308) (53)
Increase (decrease) in other liabilities ....................................... 1,458 (647)
Provision for off balance sheet credit exposure ................................ 160 144
Share-based compensation ....................................................... 18 27
-------- --------
Net cash provided by operating activities .................................. 3,074 3,522
-------- --------
Investing activities
Net decrease in interest-bearing deposits with other banks ............................ 547 1,477
Purchases of available-for-sale securities ............................................ (60,371) (1,966)
Maturities, calls and paydowns of available-for-sale securities ....................... 37,772 7,546
Proceeds of sales of other investments ................................................ 116 1,182
Purchases of other investments ........................................................ (675) (338)
Net decrease (increase) in loans made to customers .................................... 17,280 (38,831)
Purchases of premises and equipment ................................................... (532) (530)
Proceeds from sales and other disposals of premises and equipment ..................... - 44
Proceeds from sales of foreclosed assets .............................................. 217 578
-------- --------
Net cash used by investing activities ...................................... (5,646) (30,838)
-------- --------
Financing activities
Net increase (decrease) in deposits ................................................... 633 (3,376)
Net (decrease) increase in short-term borrowings ...................................... (3,560) 6,000
Proceeds from issuing long-term debt .................................................. 15,000 7,500
Repayment of long-term debt ........................................................... (2,505) (4,005)
Exercise of employee stock options .................................................... 11 406
Sale of common stock .................................................................. 119 8
Common stock repurchased and cancelled ................................................ (254) -
Cash dividends paid ................................................................... (1,067) (1,075)
-------- --------
Net cash provided by financing activities .................................. 8,377 5,458
-------- --------
Increase (decrease) in cash and cash equivalents ........................................... 5,805 (21,858)
Cash and cash equivalents, beginning of period ............................................. 25,686 46,724
-------- --------
Cash and cash equivalents, end of period ................................................... $ 31,491 $ 24,866
======== ========
See accompanying notes to unaudited consolidated financial statements.
6
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
Six Months Ended
June 30,
2008 2007
----- ----
(Dollars in thousands)
Supplemental disclosures of cash flow information
Cash payments for interest .......................................................... $7,702 $8,678
====== ======
Cash payments for income taxes ...................................................... $ 897 $1,625
====== ======
Supplemental disclosures of non-cash investing activities
Transfers of loans receivable to foreclosed assets .................................. $ 77 $1,127
====== ======
See accompanying notes to unaudited consolidated financial statements.
COMMUNITY BANKSHARES, INC.
Notes to Unaudited Consolidated Financial Statements
Accounting Principles - A summary of significant accounting policies and the
audited financial statements for 2007 are included in Community Bankshares,
Inc.'s (the "Company" or "CBI") Annual Report on Form 10-K for the year ended
December 31, 2007 filed with the Securities and Exchange Commission. Certain
amounts in the 2007 financial statements have been reclassified to conform to
the current presentation.
Management Opinion - The interim financial statements in this report are
unaudited. In the opinion of management, all the adjustments necessary to
present a fair statement of the results for the interim period have been made.
Such adjustments are of a normal and recurring nature. The results of operations
for any interim period are not necessarily indicative of the results to be
expected for an entire year. These interim financial statements should be read
in conjunction with the annual financial statements and notes thereto contained
in the 2007 Annual Report on Form 10-K.
Nonperforming Loans - As of June 30, 2008, there were $8,976,000 in nonaccrual
loans and $7,000 in loans 90 or more days past due and still accruing interest.
Earnings Per Share - Basic earnings per share is computed by dividing net income
applicable to common shares by the weighted average number of common shares
outstanding. Diluted earnings per share is computed by dividing applicable net
income by the weighted average number of shares outstanding and any dilutive
potential common shares and dilutive stock options. It is assumed that all
dilutive stock options are exercised at the beginning of each period and that
the proceeds are used to purchase shares of the Company's common stock at the
average market price during the period. Net income per share basic and net
income per share, assuming dilution, were computed as follows:
7
(Unaudited)
Period Ended June 30,
---------------------
Three Months Six Months
------------ ----------
2008 2007 2008 2007
---- ---- ---- ----
(Dollars in thousands, except per share amounts)
Net income per share, basic
Numerator - net income ............................... $ 927 $ 1,470 $ 2,028 $ 2,475
========== ========== ========== ==========
Denominator
Weighted average common shares
issued and outstanding .......................... 4,453,360 4,476,229 4,451,408 4,462,464
========== ========== ========== ==========
Net income per share, basic ..................... $ .21 $ .33 $ .46 $ .56
========== ========== ========== ==========
Net income per share, assuming dilution
Numerator - net income ............................... $ 927 $ 1,470 $ 2,028 $ 2,475
========== ========== ========== ==========
Denominator
Weighted average common shares
issued and outstanding .......................... 4,453,360 4,476,229 4,451,408 4,462,464
Effect of dilutive stock options .................. 96,660 49,123 80,049 52,981
---------- ---------- ---------- ----------
Total shares ............................ 4,550,020 4,525,352 4,531,457 4,515,445
========== ========== ========== ==========
Net income per share, assuming dilution ......... $ .20 $ .32 $ .45 $ .55
========== ========== ========== ==========
Stock Based Compensation - Effective January 1, 2006, the Company began
accounting for compensation expenses related to stock options granted to
employees and directors under the recognition and measurement principles of
Statement of Accounting Standards No. 123(R) "Share-Based Payment" ("SFAS
123(R)") using the modified prospective application method. The Company had
previously elected to continue using the methodology of Accounting Principles
Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees,"
to account for compensation expenses related to stock-based compensation until
the mandatory effective date for SFAS 123(R).
On March 31, 2008, the Company awarded 13,200 shares of restricted
stock and 45,650 stock appreciation rights ("SARS") to certain employees under
the 2007 Equity Plan. The restricted shares will vest in five years. The SARs
will vest 20% per year over the next five years. Recognition of compensation
expense for these awards began in the second quarter of 2008. Accordingly,
$18,000 of such expenses are included in salaries and employee benefits in the
statements of income. The Company's 2007 Equity Compensation Plan provides that
in the event of a change in control, such as the pending merger plan with First
Citizens discussed below, outstanding and unvested options, SARs, or other types
of equity compensation become immediately vested.
