SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 000-16461
COMMUNITY BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-0868361
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
68149 Main Street
Blountsville, Alabama 35031
(Address of principal executive offices)
(205) 429-1000
(Registrant's telephone number)
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:
|X| yes |_| no
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act rule 12b-2):
|_|yes |X| no
As of May 1, 2003, there were 4,643,740 shares of the registrant's common stock,
$.10 par value shares, outstanding.
FORM 10-Q
COMMUNITY BANCSHARES, INC.
MARCH 31, 2003
Table of Contents Page No.
Part 1 - Financial Information
Item 1 - Consolidated Statements Financial Statements (Unaudited)
Consolidated Statements of Condition as of
March 31, 2003 and December 31, 2002....................................... 3
Consolidated Statements of Income for the Three Months Ended
March 31, 2003 and 2002.................................................... 4-5
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2003 and 2002.................................................... 6-7
Notes to Consolidated Financial Statements..................................... 8-15
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations.............................. 16-20
Item 3 - Quantitative and Qualitative Disclosures About Market Risk..................... 21
Item 4 - Controls and Procedures........................................................ 22
Part 2 - Other Information
Item 1 - Legal Proceedings.............................................................. 23
Item 6 - Exhibits and Reports on Form 8-K............................................... 23
Signatures
Certifications of Periodic Financial Reports
2
PART 1
Item 1 - Financial Statements
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
(UNAUDITED)
March 31, 2003 December 31, 2002
---------------- ----------------
Assets
Cash and due from banks............................................... $ 33,121,261 $ 15,976,613
Interest-bearing deposits in banks and federal funds sold............. 21,625,000 24,230,000
Securities available for sale ........................................ 122,766,974 123,901,469
Loans (net of unearned income) ....................................... 346,639,392 359,183,888
Allowance for possible loan losses ................................ (10,123,476) (9,784,269)
---------------- ----------------
Net loans ......................................................... 336,515,916 349,399,619
Capitalized lease receivable.......................................... 3,030,327 3,053,542
Premises and equipment, net .......................................... 24,964,572 25,435,491
Accrued interest receivable........................................... 3,822,672 4,369,748
Goodwill and other intangible assets, net............................. 2,693,535 2,713,389
Other real estate owned .............................................. 8,503,423 7,676,442
Other assets ......................................................... 9,199,001 10,840,086
---------------- ----------------
Total Assets....................................................... $ 566,242,681 $ 567,596,399
================ ================
Liabilities And Shareholders' Equity
Deposits:
Noninterest-bearing................................................ $ 56,866,739 $ 52,920,683
Interest-bearing................................................... 404,876,854 406,543,121
---------------- ----------------
Total deposits ................................................. 461,743,593 459,463,804
Other short-term borrowings .......................................... 201,556 1,725,133
Accrued interest payable.............................................. 3,837,386 3,622,765
FHLB long-term debt................................................... 38,000,000 38,000,000
Capitalized lease obligations ........................................ 4,037,887 4,058,169
Other long-term debt ................................................. 3,477,457 3,577,687
Trust preferred securities ........................................... 10,000,000 10,000,000
Other liabilities .................................................... 5,822,863 6,837,884
---------------- ----------------
Total liabilities ................................................. 527,120,742 527,285,442
Shareholders' equity
Preferred stock (par value $.01 per share, 200,000 shares
authorized, no shares issued)...................................... - -
Common stock (par value $.10 per share, 20,000,000
shares authorized, 4,810,089 shares issued as of
March 31, 2003 and December 31, 2002).............................. 481,009 481,009
Additional paid in capital............................................ 30,787,584 30,806,862
Retained earnings .................................................... 10,474,852 11,023,962
Treasury stock (23,803 shares as of March 31, 2003 and
December 31, 2002)............................................... (441,768) (441,768)
Unearned ESOP shares (142,546 and 148,972 shares as of
March 31, 2003 and December 31, 2002, respectively)................ (1,935,598) (1,999,858)
Accumulated other comprehensive income (loss), net of taxes .......... (244,140) 440,750
---------------- ----------------
Total shareholders' equity ........................................ 39,121,939 40,310,957
---------------- ----------------
Total Liabilities and Shareholders' Equity $ 566,242,681 $ 567,596,399
================ ================
See accompanying notes to consolidated financial statements
3
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the Three Months Ended March 31,
2003 2002
---------------- ----------------
Interest Income
Interest and fees on loans............................................ $ 7,360,905 $ 8,820,482
Interest on investment securities:
Taxable securities.................................................... 1,374,647 1,550,545
Non taxable securities............................................... 89,325 145,088
Interest on federal funds sold........................................ 82,258 143,083
Other interest........................................................ 7,110 6,994
--------------- ----------------
Total interest income ............................................. 8,914,245 10,666,192
--------------- ----------------
Interest Expense
Interest on deposits ................................................. 2,885,208 3,650,623
Interest on short-term borrowings .................................... 1,150 4,288
FHLB long-term debt................................................... 563,350 563,350
Interest on capitalized lease obligations............................. 42,452 49,207
Interest on trust preferred securities................................ 314,164 280,303
Interest on other long-term debt...................................... 30,471 53,898
--------------- ----------------
Total interest expense................................................... 3,836,795 4,601,669
--------------- ----------------
Net interest income...................................................... 5,077,450 6,064,523
Provision for loan losses ............................................ 1,289,439 943,611
--------------- ----------------
Net interest income after provision for loan losses...................... 3,788,011 5,120,912
Noninterest Income
Service charges on deposits .......................................... 610,558 761,622
Insurance commissions. ............................................... 563,793 539,605
Bank club dues ....................................................... 106,559 105,454
Debt cancellation fees ............................................... 30,115 60,104
Other operating income ............................................... 225,537 226,417
Securities gains, net................................................. 647,641 16,646
--------------- ----------------
Total noninterest income........................................... 2,184,203 1,709,848
--------------- ----------------
Noninterest Expense
Salaries and employee benefits ....................................... 3,328,797 3,473,661
Occupancy expense .................................................... 589,005 590,763
Furniture and equipment expense....................................... 367,391 406,043
Director and committee fees .......................................... 122,200 97,100
Net loss on sale or write-down of other
real estate owned.................................................. 252,728 -
Net loss on disposal of assets........................................ - 395,575
Other operating expenses ............................................. 2,348,682 1,769,212
--------------- ----------------
Total noninterest expense.......................................... 7,008,803 6,732,354
--------------- ----------------
INCOME (Loss) from continuing operations
BEFORE INCOME TAXES................................................... (1,036,589) 98,406
Applicable income taxes.................................................. 487,480 (84,407)
--------------- ----------------
INCOME (Loss) from continuing operations........................... (549,109) 13,999
--------------- ----------------
See accompanying notes to consolidated financial statements
4
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME - CONTINUED
(UNAUDITED)
For the Three Months Ended March 31,
2003 2002
---------------- ----------------
Discontinued Operations:
Income from operations of divested branches
(includes gain on disposal of $1,551,443).......................... - 1,748,227
Applicable income taxes............................................... - (529,713)
---------------- ----------------
Net Income (Loss)..................................................... $ (549,109) $ 1,232,513
================ ================
OTHER COMPREHENSIVE INCOME:
Unrealized holding gains (losses) arising during period,
net of income taxes of $197,536 and $243,748, respectively...... $ (296,305) $ (365,622)
Reclassification adjustment related to net realized gains, net of
income taxes of $259,056 and $6,658, respectively............... (388,585) (9,988)
--------------- ----------------
Other Comprehensive Income (LOSS).................................. (684,890) (375,610)
--------------- ----------------
COMPREHENSIVE INCOME (LOSS).............................................. $ (1,233,999) $ 856,903
=============== ================
Earnings (loss) per common share - income (loss) from continuing operations:
Basic.............................................................. $ (0.12) $ 0.01
Diluted............................................................ $ (0.12) $ 0.01
Earnings (loss) per common share - net income (loss):
Basic.............................................................. $ (0.12) $ 0.27
Diluted............................................................ $ (0.12) $ 0.27
Average number of shares outstanding:
Basic.............................................................. 4,640,527 4,625,949
Diluted............................................................ 4,640,527 4,625,949
Dividends per share...................................................... $ - $ -
See accompanying notes to consolidated financial statements
5
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months Ended March 31,
2003 2002
--------------- -----------------
Cash Flows From Operating Activities
Net income (loss)....................................................... $ (549,109) $ 1,232,513
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for loan losses .............................................. 1,289,439 1,040,419
Provision for depreciation and amortization ............................ 444,682 566,866
Amortization of investment security premiums
and accretion of discounts........................................... 169,484 73,075
Deferred tax expense.................................................... 98,168 164,908
Realized investment security gains. .................................... (647,641) (16,646)
Gain on sale of branches................................................ - (1,551,443)
Loss on sale of premises and equipment ................................. - 395,575
Net loss or write-down on other real estate owned....................... 252,728 -
Decrease in accrued interest receivable................................. 547,076 1,133,827
Increase in accrued interest payable.................................... 214,621 244,834
Other .................................................................. 1,048,936 (844,973)
--------------- ----------------
Net cash provided by operating activities............................ 2,868,384 2,438,955
--------------- ----------------
Cash Flows From Investing Activities
Proceeds from sales, calls and pay downs of securities
available for sale................................................... 61,700,976 11,597,387
Proceeds from maturity of securities
available for sale................................................... 15,000,000 2,000,000
Purchase of securities available for sale............................... (76,229,805) (3,984,476)
Cash disbursed in settlement of branch divestitures..................... - (8,294,497)
Net decrease in loans to customers...................................... 10,602,672 10,719,993
Proceeds from sale of premises and equipment............................ - 60,350
Capital expenditures.................................................... (93,909) (136,100)
Net proceeds from sale of other real estate............................. 55,630 177,903
--------------- ----------------
Net cash provided by investing activities............................ 11,035,564 12,140,560
--------------- ----------------
Cash Flows From Financing Activities
Net increase in demand deposits,
NOW accounts, savings and time open deposit accounts................. 7,248,363 6,614,878
Net decrease in certificates of deposit ................................ (4,968,574) (11,355,951)
Net (decrease) increase in short-term borrowings ....................... (1,523,577) 475,289
Net decrease in capitalized lease obligations .......................... (20,282) (30,989)
Repayment of long-term debt............................................ (100,230) (207,308)
--------------- ----------------
Net cash provided by (used in) financing activities ................. 635,700 (4,504,081)
--------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS.................................. 14,539,648 10,075,434
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............................. 40,206,613 53,037,008
--------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................... $ 54,746,261 $ 63,112,442
=============== ================
See accompanying notes to consolidated financial statements
6
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
For the Three Months Ended March 31,
--------------------------------------
2003 2002
----------------- -----------------
Supplemental cash flow disclosures:
Cash paid for:
Interest.............................................................. $ 3,622,174 $ 5,814,023
Income taxes.......................................................... - 947
schedule of non-cash investing and
financing activities:
Foreclosure of other real estate owned................................ 1,256,642 1,246,862
Loan charge-offs, net of recoveries................................... 950,232 853,546
See accompanying notes to consolidated financial statements
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7
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - GENERAL
The consolidated financial statements include the accounts of Community
Bancshares, Inc. and its wholly-owned subsidiaries, collectively, hereinafter
referred to as the "Company". The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three month period ending March 31, 2003 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002.
Certain reclassifications of prior years' amounts have been made to conform to
current year presentation. These reclassifications had no effect on net income,
total assets, total liabilities, or shareholders' equity.
The Company's significant accounting policies are presented in Note 1 to the
consolidated financial statements in the Company's Annual Report on Form 10-K
for the year ended December 31, 2002. These policies, along with the disclosures
presented in the other footnotes, provide information on how significant assets
and liabilities are valued in the financial statements and how those values are
determined. Those accounting policies involving significant estimates and
assumptions by management, which have, or could have, a material impact on the
carrying value of certain assets and impact comprehensive income, are considered
critical accounting policies. The Company recognizes the following as critical
accounting policies: Accounting for Allowance for Loan Losses and Accounting for
Income Taxes.
Accounting for Allowance for Loan Losses. Management's ongoing evaluation of the
adequacy and allocation of the allowance considers both impaired and unimpaired
loans and takes into consideration the Company's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrowers' ability to repay, estimated value of any underlying collateral,
the reviews of regulators, and an analysis of current economic conditions. While
management believes that it has exercised prudent judgment and applied
reasonable assumptions which have resulted in an allowance presented in
accordance with generally accepted accounting principles, there can be no
assurance that in the future, adverse economic conditions, increased
nonperforming loans, regulatory concerns, or other factors will not require
further increases in, or reallocation of the allowance.
Accounting for Income Taxes. The Company uses the asset and liability method of
accounting for income taxes. Determination of the deferred and current provision
requires analysis by management of certain transactions and the related tax laws
and regulations. Management exercises significant judgment in evaluating the
amount and timing of recognition of the resulting tax liabilities and assets.
Those judgments and estimates are re-evaluated on a continual basis as
regulatory and business factors change.
NOTE 2 - CAPITAL SECURITIES
In March 2000, the Company formed a wholly-owned Delaware statutory business
trust, Community (AL) Capital Trust I (the "Trust"), which issued $10,000,000 of
guaranteed preferred securities representing undivided beneficial interests in
the assets of the Trust ("Capital Securities"). All of the common securities of
the Trust are owned by the Company. The proceeds from the issuance of the
Capital Securities ($10,000,000) and common securities ($310,000) were used by
the Trust to purchase $10,310,000 of junior subordinated deferrable interest
debentures of the Company which carry an annual interest rate of 10.875%. Under
the terms of the indenture, the Company may elect to defer payments of interest
for up to ten semiannual payment periods. The Company has elected to defer its
March 2002, September 2002 and March 2003 interest payments and may elect to do
so again based on the
8
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
liquidity needs of the Company when future payments become due. For the duration
of such deferral period, the Company is restricted from paying dividends to
shareholders or paying debt that is junior to the debenture. The debentures
represent the sole asset of the Trust. The debentures and related income
statement effects are eliminated in the Company's consolidated financial
statements. The Company is entitled to treat the aggregate liquidation amount of
the debentures as Tier I capital under Federal Reserve guidelines.