Variable Interest Entity - On March 8, 2004, CBI sponsored the creation of a
Variable Interest Entity ("VIE"), SCB Capital Trust I (the "Trust"), and is the
sole owner of the common securities issued by the Trust. On March 10, 2004, the
Trust issued $10,000,000 in floating rate capital securities. The proceeds of
this issuance, and the amount of CBI's capital investment, were used to acquire
$10,310,000 principal amount of CBI's floating rate junior subordinated
deferrable interest debt securities ("Debentures") due April 7, 2034, which
securities, and the accrued interest thereon, now constitute the Trust's sole
assets. The interest rate associated with the debt securities, and the
distribution rate on the common securities of the Trust, was established
initially at 3.91% and is adjustable quarterly at 3 month LIBOR plus 280 basis
points. The index rate (LIBOR) may not be lower than 1.11%. CBI may defer
8
interest payments on the Debentures for up to twenty consecutive quarters, but
not beyond the stated maturity date of the Debentures. In the event that such
interest payments are deferred by CBI, the Trust may defer distributions on the
common securities. In such an event, CBI would be restricted in its ability to
pay dividends on its common stock and to perform under other obligations that
are not senior to the junior subordinated Debentures.
The Debentures are redeemable at par at the option of CBI, in whole or
in part, on any interest payment date on or after April 7, 2009. Prior to that
date, the Debentures are redeemable at 105% of par upon the occurrence of
certain events that would have a negative effect on the Trust or that would
cause it to be required to be registered as an investment company under the
Investment Company Act of 1940 or that would cause trust preferred securities
not to be eligible to be treated as Tier 1 capital by the Federal Reserve Board.
Upon repayment or redemption of the Debentures, the Trust will use the proceeds
of the transaction to redeem an equivalent amount of trust preferred securities
and trust common securities. The Trust's obligations under the trust preferred
securities are unconditionally guaranteed by CBI. In accordance with Financial
Accounting Standards Board Interpretation 46(R), the Trust is not consolidated
in the Company's financial statements.
The Company's investment in the Trust is carried at cost in other
assets and the debentures are included in long-term debt in the consolidated
balance sheet.
Fair Value Measurements
The Company implemented Statement of Financial Accounting Standards No.
157, "Fair Value Measurements," ("SFAS No. 157") as required on January 1, 2008.
SFAS No. 157 defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly fashion between market
participants at the measurement date, and establishes a framework for measuring
fair value. It also establishes a three-level hierarchy for fair value
measurements based upon the transparency of inputs to the valuation of an asset
or liability as of the measurement date, eliminates the consideration of large
position discounts for financial instruments quoted in active markets, requires
consideration of the Company's creditworthiness when valuing its liabilities,
and expands disclosures about instruments measured at fair value. The following
is a summary of the measurement attributes applicable to financial assets and
liabilities that are measured at fair value on a recurring basis:
Fair Value Measurement at Reporting Date Using
----------------------------------------------
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
Description June 30, 2008 (Level 1) (Level 2) (Level 3)
----------- ------------- --------- --------- ---------
Assets (Dollars in thousands)
Securities available-for-sale ....... $ - $78,463 $ -
Derivatives ......................... - 7 -
Liabilities
Derivatives ......................... - 7 -
Pricing for the Company's securities available-for-sale is obtained
from an independent third-party that uses a process that may incorporate current
market prices, benchmark yields, broker/dealer quotes, issuer spreads, two-sided
9
markets, benchmark securities, bids, offers, other reference data and industry
and economic events that a market participant would be expected to use in
valuing the securities. Not all of the inputs listed apply to each individual
security at each measurement date. The independent third party assigns specific
securities into an "asset class" for the purpose of assigning the applicable
level of the fair value hierarchy used to value the securities. The techniques
used after adoption of SFAS No. 157 are consistent with the methods used
previously.
No cumulative effect adjustments were required upon initial application
of SFAS No. 157. Available-for-sale securities continue to be measured at fair
value with unrealized gains or losses recorded in other comprehensive income.
The following is a summary of the measurement attributes applicable to
assets and liabilities that are measured at fair value on a non-recurring basis:
Fair Value Measurement at Reporting Date Using
----------------------------------------------
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
Description June 30, 2008 (Level 1) (Level 2) (Level 3)
----------- ------------- --------- --------- ---------
(Dollars in thousands)
Collateral dependent impaired loans $ - $ - $ 8,976
Foreclosed Assets - 813 -
Goodwill - - 4,321
Core deposit intangibles - - 2,222
Collateral dependent impaired loans consist of nonaccrual loans for
which the underlying collateral provides the sole repayment source. The Company
measures the amount of the impairment for such loans by determining the
difference between the fair value of the underlying collateral and the recorded
amount of the loan. The fair value of the underlying collateral generally is
based on appraisals performed in accordance with applicable appraisal standards
by independent appraisers engaged by the Company. In many cases, management
updates values reflected in older appraisals obtained at the time of loan
origination and already in the Company's possession using its own knowledge,
judgments and assumptions about current market and other conditions in lieu of
obtaining a new independent appraisal. If the fair value of the collateral is
less than the recorded amount of the loan, a valuation allowance is established
for the difference; otherwise, no valuation allowance is established. The
valuation allowance for impaired loans is a component of the allowance for loan
losses. Periodically, management reevaluates the fair value of the collateral
and makes adjustments to the valuation allowance as appropriate. However, if the
fair value of the collateral subsequently recovers in value such that it exceeds
the recorded loan amount, no adjustment is made in the loan's value for the
excess. The amount of the valuation allowance for the Company's collateral
dependent impaired loans was $1,168,000 as of June 30, 2008.
Foreclosed assets consist of assets acquired through, or in lieu of,
loan foreclosure, and are held for sale and initially were recorded at fair
value, less estimated costs to sell at the date of acquisition, thus
establishing a new cost basis. Loan losses arising from the acquisitions of such
property are charged against the allowance for loan losses at the date the
property is acquired. Subsequent to acquisition, valuations are performed
periodically and the assets are carried at the lower of the new cost basis or
10
fair value. Revenues and expenses from operations and changes in any subsequent
valuation allowance are included in net foreclosed assets costs and expenses.
Goodwill was initially recorded as the difference between the purchase
price and the fair values of tangible assets, separately identifiable intangible
assets, and liabilities acquired in prior business combination transactions.
Goodwill is tested for impairment no less than annually. The Company previously
has not recognized any impairment of goodwill.
Core deposit intangibles represent the excess of the purchase price of
core deposits over their fair values at the date of their acquisition in a
purchase transaction. The core deposit intangible is amortized as a component of
other expense over the estimated lives of the deposits acquired. During the
first two quarters of 2008, $123,000 of such amortization was included in net
income.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 159 "The Fair Value Option for Financial Assets and
Financial Liabilities," ("SFAS No. 159" or the "Statement") which was effective
for the Company as of January 1, 2008. Under the provisions of SFAS No. 159,
entities may choose, but are not required, to measure many financial instruments
and certain other items at their fair values, with changes in the fair values of
those instruments reported in earnings. The Company has not elected to measure
at fair value any financial instruments under the provisions of SFAS No. 159.