The Capital Securities accrue and pay distributions semiannually at a rate of
10.875% per annum of the stated liquidation value of $1,000 per capital
security. The Company has entered into an agreement which fully and
unconditionally guarantees payment of: (i) accrued and unpaid distributions
required to be paid on the Capital Securities; (ii) the redemption price with
respect to any Capital Securities called for redemption by the Trust; and (iii)
payments due upon a voluntary or involuntary liquidation, winding up or
termination of the Trust.
The Capital Securities are mandatorily redeemable upon the maturity of the
debentures on March 8, 2030, or upon earlier redemption as provided in the
indenture pursuant to which the debentures were issued. The Company has the
right to redeem the debentures purchased by the Trust: (i) in whole or in part,
on or after March 8, 2010; and (ii) in whole (but not in part) at any time
within 90 days following the occurrence and during the continuation of a tax
event, capital treatment event or investment company event (each as defined in
the indenture). As specified in the indenture, if the debentures are redeemed
prior to maturity, the redemption price will be a percentage of the principal
amount, ranging from 105.438% in 2010 to 100.00% in and after 2020, plus accrued
but unpaid interest.
NOTE 3 - SEGMENT REPORTING
All of the Company's offices offer similar products and services, are located in
the same geographic region and serve the same customer segments of the market.
As a result, management considers all units as one operating segment and
therefore beleives that the basic financial statements and related footnotes
provide sufficient detail related to segment reporting.
NOTE 4 - STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," defines a fair value
based method of accounting for an employee stock option or similar equity
instrument. However, SFAS No. 123 allows an entity to continue to measure
compensation costs for those plans using the intrinsic value based method of
accounting prescribed by APB Opinion No. 25, Accounting for Stock issued to
Employees. Entities electing to remain with the accounting in Opinion No. 25
must make pro forma disclosures of net income and earnings per share as if the
fair value based method of accounting defined in SFAS No. 123 had been applied.
Under the fair value based method, compensation cost is measured at the grant
date based on the value of the award and is recognized over the service period,
which is usually the vesting period. Under the intrinsic value based method,
compensation cost is the excess, if any, of the quoted market price of the stock
at the grant date or other measurement date over the amount an employee must pay
to acquire the stock. The Company has elected to continue to measure
compensation cost for its stock option plans under the provisions in APB Opinion
25 and has calculated the fair value of outstanding options for purposes of pro
forma disclosure utilizing the Black-Scholes method.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
The Company's options granted during the first three months of 2003 vest
immediately; therefore, for purposes of pro forma disclosure, the compensation
expense related to these options has been recognized when granted. No options
were granted during the first three months of 2002.
9
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company's actual pro forma information follows:
For the Three Months Ended March 31,
-------------------------------------------
2003 2002
---------------- ----------------
Net income (loss):
As reported $ (549,109) $ 1,232,513
Deducts:
Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of tax 139,590 -
---------------- ----------------
Pro forma net income (loss) $ (688,699) $ 1,232,513
================ ================
Basic earnings (loss) per share:
As reported (0.12) 0.27
Pro forma (0.15) 0.27
Diluted earnings (loss) per share:
As reported (0.12) 0.27
Pro forma (0.15) 0.27
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for the options granted in 2003: dividend yield 0%; expected
volatility of .283; risk-free interest rates of 3.10%; and expected lives of 5
years.
NOTE 5 - CONTINGENCIES
Background
At a meeting of Community Bank's Board of Directors on June 20, 2000, a director
brought to the attention of the Board the total amount of money Community Bank
had paid subcontractors in connection with the construction of a new Community
Bank office in Guntersville, Alabama. Management of the Company commenced an
investigation of the expenditures. At the request of management, the architects
and subcontractors involved in the construction project made presentations to
the Boards of Directors of the Company and Community Bank on July 15 and July
18, 2000, respectively. At the July 18, 2000 meeting of the Board of Directors
of Community Bank, another director alleged that Community Bank had been
overcharged by subcontractors on that construction project and another current
construction project. On July 18, 2000, the Boards of Directors of the Company
and Community Bank appointed a joint committee comprised of independent
directors of the Company and of Community Bank to investigate the alleged
overcharges. The joint committee retained independent legal counsel and an
independent accounting firm to assist the committee in its investigation and has
made its report to the Boards of Directors. The directors of Community Bank who
alleged the construction overcharges have made similar charges to bank
regulatory agencies and law enforcement authorities. Management believes that
these agencies and authorities are currently conducting investigations regarding
this matter.
Benson Litigation
On July 21, 2000, three shareholders of the Company, M. Lewis Benson, Doris E.
Benson and John M. Packard, Jr., filed a lawsuit in the state Circuit Court of
Marshall County, Alabama against the Company, Community Bank, certain directors
and officers of the Company and Community Bank, an employee of Community Bank
and two construction subcontractors. The plaintiffs purported to file the
lawsuit as a shareholder derivative action, which relates to the alleged
10
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
construction overcharges being investigated by the joint committee of the Boards
of Directors of the Company and Community Bank. The complaint alleges that the
directors, officers and employee named as defendants in the complaint breached
their fiduciary duties, failed to properly supervise officers and agents of the
Company and Community Bank, and permitted waste of corporate assets by allegedly
permitting the subcontractor defendants to overcharge Community Bank in
connection with the construction of two new Community Bank offices, and to
perform the construction work without written contracts, budgets, performance
guarantees and assurances of indemnification. In addition, the complaint alleges
that Kennon R. Patterson, Sr., the Chairman, President and Chief Executive
Officer of the Company, breached his fiduciary duties by allegedly permitting
the two named subcontractors to overcharge for work performed on the two
construction projects in exchange for allegedly discounted charges for work
these subcontractors performed in connection with the construction of Mr.
Patterson's residence. The complaint further alleges that the director
defendants knew or should have known of this alleged arrangement between Mr.
Patterson and the subcontractors. The complaint also alleges that Mr. Patterson,
the Community Bank employee and the two subcontractor defendants made false
representations and suppressed information about the alleged overcharges and
arrangement between Mr. Patterson and the subcontractors.
On August 15, 2000, the plaintiffs filed an amended complaint adding Andy C.