The adoption of the Statement had no effect on the Company's financial
statements.
Proposed Merger Transaction
On June 25, 2008, the Company, Community Resource Bank, N. A., (CRB)
and First Citizens Bank and Trust Company, Inc., (FCB) a wholly-owned subsidiary
of First Citizens Bancorporation, Inc. executed a definitive agreement to merge,
subject to approvals by regulatory agencies and the Company's shareholders. The
transaction, which is expected to close in the fourth quarter of 2008, requires
FCB to pay the Company's shareholders $21.00 in cash for each outstanding share
of the Company's common stock. FCB will be the surviving corporation of the
merger, and the Company and CRB will cease to exist.
New Accounting Pronouncements
In December 2007, the FASB issued Statement of Financial Accounting
Standards No. 160 "Noncontrolling Interests in Consolidated Financial
Statements, an amendment of ARB No. 51" ("SFAS No. 160"). SFAS No. 160 is
effective for years beginning after December 31, 2008 and is to be applied
prospectively with retrospective presentation and disclosure requirements for
comparative financial statements. Early adoption is prohibited. SFAS No. 160
seeks to improve the relevance, comparability and transparency of financial
information that a reporting entity provides in its consolidated financial
statements by separately identifying and reporting several financial statement
components into amounts that are attributable to the reporting entity or that
are attributable to noncontrolling interests. SFAS No. 160 also specifies the
conditions under which an entity is required to deconsolidate its interest in a
subsidiary. The Company currently has no consolidated subsidiaries that are not
wholly owned nor are any transactions contemplated that would result in such a
condition. Therefore, it is expected that the adoption of SFAS No. 160 in
January 2009 will have no effect on the Company's consolidated financial
statements.
11
CAUTIONARY NOTICE WITH RESPECT TO FORWARD-LOOKING STATEMENTS
This report contains "forward-looking statements" within the meaning of
the securities laws. The Private Securities Litigation Reform Act of 1995
provides a safe harbor for forward-looking statements. In order to comply with
the terms of the safe harbor, the Company notes that a variety of factors could
cause the Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forwarding-looking statements.
All statements that are not historical facts are statements that could
be "forward-looking statements." You can identify these forward-looking
statements through the use of words such as "may," "will," "should," "could,"
"would," "expect," "anticipate," "assume," "indicate," "contemplate," "seek,"
"plan," "predict," "target," "potential," "believe," "intend," "estimate,"
"project," "continue," or other similar words. Forward-looking statements
include, but are not limited to, statements regarding the Company's future
business prospects, revenues, working capital, liquidity, capital needs,
interest costs, income, business operations and proposed services.
These forward-looking statements are based on current expectations,
estimates and projections about the banking industry, management's beliefs, and
assumptions made by management. Such information includes, without limitation,
discussions as to estimates, expectations, beliefs, plans, strategies, and
objectives concerning future financial and operating performance. These
statements are not guarantees of future performance and are subject to risks,
uncertainties and assumptions that are difficult to predict. Therefore, actual
results may differ materially from those expressed or forecasted in such
forward-looking statements. The risks and uncertainties include, but are not
limited to:
o future economic and business conditions;
o lack of sustained growth in the economies of the Company's market
areas;
o government monetary and fiscal policies;
o the effects of changes in interest rates on the levels, composition
and costs of deposits, loan demand, and the values of loan collateral,
securities, and interest sensitive assets and liabilities;
o the effects of competition from a wide variety of local, regional,
national and other providers of financial, investment, and insurance
services, as well as competitors that offer banking products and
services by mail, telephone, computer and/or the Internet;
o credit risks;
o higher than anticipated levels of defaults on loans;
o misperceptions by depositors about the safety of their deposits;
o capital adequacy;
o the failure of assumptions underlying the establishment of the
allowance for loan losses and other estimates, including the value of
collateral securing loans;
o availability of liquidity sources;
o the risks of opening new offices, including, without limitation, the
related costs and time of building customer relationships and
integrating operations as part of these endeavors and the failure to
achieve expected gains, revenue growth and/or expense savings from
such endeavors;
o changes in laws and regulations, including tax, banking and securities
laws and regulations;
o changes in accounting policies, rules and practices;
12
o changes in technology or products may be more difficult or costly, or
less effective, than anticipated;
o the effects of war or other conflicts, acts of terrorism or other
catastrophic events that may affect general economic conditions and
economic confidence; and
o other factors and information described in this report and in any of
the other reports that we file with the Securities and Exchange
Commission under the Securities Exchange Act of 1934.
All forward-looking statements are expressly qualified in their
entirety by this cautionary notice. The Company has no obligation, and does not
undertake, to update, revise or correct any of the forward-looking statements
after the date of this report. The Company has expressed its expectations,
beliefs and projections in good faith and believes they have a reasonable basis.
However, there is no assurance that these expectations, beliefs or projections
will result or be achieved or accomplished.
References to our Website Address
References to our website address throughout this Quarterly Report on
Form 10-Q and in any documents incorporated into this Form 10-Q by reference are
for informational purposes only, or to fulfill specific disclosure requirements
of the Securities and Exchange Commission's rules or the American Stock Exchange
listing standards. These references are not intended to, and do not, incorporate
the contents of our website by reference into this Form 10-Q or the accompanying
materials.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Critical Accounting Policies
CBI has adopted various accounting policies, which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of CBI's financial statements. The significant
accounting policies of CBI are described in detail in the notes to CBI's audited
consolidated financial statements included in CBI's 2007 Annual Report on Form
10-K filed with the Securities and Exchange Commission.
Certain accounting policies involve significant judgments and estimates
by management, which have a material impact on the carrying value of certain
assets and liabilities. Management considers such accounting policies to be
critical accounting policies. The judgments and estimates used by management are
based on historical experience and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the judgments and
assumptions made by management, actual results could differ from these judgments
and estimates, which could have a material impact on the carrying values of
assets and liabilities and the results of operations of CBI.
CBI is a holding company for a community bank and a mortgage company
and, as a financial institution, believes the allowance for loan losses is a
critical accounting policy that requires the most significant judgments and
estimates used in preparation of its consolidated financial statements. Refer to
the sections "Allowance for Loan Losses" and "Provision for Loan Losses" under
Item 7 - Management's Discussion and Analysis of Financial Conditions and
Results of Operations in CBI's Annual Report on Form 10-K for 2007 for a
13
detailed description of CBI's estimation process and methodology related to the
allowance for loan losses.