Mann, a shareholder of the Company, as a plaintiff and adding a former director
of the Company and Community Bank as a defendant. The amended complaint
generally reiterates the allegations of the original complaint. In addition, the
amended complaint alleges that Community Bank was overcharged on all
construction projects from January 1997 to the present. The amended complaint
also alleges that the defendants breached their fiduciary duties and are guilty
of gross financial mismanagement, including allegations concerning the making or
approval of certain loans and taking allegedly improper actions to conceal the
fact that certain loans were uncollectible. On September 18, 2000 the plaintiffs
filed a second amended complaint. The second amended complaint generally
reiterates the allegations of the original and first amended complaints. In
addition, the second amended complaint alleges that the plaintiffs were
improperly denied their rights to inspect and copy certain records of the
Company and Community Bank. The second amended complaint also alleges that the
directors of the Company abdicated their roles as directors either by express
agreement or as a result of wantonness and gross negligence. The second amended
complaint asserts that the counts involving inspection of corporate records and
director abdication are individual, non-derivative claims. The second amended
complaint seeks, on behalf of the Company, an unspecified amount of compensatory
damages in excess of $1 million, punitive damages, disgorgement of allegedly
improperly paid profits and appropriate equitable relief. Upon motion of the
defendants, the case was transferred to the state Circuit Court in Blount
County, Alabama by order dated September 21, 2000, as amended on October 12,
2000.
On August 24, 2000, the Board of Directors of the Company designated the
directors of the Company who serve on the joint investigative committee as a
special litigation committee to investigate and evaluate the allegations and
issues raised in this lawsuit and to arrive at such decisions and take such
action as the special litigation committee deems appropriate. On June 8, 2001,
the special litigation committee filed its report under seal with the court. On
June 18, 2001, the court entered an order affirming the confidentiality of the
special committee's report. On June 28, 2001, the Company, Community Bank and
various other defendants filed a motion with the court to adopt the report of
the special committee, for partial summary judgment and to realign the Company
and Community Bank as plaintiffs in the lawsuit.
Following a hearing on August 29, 2001, the court denied these motions on
November 8, 2001. The court also ruled that the plaintiffs were entitled to
conduct discovery except as it related to one of the subcontractor defendants
and granted the plaintiffs' motion to unseal the report of the special
litigation committee. On November 14, 2001, the directors of the Company filed a
motion for the court to alter, amend, or vacate its November 8, 2001 rulings. On
February 7, 2002, the Company and Community Bank filed a motion to disqualify
Maynard, Cooper & Gale, P.C., the law firm representing the plaintiffs, due to
conflicts of interest. The court held a hearing on these motions on February 22,
2002 and the parties are awaiting a ruling. A tentative settlement of the
lawsuit was announced in November, 2002, but was not finalized. On or about
April 21, 2003 the plaintiffs filed a motion to enforce the tentative
settlement. One of the subcontractors named as a defendant in this action,
Morgan City Construction, Inc., and its principals, Mr. and
11
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Mrs. Dewey Hamaker, have been tried and convicted in the United States District
Court for the Northern District of Alabama.
Because of the inherent uncertainties of the litigation process, the Company is
unable at this time to predict the outcome of this lawsuit and its effect on the
Company's financial condition and results of operations.
Packard Derivative Litigation
On April 4, 2003, a group composed of the same plaintiffs as in the Benson case
filed another derivative action against Sheffield Electrical Contractors, Inc.,
Steve Sheffield, Jay Bolden, Dudley, Hopton-Jones, Sims & Freeman, PLLP, Glynn
Debter, Kennon R. Patterson, Jr., Robert O. Summerford, Jimmie Trotter, John
Lewis, Jr., Merritt Robbins, Stacy Mann, B. K. Walker, Jr., Denny Kelly, Roy B.
Jackson, Loy McGruder, and Hodge Patterson. The complaint in this new derivative
lawsuit, besides adding defendants known during but not named in the Benson
lawsuit, is based upon the same allegations as in the Benson case but bases its
claims against the director-defendants not "for what they did (and did not do)
before learning of the over billing [sic.] allegations against Patterson [Kennon
R. Patterson, Sr., the Company's former Chairman and CEO] in July 2000" but,
instead "only for what they have done (and failed to do) after the filing of the
Benson lawsuit-- that is, after they learned of the allegations against
Patterson in July 2000." [Emphasis in the original.] On May 8, 2003 the Company,
Community Bank and most of the individual defendants filed a motion to transfer
the suit to the Circuit Court of Blount County, Alabama, or, in the alternative,
to dismiss the suit.
Because of the inherent uncertainties of the litigation process, the Company is
unable at this time to predict the outcome of this lawsuit and its effect on the
Company's financial condition and results of operations.
Corr Family Litigation
On September 14, 2000, Bryan A. Corr and six other shareholders of the Company
related to Mr. Corr filed an action in the Circuit Court of Blount County,
Alabama, against the Company, Community Bank, and certain directors and officers
of the Company and Community Bank. The plaintiffs have alleged that the
directors of the Company actively participated in or ratified the
misappropriation of corporate income. The action was not styled as a shareholder
derivative action. On January 3, 2001, the defendants filed a motion for summary
judgment on the basis that these claims are derivative in nature and cannot be
brought on behalf of individual shareholders. The court has not ruled on the
motion. Although management currently believes that this action will not have a
material adverse effect on the Company's financial condition or results of
operations, regardless of the outcome, the action could be costly, time
consuming, and a diversion of management's attention.
12
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Lending Acts Litigation
On October 11, 2002, William Alston, Murphy Howard, and Jason Tittle filed an
action against Community Bank, Community Bancshares, Inc., Holsombeck Motors,
Inc., Lee Brown d/b/a Alabama Bond & Investigation a/k/a ABI Recovery, Chris
Holmes d/b/a Alabama Bond & Investigation a/k/a ABI Recovery, Regina Holsombeck,
Kennon "Ken" Patterson, Sr., Hodge Patterson, James Timothy "Tim" Hodge, Ernie
Stephens, and the State of Alabama Department of Revenue. The plaintiffs in this
class action allege that Community Bank and others conspired or used
extortionate methods to effect a lending scheme of "churning phantom loans", and
that profits from the scheme were used to secure an interest in and/or to invest
in an enterprise that affects interstate commerce. The allegations state that
Community Bank used various methods to get uneducated customers with fair to
poor credit to sign numerous "phantom loans" when the customers only intended to
sign for one loan. Claims include racketeering activity within the meaning of
the Racketeer Influenced and Corrupt Organizations Act of 1970, conspiracy,
spoliation, conversion, negligence, wantonness, outrage, and civil conspiracy.
The Company and Community Bank intend to defend the action vigorously and
currently are conducting discovery to ascertain what substance, if any, there is
to the claims. Although management currently believes that this action will not
have a material adverse effect on the Company's financial condition or results
of operations, regardless of the outcome, the action could be costly, time
consuming, and a diversion of management's attention.
Patterson Litigation
On April 9, 2003 Kennon R. Patterson, Sr., former Chairman, President and Chief
Executive Officer of the Company, filed an adversary proceeding in the United
States Bankruptcy Court for the Northern District of Alabama in connection with
his petition for protection under Chapter 11 of the United States Bankruptcy
Code. Defendants of the adversary proceeding are the Company, Community Bank,
five directors of the Company and Community Bank and the law firm of Powell,
Goldstein, Frazer and Murphy, LLP which represents Community Bank's Audit
Committee. The complaint alleges that the Company breached its employment
agreement with Mr. Patterson by terminating his employment on January 27, 2003
and failed to pay him for compensation and benefits which had allegedly accrued
prior to his termination. The complaint also alleges that Community Bank,
members of Community Bank's Audit Committee, the Audit Committee's independent
counsel and the Company's current Chairman, President and Chief Executive
Officer conspired to interfere with Mr. Patterson's contract and business
relationship with the Company. The suit seeks damages in excess of $150 million
for, among other things, lost compensation and benefits, mental anguish, and
damage to Mr. Patterson's reputation. The Company believes that this lawsuit is
without merit and intends to defend the action vigorously. On May 9, 2003 the
defendants filed a motion to dismiss the suit. Although management currently
believes that this action will not have a material adverse effect on the
Company's financial condition or results of operations, regardless of the
outcome, the action could be costly, time consuming and a diversion of
management's attention.
Employee Litigation
On May 5, 2003 two former executive officers of the Company and Community Bank
filed separate suits in the Circuit Court of Blount County, Alabama, against the
Company, Community Bank, Kennon R. Patterson, Sr., former Chairman and Chief
Executive Officer of the Company and Community Bank, and a number of fictitious
defendants. Bishop K. Walker, Jr., former Senior Executive Vice President and
General Counsel of the Company, and Denny G. Kelly, former President of
Community Bank, allege that they were induced to retire based on
misrepresentations made by Kennon R. Patterson, Sr. who was allegedly acting
within the scope of his duties as an agent of the Company and Community Bank.
Plaintiffs claim that these actions constituted fraud, promissory fraud,
fraudulent suppression, fraud in the inducement, deceit, fraudulent deceit,
negligence, recklessness, wantonness and breach of contract. The complaints ask
for an unspecified amount of compensatory and punitive damages. Although
13
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
management currently believes that this action will not have a material adverse
effect on the Company's financial condition or results of operations, regardless
of the outcome, the action could be costly, time consuming and a diversion of
management's attention.
General
The Company and its subsidiaries are from time to time also parties to other
legal proceedings arising in the ordinary course of business. Management
believes, after consultation with legal counsel, that no such proceedings, if
resulting in an outcome unfavorable to the Company, will, individually or in the
aggregate, have a material adverse effect on the Company's financial condition
or results of operations.
The Company's Certificate of Incorporation provides that, in certain
circumstances, the Company will indemnify and advance expenses to its directors
and officers for judgments, settlements and legal expenses incurred as a result
of their service as officers and directors of the Company. Community Bank's
Bylaws contain a similar provision for indemnification of directors and officers
of Community Bank.
NOTE 6 - DISCONTINUED OPERATIONS
During 2002, Community Bank consummated the sale of the following branches: two
Pulaski, Tennessee locations on March 31, 2002, two DeKalb County, Alabama
locations on May 3, 2002, and six Marshall County, Alabama locations on May 31,
2002. Income and expenses related to these locations are included in
discontinued operations for the three months ended March 31, 2002 for
comparative purposes.
NOTE 7 - INTANGIBLE ASSETS
In June 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible
Assets. The statement requires that goodwill and other intangible assets with
indefinite useful lives no longer be amortized, but instead an entity must
perform an assessment of whether these assets are impaired as of the date of
adoption and test for impairment at least annually in accordance with the
provisions of the statement. The statement also required that intangible assets
with determinable lives be amortized. The Company adopted Statement No. 142 on
January 1, 2002.
Acquired goodwill and other intangible assets at March 31, 2003, are detailed as
follows:
As of March 31, 2003
-------------------------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------------- --------------- --------------
Identifiable amortizing assets................................. $ 2,173,861 $ 1,273,133 $ 900,728
Nonamortizing goodwill......................................... 2,851,372 1,058,565 1,792,807
-------------- --------------- --------------
Total acquired intangible asset................................ $ 5,025,233 $ 2,331,698 $ 2,693,535
============== =============== ==============
Aggregate amortization expense for the period ended March 31, 2003 was $19,854.
Aggregate amortization expense of $79,417 is estimated for the years ending
December 31, 2003 and 2004.
Note 8 - Recently Issued Accounting Standards
In January 2003, the FASB issued FIN 46, which clarifies the application of
Accounting Research Bulletin ("ARB") 51, Consolidated Financial Statements, to
certain entities (called variable interest entities) in which equity investors
do not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its
14
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES-CONTINUED NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
activities without additional subordinated financial support from other parties.
The disclosure requirements of this Interpretation are effective for all
financial statements issued after January 31, 2003. The consolidation
requirements apply to all variable interest entities created after January 31,
2003. In addition, public companies must apply the consolidation requirements to
variable interest entities that existed prior to February 1, 2003 and remain in
existence as of the beginning of annual or interim periods beginning after June
15, 2003. Management is currently assessing the impact of FIN 46, and does not
expect this Interpretation to have a material impact to the Consolidated
Financial Statements.
On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. The provisions of SFAS No. 149 are effective for fiscal quarters
beginning after June 15, 2003. Management does not believe the provisions of
this standard will have a material impact on results of future operations.
15
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion is intended to assist in an understanding of the financial
condition and results of operations of Community Bancshares, Inc. (the "Company)
and its subsidiaries. Unless the context otherwise indicates, the Company shall
include the Company and its subsidiaries. This analysis should be read in
conjunction with the financial statements and related notes appearing in Item 1
of this Report and Management's Discussion and Analysis of Financial Condition
and Results of Operations appearing in the Company's Annual Report on Form 10-K
for the year ended December 31, 2002.
Forward looking information
Certain statements in this Report are "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. These forward-looking
statements are not based on historical facts and may be identified by their
reference to a future period or by the use of forward-looking terminology, such
as "anticipate," "estimate," "expect," "may" and "should." These forward-looking
statements include, without limitation, those relating to the Company's future
growth and profitability, economic prospects of market areas, dividends, pending
litigation, branch office divestitures, non-compliant or impaired loans, capital
requirements, operating strategy, deposits, consumer base, allowance for loan
losses, non-performing assets, interest rate sensitivity, market risk and impact
of inflation. We caution you not to place undue reliance on these
forward-looking statements. Actual results could differ materially from those
indicated in such forward-looking statements due to a variety of factors. These
factors include, but are not limited to, changes in economic conditions and
government fiscal and monetary policies, changes in prevailing interest rates
and effectiveness of the Company's interest rate strategies, laws, regulations
and regulatory authorities affecting financial institutions, changes in and
effectiveness of the Company's operating or expansion strategies, geographic
concentration of the Company's assets and operations, competition from other
financial services companies, unexpected financial results or outcomes of legal
proceedings, and other risks detailed from time to time in the Company's press
releases and filings with the Securities and Exchange Commission. We undertake
no obligation to update these forward-looking statements to reflect events or
circumstances occurring after the date of this Report.
FINANCIAL CONDITION
March 31, 2003 compared to December 31, 2002
Summary
Total assets at March 31, 2003 were $566,243,000, down from $567,596,000 at
December 31, 2002. Although total assets remained stable, the Company continued
to experience declines in loans. As this occurred, asset balances shifted from
loans to cash and due from banks.