CHANGES IN FINANCIAL CONDITION
The first six months of 2008 were very difficult for most financial
institutions. The real estate-related credit crisis, coupled with the
significant actions by the Federal Reserve Board to lower short-term interest
rates, made this period challenging. Higher levels of uncertainty have become
the normal state of affairs. In such an environment, opportunities to lend money
prudently decreased significantly. Yields on securities issued by government
agencies and government-sponsored enterprises, which would ordinarily be
considered safe investments, continue to be depressed and offer yields that are,
for short-term instruments, too low to generate improvement in net interest
margins.
In response to these conditions, the Company tightened its loan
underwriting standards. These measures, combined with lower levels of economic
activity, led to a decrease of $17,771,000, or 3.8%, in loans receivable during
the six months ended June 30, 2008. Loans receivable were 82.1% and 86.2% of
earning assets as of June 30, 2008 and December 31, 2007, respectively. To
offset the reduction in loan interest income the Company increased its portfolio
of available-for-sale securities by $20,595,000 during the 2008 six-month
period. Available-for-sale securities were 14.4% and 10.8% of earning assets as
of June 30, 2008 and December 31, 2007, respectively. Investments in
mortgage-backed securities issued by government-sponsored enterprises (FNMA and
FHLMC) increased by approximately $30,000,000 and securities issued by
government agencies decreased by approximately $9,500,000. Despite an increase
in the weighted-average maturity of the available-for-sale portion of the
investment portfolio from 1.39 years at December 31, 2007 to 5.32 years at June
30, 2008, that portfolio's weighted average yield decreased by 27 basis points
during the period. Federal funds sold increased by $559,000 and other
investments increased by $1,883,000 during the six months.
Deposits increased by only $633,000, or .13%, from the December 31,
2007 amount, short-term borrowings decreased by $3,560,000, or 36.0%, and
long-term debt increased by $12,495,000, or 42.1%. Management believes it is
likely that market interest rates will begin to increase later in 2008.
Consequently, the Company chose to secure relatively longer-term financing by
borrowing $15,000,000 in two convertible advances from the Federal Home Loan
Bank of Atlanta "FHLB") in February 2008. One advance of $7.5 million has an
initial fixed rate until February 2009, after which it may be converted to
variable at the option of the FHLB on a quarterly basis. The other advance of
$7.5 million has an initial fixed rate until February 2010, at which time it may
be converted to variable at the option of the FHLB on a one time basis. If the
FHLB exercises its options to convert the instruments to variable rates, the
Company has the right to prepay the advances without penalty on the initial
reset date or any subsequent reset date. The weighted average rate paid for
these funds was 2.35%, or about 149 basis points less than the average rate paid
for time deposits during the second quarter of 2008. The Company has
pre-existing advances from the FHLB totaling $16,700,000 which have a weighted
average rate of 5.16%. Of those advances, $14,700,000 remains convertible to
variable rates at the option of the FHLB.
14
RESULTS OF OPERATIONS
Earnings Performance
Three Months Ended June 30, 2008 and 2007
For the quarter ended June 30, 2008, CBI recorded net income of
$927,000 compared with $1,470,000 for the comparable period of 2007. The
$543,000 decrease is attributable primarily to $712,000 of non-recurring gains
on the sale of other investments in the 2007 period, a $271,000 decrease in
mortgage loan brokerage income and a $365,000 increase in the provision for loan
losses. Partially offsetting these items were decreases of $500,000 in
noninterest expenses and $267,000 in income tax expense.
Summary Income Statement
------------------------
(Dollars in thousands)
For the Three Months Ended June 30, 2008 2007 Dollar Change Percentage Change
----------------------------------- ---- ---- ------------- -----------------
Interest income .................................... $ 8,810 $ 9,751 $ (941) -9.7%
Interest expense ................................... 3,368 4,434 (1,066) -24.0%
------- ------- ------
Net interest income ................................ 5,442 5,317 125 2.4%
Provision for loan losses .......................... 540 175 365 208.6%
Noninterest income ................................. 1,697 2,767 (1,070) -38.7%
Noninterest expenses ............................... 5,101 5,601 (500) -8.9%
Income tax expense ................................. 571 838 (267) -31.9%
------- ------- ------
Net income ......................................... $ 927 $ 1,470 $ (543) -36.9%
======= ======= ======
Six Months Ended June 30, 2008 and 2007
CBI's consolidated net income for the six months ended June 30, 2008
was $2,028,000, a decrease of $447,000 from the $2,475,000 recorded for the same
period of 2007. Primarily responsible for this decline were a $460,000 increase
in the provision for loan losses in the 2008 period and nonrecurring gains of
$712,000 realized on the sale of other investments in the 2007 period. Partially
offsetting those effects were a $295,000 increase in net interest income and
reductions in the 2008 amounts of noninterest expenses and income tax expense
totaling $628,000 and $218,000, respectively.
Summary Income Statement
------------------------
(Dollars in thousands)
For the Six Months Months Ended June 30, 2008 2007 Dollar Change Percentage Change
---------------------------------------- ---- ---- ------------- -----------------
Interest income .................................... $18,248 $19,184 $ (936) -4.9%
Interest expense ................................... 7,394 8,625 (1,231) -14.3%
------- ------- ------
Net interest income ................................ 10,854 10,559 295 2.8%
Provision for loan losses .......................... 1,010 550 460 83.6%
Noninterest income ................................. 3,464 4,592 (1,128) -24.6%
Noninterest expenses ............................... 10,087 10,715 (628) -5.9%
Income tax expense ................................. 1,193 1,411 (218) -15.5%
------- ------- ------
Net income ......................................... $ 2,028 $ 2,475 $ (447) -18.1%
======= ======= ======
15
Net Interest Income
Net interest income is the amount of interest income earned on interest
earning assets (primarily loans, securities, interest bearing deposits with
other banks, and federal funds sold), less the interest expense incurred on
interest bearing liabilities (interest bearing deposits and other borrowings),
and is the principal source of the Company's earnings. Net interest income is
affected by the level of interest rates, volume and mix of interest earning
assets and interest bearing liabilities and the relative funding of those
assets.
The Federal Reserve Board lowered the federal funds interest rate by
100 basis points during the last four months of 2007 and by 200 basis points
during the first quarter of 2008. Because most of the Company's earning assets
and interest-bearing liabilities are relatively short-term instruments, yields
on the various categories of interest-earning assets and rates paid for
interest-bearing liabilities fell during those periods.
Three Months Ended June 30, 2008 and 2007
Net interest income for the three months ended June 30, 2008 was
$5,442,000, an increase of $125,000, or 2.4%, over the amount reported for the
second quarter of 2007. Interest income and interest expense for the 2008
quarter were both significantly lower than during the same period of 2007,
primarily due to lower interest rates earned on, or paid for, related assets and
liabilities.