Earning Assets
The earning assets of the Company are mainly composed of investment securities,
federal funds sold and loans. Investment securities decreased $1,134,000, or
0.9%, to $122,767,000 at March 31, 2003 from $123,901,000 at December 31, 2002.
The investment securities portfolio is used to make various term investments, to
provide a source of liquidity and to serve as collateral to secure certain
government deposits. Short-term investments in the form of interest-bearing
deposits with banks were $260,000 at March 31, 2003 compared to $200,000 at
December 31, 2002. The Company had $21,365,000 in federal funds sold at March
31, 2003, compared to $24,030,000 at December 31, 2002, representing a decrease
of $2,665,000, or 11.1%.
Cash and due from banks increased $17,145,000 during the first quarter of 2003.
Earnings credit rates are applied to balances held in the Company's
correspondent bank accounts held with other banks. The Company is given a credit
based on its balance and the credit is used to offset service charges to the
Company. These earnings credit rates are currently higher than the federal funds
sold rates. The Company increased its balances in its main correspondent account
during 2003 to take advantage of the better rate; therefore, earning a larger
credit against
16
service charges it would have paid than the interest income it otherwise would
have received had the funds been in federal funds sold.
Loans comprise the largest single category of the Company's earning assets.
Loans, net of unearned income, were $346,639,000 at March 31, 2003 down
$12,545,000, or 3.5%, from $359,184,000 at December 31, 2002. The Company
continues to experience a decline in total loans because of economic downturns,
the tightening of the Company's credit standards, and increased charge-offs of
loans made in previous years.
Nonperforming Assets and Past Due Loans
Between December 31, 2002 and March 31, 2003, the ratio of the allowance for
loan losses to total nonperforming assets (defined as nonaccruing loans, loans
past due 90 days or greater, restructured loans, nonaccruing securities, and
other real estate) declined from 43.95% at year-end 2002 to 34.98% at March 31,
2003. The ratio of total nonperforming assets to total assets increased to 5.11%
at March 31, 2003 from 3.92% at year-end 2002, while the ratio of nonperforming
loans to total loans, net of unearned income, increased to 5.90% at March 31,
2003 from 4.06% at December 31, 2002. These changes were primarily due to an
increase in nonaccruing loans of $7,552,000 or 74.8%, to $17,651,000 at March
31, 2003 from $10,099,000 at December 31, 2002 and an increase in other real
estate of $827,000, or 10.8%, to $8,503,000 at March 31, 2003 from $7,676,000 at
December 31, 2002. These increases were partially offset by a decline in loans
past due 90 days or more of $885,000, or 71.3%, to $356,000 at March 31, 2003
from $1,241,000 at December 31, 2002. Total nonperforming assets increased
$6,683,000, or 30.0%, to $28,943,000 at March 31, 2003 from $22,260,000 at
December 31, 2002. The significant increase in nonaccrual loans was mostly due
to a $5,150,000 real estate loan to the Company's former Chairman and Chief
Executive Officer who filed bankruptcy in January, 2003. It is the Company's
policy to place loans on nonaccrual status when a borrower files bankruptcy.
Funding
The Company's primary sources of funding are from deposits from the customers of
Community Bank and from other short-term and long-term borrowings. Total
deposits of $461,744,000 at March 31, 2003 reflected an increase of $2,280,000,
or 0.5%, from $459,464,000 at year-end 2002. Deposits are Community Bank's
primary source of funds. Noninterest-bearing deposits increased $3,946,000, or
7.5%, to $56,867,000 at March 31, 2003 from $52,921,000 at December 31, 2002,
while interest-bearing deposits decreased $1,666,000, or 0.4%, to $404,877,000
at March 31, 2003 from $406,543,000 at December 31, 2002. Certificates of
deposit of $100,000 or more increased $13,985,000, or 19.8%, to $84,612,000 at
March 31, 2003 from $70,627,000 at December 31, 2002.
Total short-term borrowings decreased $1,523,000, or 88.3%, to $202,000 at March
31, 2003 from $1,725,000 at December 31, 2002. FHLB long-term debt remained
constant at $38,000,000 for both March 31, 2003 and December 31, 2002 while
other long-term debt decreased $101,000, or 2.8%, to $3,477,000 at March 31,
2003 from $3,578,000 at December 31, 2002.
In March 2000, the Company formed a wholly-owned Delaware statutory business
trust, Community (AL) Capital Trust I (the "Trust"), which issued $10,000,000 of
guaranteed preferred securities representing undivided beneficial interests in
the assets of the Trust ("Capital Securities"). All of the common securities of
the Trust are owned by the Company. The proceeds from the issuance of the
Capital Securities ($10,000,000) and common securities ($310,000) were used by
the Trust to purchase $10,310,000 of junior subordinated deferrable interest
debentures of the Company which carry an annual interest rate of 10.875%. Under
the terms of the indenture, the Company may elect to defer payments of interest
for up to ten semiannual payment periods. The Company has elected to defer its
March 2002, September 2002 and March 2003 interest payments and may elect to do
so again based on the liquidity needs of the Company when future payments become
due. For the duration of such deferral period, the Company is restricted from
paying dividends to shareholders or paying debt that is junior to the debenture.
The debentures represent the sole asset of the Trust. The debentures and related
income statement effects are eliminated in the Company's consolidated financial
statements. The Company is entitled to treat the aggregate liquidation amount of
the debentures as Tier I capital under Federal Reserve guidelines.
18
The Capital Securities accrue and pay distributions semiannually at a rate of
10.875% per annum of the stated liquidation value of $1,000 per capital
security. The Company has entered into an agreement which fully and
unconditionally guarantees payment of: (i) accrued and unpaid distributions
required to be paid on the Capital Securities; (ii) the redemption price with
respect to any Capital Securities called for redemption by the Trust; and (iii)
payments due upon a voluntary or involuntary liquidation, winding up or
termination of the Trust.
The Capital Securities are mandatorily redeemable upon the maturity of the
debentures on March 8, 2030, or upon earlier redemption as provided in the
indenture pursuant to which the debentures were issued. The Company has the
right to redeem the debentures purchased by the Trust: (i) in whole or in part,
on or after March 8, 2010; and (ii) in whole (but not in part) at any time
within 90 days following the occurrence and during the continuation of a tax
event, capital treatment event or investment company event (each as defined in
the indenture). As specified in the indenture, if the debentures are redeemed
prior to maturity, the redemption price will be a percentage of the principal
amount, ranging from 105.438% in 2010 to 100.00% in and after 2020, plus accrued
but unpaid interest.
Liquidity
The following is a discussion of cash flows. The Company experienced an
approximate $14,540,000 increase in cash and cash equivalents during the first
three months of 2003. Cash provided by operating activities was $2,868,000.
Investing activities provided an increase of $11,036,000, mostly from loan
payments from customers. Financing activities provided $636,000 of cash and cash
equivalents for the first quarter of 2003. Certificates of deposits decreased
$4,969,000, but was more than offset by increases in cash from the growth of
demand deposits, NOW deposits, and other savings deposits totaling $7,248,000.
Dividends paid by Community Bank are the primary source of funds available to
the Company. The Company relies on dividends from Community Bank in order to pay
expenses, service debt and pay dividends to shareholders. Certain restrictions
exist regarding the ability of Community Bank to transfer funds to the Company
in the form of cash dividends, loans or advances. Although dividends from
Community Bank are the primary source of funding, the Company also receives cash
from its subsidiaries for its portion of tax benefit on intercompany income tax
settlements. Community Bank discontinued paying the Company a management fee in
2003. The Company's primary cash outflow is now debt service. Community Bank is
unable to pay a dividend to the Company without prior approval of the regulatory
authorities. The Company could become unable to service its debt without
dividends from Community Bank.
Capital Resources
Total shareholders' equity at March 31, 2003 was 6.91% of total assets as
compared to 7.10% at December 31, 2002. The decrease experienced during the
first three months of 2003 is primarily a result of net losses of $549,000.
Bank regulatory authorities have issued risk-based capital guidelines that take
into consideration risk factors associated with various categories of assets,
both on and off the balance sheet. Under the guidelines, capital strength is
measured in two tiers, which are used in conjunction with risk-adjusted assets
to determine the risk-based capital ratios. The Company's Tier I capital, which
includes common stock, retained earnings and guaranteed preferred beneficial
interest in the Company's junior subordinate deferrable interest debentures,
amounted to $46,313,000 at March 31, 2003, compared to $46,817,000 at December
31, 2002. Tier II capital components include supplemental capital components,
such as qualifying allowance for loan losses and qualifying subordinated debt.
Tier I capital plus the Tier II capital components are referred to as total
risk-based capital, which was $50,828,000 at March 31, 2003 as compared to
$52,897,000 at year-end 2002. The percentage ratios, as calculated under the
guidelines, for tier I and total risk-based capital were 13.03% and 14.29%,
respectively, at March 31, 2003, compared to 12.95% and 14.63%, respectively, at
year-end 2002. At March 31, 2003, both tier I and total risk-based capital of
the Company exceeded the regulatory minimum ratios of 4% and 8%, respectively.
18
Another important indicator of capital adequacy in the banking industry is the
leverage ratio. The tier I leverage ratio is defined as the ratio that the
Company's tier I capital bears to total average assets minus goodwill. The
Company's tier I leverage ratios were 8.25% and 8.20% at March 31, 2003 and
December 31, 2002, respectively, exceeding the regulatory minimum requirement of
4%.
RESULTS OF OPERATIONS
Three months ended March 31, 2002 and 2001
Summary
The Company's net loss for the three months ended March 31, 2003 was $549,000, a
decrease of $1,782,000 from net income of $1,233,000 for the same period in
2002. Both basic and diluted net loss per share was $0.12 for the three months
ended March 31, 2003, as compared to net income per share of $0.27 for the same
period in 2002.
The following discussion is on results of operations from continuing operations
of the Company. Refer to Note 6 of the Notes to Consolidated Financial
Statements for a description of the presentation for discontinued operations.
Net Interest Income
Net interest income, the difference between interest earned on assets and the
cost of interest-bearing liabilities, was $5,077,000 for the three months ended
March 31, 2003. Net interest income, before provision for loan losses, decreased
$988,000, or 16.3%, from $6,065,000 for the same period of 2002. Revenues from
interest earning assets of the Company decreased $1,752,000, or 16.4%, to
$8,914,000 for the three months ended March 31, 2003 from $10,666,000 for the
same period in 2002. This decrease was due to lower yields on and volume of
interest earning assets. Average earning assets outstanding during the first
quarter of 2003 were $503,928,000, which represents a decrease of $37,849,000,
or 7.0%, from $541,777,000 for the first quarter of 2002. The Company's yield on
its average earning assets decreased 81 basis points to 7.17% for the first
three months of 2003, compared to 7.98% for the same period of 2002. This
decrease is somewhat reflective of the overall decrease in interest rates
experienced during the year 2002. Interest expense for the three months ended
March 31, 2003 decreased $765,000, or 16.6%, to $3,837,000 from $4,602,000 for
the corresponding period of 2002. This decrease occurred due to a decline in
rates paid on and volume of interest-bearing liabilities. Average
interest-bearing liabilities during the first quarter of 2003 were $460,854,000,
which represents a decrease of $7,938,000, or 1.7%, from $468,792,000 for the
same period of 2002. The rate paid on average interest-bearing liabilities
decreased 60 basis points to 3.38% for the three month period ended March 31,
2003, compared to 3.98% for the first three months of 2002. This decrease is
also attributable to the overall decline in interest rates during the year 2002.
The Company's net interest margin for the three months ended March 31, 2003
decreased 45 basis points to 4.09%, from 4.54% for the three months ended March
31, 2002, due to the decrease in net interest income. Net interest margin is
computed by dividing net interest income by average interest earning assets.
This ratio represents the difference between the average yield returned on
average interest earning assets and the average rate paid on funds used to
support those interest earning assets, including both interest-bearing and
noninterest-bearing sources.
The Company's net interest spread for the three months ended March 31, 2003
decreased 21 basis points to 3.79%, from 4.00% for the three months ended March
31, 2002, as the average cost of interest-bearing sources of funds decreased 60
basis points while the average yield on interest earning assets decreased 81
basis points. Net interest spread measures the difference between the average
yield on interest earning assets and the average rate paid on interest-bearing
sources of funds.
19
Provision for Loan Losses and Allowance for Loan Losses
At March 31, 2003, the allowance for loan losses was $10,123,000 which
represented an increase of $339,000, or 3.5%, from the December 31, 2002 amount
of $9,784,000. The provision for loan losses was $1,289,000 and $944,000 for the
three months ended March 31, 2003 and 2002, respectively. The increase resulted
from management's decision to make provisions for current losses in the loan
portfolio as it continues its effort to improve the overall credit quality of
the Company. In this effort, management has increased the allowance for loan
losses account as a percent of loans to reserve for potential losses in the loan
portfolio by recognizing additional provisions for loan loss expense. As a
percentage of total loans, net of unearned income, the allowance for loan losses
increased to 2.92% at March 31, 2003, compared to 2.72% at December 31, 2002.
Loan charge-offs exceeded recoveries by $950,000 during the first three months
of 2003, which represented an increase of $96,000, or 11.2%, from $854,000 for
the same period during 2002. Management believes that the allowance for loan
losses at March 31, 2003 is adequate; however, no assurance can be given that
additional losses may not occur or that additional provisions to the allowance
for loan losses will not be necessary.