The average yield on earning assets was 6.44% for the second quarter of
2008, compared with 7.30% for the second quarter of 2007. The average cost of
time deposits fell to 3.84% for the second quarter of 2008, compared with 4.68%
for the same period of 2007 and the average cost of all interest-bearing
liabilities was 2.88% for the 2008 quarter and 3.89% for the same period of
2007. Accordingly, the interest rate spread (interest earning assets yield minus
the rate paid for interest-bearing liabilities) for the 2008 second quarter
widened to 3.56%, or 15 basis points more than for the same period of 2007. Net
yield on earning assets (net interest income divided by average interest earning
assets) for the 2008 quarter was 3.98%, unchanged from the same period of 2007.
The mix of average earning assets and average interest-bearing
liabilities changed slightly since the second quarter of 2007 as shown in the
table "Average Balances, Yields and Rates Three Months Ended June 30, 2008 and
2007." Average amounts of interest earning assets were $14,328,000 higher in the
2008 period than in the 2007 period and the average amounts of interest-bearing
liabilities were $13,011,000 higher in the 2008 three month period.
16
Average Balances, Yields and Rates
Three Months Ended June 30,
---------------------------
2008 2007
------------------------------------ ------------------------------------
Interest Interest
Average Income / Yields / Average Income / Yields /
Balances Expense Rates (1) Balances Expense Rates (1)
-------- ------- --------- -------- ------- ---------
(Dollars in thousands)
Assets
Interest bearing deposits with other banks ...... $ 1,314 $ 1 0.31% $ 1,008 $ 13 5.17%
Investment securities - taxable ................. 74,900 954 5.12% 80,597 988 4.92%
Investment securities - tax exempt (2) .......... 4,139 38 3.69% 4,645 42 3.63%
Federal funds sold .............................. 17,216 89 2.08% 6,452 80 4.97%
Loans, including loans held for sale (2) (3) .... 452,786 7,728 6.86% 443,325 8,628 7.81%
-------- ------- -------- -------
Total interest earning assets ......... 550,355 8,810 6.44% 536,027 9,751 7.30%
Cash and due from banks ......................... 18,378 16,984
Allowance for loan losses ....................... (5,935) (6,045)
Premises and equipment, net ..................... 10,823 8,004
Intangible assets ............................... 6,572 5,907
Other assets .................................... 7,041 11,967
-------- --------
Total assets .......................... $587,234 $572,844
======== ========
Liabilities and shareholders' equity
Interest bearing deposits
Interest bearing transaction accounts ..... $ 78,110 $ 162 0.83% $ 72,862 $ 273 1.50%
Savings ................................... 84,939 283 1.34% 89,660 627 2.80%
Time deposits ............................. 254,889 2,433 3.84% 246,329 2,872 4.68%
-------- ------- -------- -------
Total interest bearing deposits ....... 417,938 2,878 2.77% 408,851 3,772 3.70%
Short-term borrowings ........................... 9,506 29 1.23% 18,056 187 4.15%
Long-term debt .................................. 42,175 461 4.40% 29,701 475 6.41%
-------- ------- -------- -------
Total interest bearing liabilities .... 469,619 3,368 2.88% 456,608 4,434 3.89%
Noninterest bearing demand deposits ............. 61,013 59,693
Other liabilities ............................... 2,119 2,307
Shareholders' equity ............................ 54,483 54,236
-------- --------
Total liabilities and
shareholders' equity .............. $587,234 $572,844
======== ========
Interest rate spread ............................ 3.56% 3.41%
Net interest income and net yield
on earning assets ......................... $ 5,442 3.98% $ 5,317 3.98%
(1) Yields and rates are annualized.
(2) Yields on tax-exempt securities and loans have not been stated on a
tax-equivalent basis.
(3) Nonaccruing loans are included in the average balances and income from such
loans is recognized on a cash basis.
17
Six Months Ended June 30, 2008 and 2007
Net interest income for the six months ended June 30, 2008 increased by
$295,000, or 2.8% over the amount for the same period of 2007. Both interest
income and interest expense decreased significantly in the 2008 period. However,
interest expense decreased further during the period due to the Company's
aggressive asset and liability management strategy of lowering rates paid for
interest bearing liabilities. For the 2008 year-to-date period, the interest
rate spread increased by 9 basis points and the net yield on earning assets
decreased by 3 basis points as compared with the same period of 2007.
18
Average Balances, Yields and Rates
Six Months Ended June 30,
-------------------------
2008 2007
------------------------------------- ------------------------------------
Interest Interest
Average Income / Yields / Average Income / Yields /
Balances Expense Rates (1) Balances Expense Rates (1)
-------- ------- --------- -------- ------- ---------
(Dollars in thousands)
Assets
Interest bearing deposits with other banks .... $ 1,336 $ 12 1.81% $ 1,773 $ 46 5.23%
Investment securities - taxable ............... 65,621 1,720 5.27% 82,648 2,008 4.90%
Investment securities - tax exempt (2) ........ 4,200 77 3.69% 4,697 85 3.65%
Federal funds sold ............................ 19,845 270 2.74% 10,282 260 5.10%
Loans, including loans held for sale (2) (3) .. 458,642 16,169 7.09% 433,533 16,785 7.81%
--------- -------- --------- --------
Total interest earning assets ....... 549,644 18,248 6.68% 532,933 19,184 7.26%
Cash and due from banks ....................... 19,405 17,156
Allowance for loan losses ..................... (5,780) (5,458)
Premises and equipment ........................ 10,797 8,694
Intangible assets ............................. 6,603 6,849
Other assets .................................. 7,115 9,745
--------- ---------
Total assets ........................ $ 587,784 $ 569,919
========= =========
Liabilities and shareholders' equity
Interest bearing deposits
Interest bearing transaction accounts ... $ 78,923 $ 330 0.84% $ 74,945 $ 532 1.43%
Savings ................................. 85,618 658 1.55% 92,886 1,299 2.82%
Time deposits ........................... 257,319 5,366 4.19% 243,963 5,579 4.61%
--------- -------- --------- --------
Total interest bearing deposits ..... 421,860 6,354 3.03% 411,794 7,410 3.63%
Short-term borrowings ......................... 10,548 88 1.68% 14,958 303 4.08%
Long-term debt ................................ 39,760 952 4.82% 27,998 912 6.57%
--------- -------- --------- --------
Total interest bearing liabilities .. 472,168 7,394 3.15% 454,750 8,625 3.82%
Noninterest bearing demand deposits ........... 59,182 59,382
Other liabilities ............................. 2,000 2,065
Shareholders' equity .......................... 54,434 53,722
--------- ---------
Total liabilities and
shareholders' equity .............. $ 587,784 $ 569,919
========= =========
Interest rate spread .......................... 3.53% 3.44%
Net interest income and net yield
on earning assets ....................... $ 10,854 3.97% $ 10,559 4.00%
(1) Yields and rates are annualized.
(2) Yields on tax-exempt securities and loans have not been stated on a
tax-equivalent basis.
(3) Nonaccruing loans are included in the average balances and income from such
loans is recognized on a cash basis.
Provision and Allowance for Loan Losses
The provision for loan losses for the 2008 three month period was
$540,000, an increase of $365,000, or 208.6%, over the $175,000 recorded for the
same period of 2007. The provision for loan losses increased to $1,010,000 for
the 2008 six month period from $550,000 for the 2007 six month period, an
increase of $460,000 or 83.6%.
19
The activity in the allowance for loan losses is summarized in the
following table:
Six Months Year Ended Six Months
Ended December 31, Ended
June 30, 2008 2007 June 30, 2007
------------- ---- -------------
(Dollars in thousands)
Allowance at beginning of period .................................. $ 5,343 $ 4,662 $ 4,662
Provision for loan losses ......................................... 1,010 3,155 550
Net charge-offs ................................................... (414) (2,474) 521
--------- --------- ---------
Allowance at end of period ........................................ $ 5,939 $ 5,343 $ 5,733
========= ========= =========
Allowance as a percentage of loans outstanding .................... 1.33% 1.15% 1.28%
Loans at end of period ............................................ $ 446,268 $ 464,039 $ 447,945
========= ========= =========
Following is a summary of non-performing loans as of June 30, 2008 and
December 31, 2007:
June 30, December 31,
2008 2007
---- ----
(Dollars in thousands)
Non-performing loans
Nonaccrual loans .................................. $8,976 $ 6,542
Past due 90 days or more and still accruing ....... 7 -
------ ---------
Total ............................... $8,983 $ 6,542
====== =========
Non-performing loans as a percentage of:
Loans outstanding ................................. 2.01% 1.41%
Allowance for loan losses ......................... 151.25% 122.44%
The following table shows quarterly changes in nonperforming and
potential problem loans since December 31, 2005. Potential problem loans are
loans as to which information about the borrowers' possible credit problems
causes management to have serious doubts about the their ability to comply with
current repayment terms and which may result in subsequent classification of
such loans as non-performing loans.
20
90 Days or
More Past Due Total Percentage Percentage
Nonaccrual and Still Nonperforming of Total Potential of Total
Loans Accruing Loans Loans Problem Loans Loans
----- -------- ----- ----- ------------- -----
(Dollars in thousands)
December 31, 2005 ............ $ 11,651 $ 729 $ 12,380 2.99% $ 29,313 7.08%
Net change ................... 3,128 949 4,077 (2,767)
-------- -------- -------- --------
March 31, 2006 ............... 14,779 1,678 16,457 3.94% 26,546 6.36%
Net change ................... (3,628) (1,476) (5,104) (3,461)
-------- -------- -------- --------
June 30, 2006 ................ 11,151 202 11,353 2.71% 23,085 5.51%
Net change ................... (2,483) 175 (2,308) (219)
-------- -------- -------- --------
September 30, 2006 ........... 8,668 377 9,045 2.19% 22,866 5.55%
Net change ................... (3,954) (145) (4,099) (7,475)
-------- -------- -------- --------
December 31, 2006 ............ 4,714 232 4,946 1.21% 15,391 3.76%
Net change ................... 1,612 (65) 1,547 (1,143)
-------- -------- -------- --------
March 31, 2007 ............... 6,326 167 6,493 1.53% 14,248 3.36%
Net change ................... (1,169) (167) (1,336) 385
-------- -------- -------- --------
June 30, 2007 ................ 5,157 - 5,157 1.15% 14,633 3.27%
Net change ................... 2,323 - 2,323 1,332
-------- -------- -------- --------
September 30, 2007 ........... 7,480 - 7,480 1.64% 15,965 3.50%
Net change ................... (938) - (938) (810)
-------- -------- -------- --------
December 31, 2007 ............ 6,542 - 6,542 1.41% 15,155 3.27%
Net change ................... 387 192 579 6,880
-------- -------- -------- --------
March 31, 2008 ............... 6,929 192 7,121 1.57% 22,035 4.87%
Net change ................... 2,047 (185) 1,862 2,566
-------- -------- -------- --------
June 30, 2008 ................ $ 8,976 $ 7 $ 8,983 2.01% $ 24,601 5.51%
======== ======== ======== ========
During the second quarter of 2008, nonperforming loans increased by
$1,862,000 while potential problem loans increased by $2,566,000. The largest
component of the increase in nonaccrual loans was a $900,000 residential
construction loan. The remaining increase was composed of a variety of different
real estate and commercial loans from which management does not anticipate major
additional losses. The increase in potential problem loans is related to the
bank's ongoing internal loan review program and the anticipated impact of
general economic conditions.
Management will continue to monitor the levels of non-performing loans
and address the weaknesses in these credits to enhance the ultimate collection
or recovery of these assets. Management considers the levels and trends in
non-performing assets and potential problem loans in determining how the
provision and allowance for loan losses is estimated and adjusted. In the
opinion of management, the Company's allowance for loan losses at June 30, 2008
is adequate to provide for losses that may be inherent in the loan portfolio.
21
Noninterest Income
Noninterest income for the 2008 second quarter was $1,697,000, a
decrease of $1,070,000 from the $2,767,000 reported for the same 2007 period.
The Company realized a one-time $712,000 gain on the sale of other investments
during the 2007 period, primarily from the sale of surplus stock of a
correspondent bank which resulted from the merger of the Company's four bank
subsidiaries into one bank late in 2006. Mortgage loan brokerage income was
$271,000 lower during the 2008 period.
For the six months ended June 30, 2008, noninterest income decreased
$1,128,000, or 24.6%, from noninterest income of $4,592,000 for the first six
months of 2007. Again, this decrease resulted primarily from the one-time gain
from the sale of other investments that occurred in 2007. Mortgage loan
brokerage income for the first six months of 2008 decreased $404,000 compared
with the same period of 2007, as originations of such loans decreased by
approximately 34.9%, consistent with the overall slowing of the real estate
market in the Company's market area and due to the Company's decision in early
2008 to discontinue its wholesale mortgage operation.
Noninterest Expenses
Noninterest expenses for the second quarter of 2008 decreased by
$500,000, or 8.9%, from the amounts reported for the same period of 2007.
Salaries and employee benefits expenses decreased by $166,000, or 5.4%, in the
2008 period, primarily due to the discontinuation of the mortgage division's
wholesale lending operation in early first quarter of 2008.
Noninterest expenses for the first six months of 2008 were $628,000, or
5.9%, less than for the same period of 2007. Salaries and employee benefits for
the 2008 six month period were $253,000, or 4.2%, less than for the same period
of 2007, primarily due to the elimination of the mortgage division's wholesale
lending operations. In addition, expenses were reduced by the elimination of
loan production costs associated with wholesale lending, notably yield spread
payments to brokers. Other factors contributing to the lower noninterest
expenses were various non-recurring expenses recorded in 2007 including
consulting costs related to preparation of a strategic plan and a deposit
related fraud loss. These same factors also impacted the quarterly periods.
Income Taxes
Income tax expense was $267,000 lower in the 2008 second quarter than
for the 2007 period, as a result of lower taxable income before taxes. Income
tax expense for the 2008 six month period was $218,000 less than for the same
period of 2007 due to lower net income before taxes.
LIQUIDITY
Liquidity is the ability to meet current and future obligations through
liquidation or maturity of existing assets or the acquisition of additional
liabilities. Adequate liquidity is necessary to meet the requirements of
customers for loans and deposit withdrawals in a timely and economical manner.
The most manageable sources of liquidity are composed of liabilities, with the
primary focus of liquidity management being the ability to attract deposits
within CBI's market areas. Individual and commercial deposits are the primary
source of funds for credit activities, along with long-term borrowings from the
22
Federal Home Loan Bank of Atlanta. Cash and amounts due from banks and federal
funds sold are CBI's primary sources of asset liquidity. These funds provide a
cushion against short-term fluctuation in cash flow from both loans and
deposits. Securities available-for-sale are CBI's principal source of secondary
asset liquidity. However, the availability of this source is limited by pledging
commitments for public deposits and securities sold under agreements to
repurchase, and is influenced by market conditions.
Total deposits as of June 30, 2008 were $482,340,000, an increase of
$633,000 over the amount as of December 31, 2007. During the first six months of
2008, funds moved from noninterest bearing demand deposit, interest-bearing
transaction and savings accounts into time deposit accounts. As of June 30, 2008
the loan to deposit ratio, excluding loans held for sale, was 92.5%, compared
with 96.3% at December 31, 2007 and 93.3% at June 30, 2007.
Management believes CBI's liquidity sources are adequate to meet its
current and projected operating needs.
CAPITAL RESOURCES
CBI and its bank subsidiary are subject to regulatory risk-based
capital adequacy standards. Under these standards, bank holding companies and
banks are required to maintain certain minimum ratios of capital to
risk-weighted assets and average total assets. Under the provisions of the
Federal Deposit Insurance Corporation Improvement Act of 1991, federal bank
regulatory authorities are required to implement prescribed "prompt corrective
actions" upon the deterioration of the capital position of a bank. If the
capital position of an affected institution were to fall below a certain level,
increasingly stringent regulatory corrective actions would be mandated.
The June 30, 2008 risk-based capital ratios for CBI and the bank are
presented in the following table, compared with the "well capitalized"
requirement for the bank and minimum ratios under the regulatory definitions and
guidelines:
June 30, 2008
-------------
Tier 1 Total Capital Leverage
------ ------------- --------
Community Bankshares, Inc. 13.42% 14.67% 10.08%
Community Resource Bank 11.85% 13.10% 8.87%
Minimum "well capitalized" requirement 6.00% 10.00% 6.00%
Minimum requirement 4.00% 8.00% 5.00%
As shown in the table above, each of the capital ratios exceeds the
minimum regulatory requirement and the bank exceeds the requirement to be
considered "well capitalized." In the opinion of management, the current and
projected capital positions of CBI and the bank are adequate.
OFF-BALANCE-SHEET ARRANGEMENTS
In the normal course of business, CBI engages in transactions that, in
accordance with generally accepted accounting principles, are not recorded in
the financial statements (generally commitments to extend credit) or are
recorded in amounts that differ from their notional amounts (generally
23
derivatives). These transactions involve elements of credit, interest rate and
liquidity risk of varying degrees.
Variable Interest Entity
As discussed under "Capital Resources" and in the notes to unaudited
consolidated financial statements under "Variable Interest Entity," as of June
30, 2008, CBI held an equity interest in, and guarantees the liabilities of, a
non-consolidated variable interest entity, SCB Capital Trust I.
Commitments
CBI is party to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. Such commitments involve varying
degrees of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets. Exposure to credit loss is represented by the
contractual, or notional, amounts of these commitments. The same credit policies
are used in making commitments as are used for on-balance-sheet instruments.
The following table sets forth the contractual amounts of commitments
which represent credit risk:
June 30, 2008
-------------
(Dollars in
thousands)
Loan commitments .............................. $ 62,826
Standby letters of credit ..................... 1,150
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being fully drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if deemed necessary by management upon extension of credit, is based
on management's credit evaluation of the counter-party. Collateral held varies
but may include personal residences, accounts receivable, inventory, property,
plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. Those letters of
credit are primarily issued to support private borrowing arrangements. All
letters of credit are short-term guarantees. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. Generally, collateral supporting those commitments is
held if deemed necessary. Since many of the standby letters of credit are
expected to expire without being drawn upon, the total letter of credit amounts
do not necessarily represent future cash requirements.
24
Derivative Financial Instruments
In April, 2003, the Financial Accounting Standards Board issued
Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." Among other requirements, this Statement provides that loan
commitment contracts entered into or modified after June 30, 2003 that relate to
the origination of mortgage loans that will be held for sale shall be accounted
for as derivative instruments by the issuer of the loan commitment. In March,
2004, the SEC issued its Staff Accounting Bulletin No 105 "Application of
Accounting Principles to Loan Commitments," which resulted in no changes in
CBI's accounting for such commitments. CBI issues mortgage loan rate lock
commitments to potential borrowers to facilitate its origination of home
mortgage loans that are intended to be sold. Between the time that CBI issues
its commitments and the time that the loans close and are sold, CBI is subject
to variability in the selling prices related to those commitments due to changes
in market rates of interest. However, CBI offsets this variability through the
use of so-called "forward sales contracts" to investors in the secondary market.
Under these arrangements, an investor agrees to purchase the closed loans at a
predetermined price. CBI generally enters into such forward sales contracts at
the same time that rate lock commitments are issued. These arrangements
effectively insulate CBI from the effects of changes in interest rates during
the time the commitments are outstanding, but the arrangements do not qualify as
fair value hedges. These derivative financial instruments are carried in the
balance sheet at estimated fair value and changes in the estimated fair values
of these derivatives are recorded in the statement of income in net gains or
losses on loans held for sale.
Derivative financial instruments are written in amounts referred to as
notional amounts. Notional amounts only provide the basis for calculating
payments between counterparties and do not represent amounts to be exchanged
between parties or a measure of financial risk. The following table includes the
notional principal amounts of rate lock commitments and forward sales contracts
as of June 30, 2008, and the estimated fair values of those financial
instruments included in other assets and liabilities in the balance sheet as of
that date.
June 30, 2008
-------------
Estimated
Fair Value
Notional Asset
Amount (Liability)
------ -----------
(Dollars in thousands)
Rate lock commitments to potential borrowers
to originate mortgage loans to be
held for sale ................................... $ 4,266 $ (7)
Forward sales contracts with investors
of mortgage loans to be held for sale ........... $ 4,266 $ 7
25
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. CBI's market risk arises principally from interest rate risk inherent
in its lending, deposit and borrowing activities. Management actively monitors
and manages its interest rate risk exposure. Although CBI manages other risks,
such as credit quality and liquidity risk in the normal course of business,
management considers interest rate risk to be its most significant market risk
and this risk could potentially have the largest material effect on CBI's
financial condition and results of operations. Other types of market risks such
as foreign currency exchange risk and commodity price risk do not arise in the
normal course of community banking activities.
CBI's Asset/Liability Committee uses a simulation model to assist in
achieving consistent growth in net interest income while managing interest rate
risk. According to the model, as of June 30, 2008, CBI is positioned so that net
interest income would increase $21,000 and net income would increase $11,000 in
the next twelve months if interest rates rose 100 basis points. Conversely, net
interest income would decrease $21,000 and net income would decrease $11,000 in
the next twelve months if interest rates declined 100 basis points. Computation
of prospective effects of hypothetical interest rate changes are based on
numerous assumptions, including relative levels of market interest rates and
loan prepayment, and should not be relied upon as indicative of actual results.
Further, the computations do not contemplate any actions CBI and its customers
could undertake in response to changes in interest rates.
As of June 30, 2008 there was no significant change from the interest
rate sensitivity analysis for the various changes in interest rates calculated
as of December 31, 2007. The foregoing disclosures related to the market risk of
CBI should be read in connection with Item 7 - Management's Discussion and
Analysis of Financial Position and Results of Operations included in the 2007
Annual Report on Form 10-K.
Item 4T. Controls and Procedures
Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Sections 240.13a-15(e) or 240.15d-15(e)), the Company's chief
executive officer and chief financial officer concluded that such controls and
procedures, as of the end of the period covered by this quarterly report, were
effective.
In connection with management's evaluation required by 17 C.F.R.
240.13a-15(d) or 240.15d-15(d) of the Company's internal control over financial
reporting, management has determined that there has been no change in the
Company's internal control over financial reporting during the most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
26
PART II--OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Purchases of securities
(c) Total (d) Maximum
Number of Number of
Shares Purchased Shares
as Part of That May Yet
(a) Total Publicly Be Purchased
Number of (b) Average Announced Under the
Shares Price per Plans or Plans or
Period Purchased Share Programs Programs
------ --------- ----- -------- --------
4/1/08 - 4/30/08 2,500 $ 12.85 2,500 437,700
5/1/08 - 5/31/08 4,500 $ 12.28 4,500 433,200
6/1/08 - 6/30/08 - $ - - 433,200
----- -----
Total 7,000 $ 12.49 7,000
===== =====
(1) On July 30, 2007, the Board of Directors authorized the repurchase of up to
500,000 shares of the Company's common stock. The program was originally set to
expire on July 30, 2008. However, the program was terminated early under the
terms of the Agreement and Plan of Merger entered into with First Citizens Bank
and Trust Company, Inc. on June 25, 2008.
Item 4. Submission of Matters to a Vote of Security Holders
On Tuesday, May 20, 2008, the shareholders of Community Bankshares,
Inc. held their regular annual meeting. At the meeting, one matter was submitted
to a vote with results as follows:
1. Election of four directors to hold office for three year terms and one
director to hold office for a one-year term:
SHARES VOTED
AGAINST OR BROKER
DIRECTORS FOR AUTHORITY WITHHELD NON-VOTES
--- ------------------ ---------
Three year term:
Thomas B. Edmunds 3,341,862 14,888 1,087,282
Henrietta C. Guthrie 3,341,900 14,850 1,087,282
Wm. Reynolds Williams 3,226,450 130,300 1,087,282
Charles E. Fienning 3,341,651 15,099 1,087,282
One year term:
James Richard Williamson 3,341,860 14,890 1,087,282
The following directors continue to serve until the expiration of their
terms at the annual meetings to be held in the years indicated and were not
voted on at the 2008 annual meeting: E. J. Ayers, Jr. - 2009; Alvis J. Bynum -
2009; J. V. Nicholson, Jr. - 2009; Charles P. Thompson, Jr. - 2009; Samuel L.
27
Erwin - 2010; Anna O. Dantzler - 2010; Richard L. Havekost - 2010; and Samuel F.
Reid, Jr. - 2010.
Item 6. Exhibits
Exhibits 2 Agreement and Plan of Merger, dated June 25, 2008, by and
among Community Bankshares, Inc., Community Resource Bank,
N. A., and First Citizens Bank and Trust Company, Inc.
(Incorporated by reference to Registrant's Form 8-K filed
July 1, 2008)
31-1 Rule 13a-14(a)/15d-14(a) Certification of principal
executive officer
31-2 Rule 13a-14(a)/15d-14(a) Certification of principal
financial officer
32 Certifications Pursuant to 18 U.S.C. Section 1350
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DATED: August 7, 2008
COMMUNITY BANKSHARES, INC.
By: s/ Samuel L. Erwin
-------------------------------------------
Samuel L. Erwin
Chief Executive Officer
By: s/ William W. Traynham
-------------------------------------------
William W. Traynham
President and Chief Financial Officer
(Principal Accounting Officer)
29
EXHIBIT INDEX
Exhibits 2 Agreement and Plan of Merger, dated June 25, 2008, by and
among Community Bankshares, Inc., Community Resource Bank,
N. A., and First Citizens Bank and Trust Company, Inc.
(Incorporated by reference to Registrant's Form 8-K filed
July 1, 2008)
31-1 Rule 13a-14(a)/15d-14(a) Certification of principal
executive officer
31-2 Rule 13a-14(a)/15d-14(a) Certification of principal
financial officer
32 Certifications Pursuant to 18 U.S.C. Section 1350
30