Noninterest Income
Noninterest income for the three months ended March 31, 2003 increased $474,000,
or 27.7%, to $2,184,000, from $1,710,000 for the same period of 2002. Service
charges on deposit accounts decreased $151,000, or 19.8%, to $611,000 for the
first quarter of 2003 from $762,000 in the first quarter of 2002. Debt
cancellation fees decreased during the first quarter of 2003, as compared to the
first quarter of 2002, $30,000, or 50.0%, due to decreased volume in debt
cancellation coverage associated with the decline in the Company's loan
portfolio. Other operating income remained stable at $226,000. The Company
recorded net gains on the sale of investment securities of $648,000 during the
three months ended March 31, 2003, compared to net gains on the sale of
investment securities of $17,000 for the same period of 2002. The net securities
gains were the primary reason for the increase in noninterest income, although
the Company also experienced a 4.4%, or $24,000 increase in insurance
commissions attributable to increased revenues from the Company's subsidiary,
Community Insurance Corp.
Noninterest Expenses
Noninterest expenses for the three months ended March 31, 2003 were $7,009,000,
representing a $277,000, or 4.1%, increase from $6,732,000 for the same period
of 2002. The primary components of noninterest expenses are salaries and
employee benefits, which decreased $145,000, or 4.2%, to $3,329,000 for the
three months ended March 31, 2003 from $3,474,000 for the same period of 2002.
Occupancy costs decreased $2,000, or 0.3%, to $589,000 for the first quarter of
2003 from $591,000 for the same period of 2002. Furniture and equipment expenses
for the three month periods ended March 31, 2003 decreased $39,000, or 9.6%, to
$367,000 from $406,000 for the same period of 2002. Director and committee fees
increased $25,000, or 25.8%, to $122,000 for the first quarter of 2003 from
$97,000 for the first quarter of 2002. This increase is the result of increased
Board meetings due to the many changes the Company has experienced during the
first quarter of 2003. Other operating expenses were $2,349,000 and $1,769,000
for the three month periods ended March 31, 2003 and 2002, respectively. This
increase of $580,000, or 32.8%, was primarily due to increased expenses,
especially legal fees, related to the continued litigation against the Company
and even more so related to the agreement with the Alabama State Banking
Department and the investigation into payments made in connection with
construction projects of the Bank.
Income Taxes
The Company attempts to maximize its net income through active tax planning. Tax
benefits were $487,000 for the three month period ended March 31,2003 compared
to tax expense of $614,000 for the same period in 2002.
20
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Sensitivity
Community Bank's net interest income, and the fair value of its financial
instruments, are influenced by changes in the level of interest rates. Community
Bank manages its exposure to fluctuations in interest rates through policies
established by its Asset/Liability Committee ("ALCO"). The ALCO meets
periodically to monitor its interest rate risk exposure and implement strategies
that might improve its balance sheet positioning and/or earnings. Management
utilizes an Interest Rate Simulation model to estimate the sensitivity of the
Bank's net interest income and net income to changes in interest rates. Such
estimates are based upon a number of assumptions for each scenario, including
balance sheet growth, deposit repricing characteristics and prepayment rates.
The estimated impact on Community Bank's net interest income sensitivity over a
one year time horizon at March 31, 2003 is shown below. Such analysis assumes an
immediate and nonparallel shift in interest rates and the Bank's estimates of
how interest-bearing transaction accounts will reprice.
RATE SHOCK ANALYSIS
-100 +100
Basis Basis
Points Level Points
(Dollars in thousands)
Prime Rate.................................................... 3.25% 4.25% 5.25%
Interest Income............................................... $ 32,868 $ 34,501 $ 35,883
Interest Expense.............................................. 11,698 12,674 13,969
----------- ----------- -----------
Net Interest Income...................................... $ 21,170 $ 21,827 $ 21,914
=========== =========== ===========
Dollar change from Level...................................... $ (657) $ 87
Percentage change from Level.................................. (3.01)% 0.40%
As shown above, in a 100 basis point rising rate environment, the net interest
margin is projected to increase 0.40% and in a 100 basis point falling rate
environment, the net interest margin is projected to decrease 3.01%. These
percent changes from a level rate scenario fall comfortably within Community
Bank's ALCO policy limit of +/-7.00%.
21
Item 4 - Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
The Company has evaluated the effectiveness of its disclosure controls and
procedures pursuant to Securities Exchange Act Rule 13a-14. The evaluation
was performed under the supervision and with the participation of
management, including the chief executive officer and the chief financial
officer, within 90 days prior to the date of the filing of this annual
report. Based on this evaluation, the chief executive officer and chief
financial officer have concluded that the disclosure controls and
procedures are effective in ensuring that all material information required
to be disclosed in this annual report has been communicated to them in a
manner appropriate to allow timely decisions regarding required disclosure.
(b) Changes in internal controls.
Subsequent to the date of their evaluation, there were no significant
changes in internal controls or other factors that could significantly
affect internal controls, including any corrective actions with regard to
significant deficiencies and material weaknesses.
22
PART II OTHER INFORMATION
Item 1 - Legal Proceedings
On or about April 21, 2003 the plaintiffs in the lawsuit styled Benson et al v.
Community Bancshares, Inc. et al. filed a motion to enforce the tentative
settlement announced in November, 2002.
On May 5, 2003 two former executive officers of the Company and Community Bank
filed separate suits in the Circuit Court of Blount County, Alabama, against the
Company, Community Bank, Kennon R. Patterson, Sr., former Chairman and Chief
Executive Officer of the Company and Community Bank, and a number of fictitious
defendants. Bishop K. Walker, Jr., former Senior Executive Vice President and
General Counsel of the Company, and Denny G. Kelly, former President of
Community Bank, allege that they were induced to retire based on
misrepresentations made by Kennon R. Patterson, Sr. who was allegedly acting
within the scope of his duties as an agent of the Company and Community Bank.
Plaintiffs claim that these actions constituted fraud, promissory fraud,
fraudulent suppression, fraud in the inducement, deceit, fraudulent deceit,
negligence, recklessness, wantonness and breach of contract. The complaints ask
for an unspecified amount of compensatory and punitive damages. Although
management currently believes that this action will not have a material adverse
effect on the Company's financial condition or results of operations, regardless
of the outcome, the action could be costly, time consuming and a diversion of
management's attention.
On May 8, 2003 the Company, Community Bank and most of the individual defendants
filed a motion to transfer the lawsuit styled Packard et al. v. Sheffield
Electrical Contractors, Inc. et al. from the Circuit Court of Jefferson County,
Alabama, to the Circuit Court of Blount County, Alabama, or, in the alternative,
to dismiss the suit.
On May 9, 2003 the defendants in the lawsuit styled Patterson v. Community
Bancshares, Inc. et al. filed a motion to dismiss the suit.
Except as noted above, no reportable events or material developments have
occurred since the filing of the Company's Annual Report on Form 10-K (the "Form
10-K"), for the year ended December 31, 2002 and filed on April 15, 2003. In
connection with the settlement of the lawsuit brought by Michael Alred and
Michael Bean against Community Bank, as disclosed in the Form 10-K, Messrs.
Alred and Bean were dismissed as defendants in the lawsuit styled Community
Bancshares, Inc. et al. v. Corr et al.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
11 Statement of computation of per share earnings
99.1 Chief Executive Officer - Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer - Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
January 27, 2003 - Disclosure of Patrick Frawley replacing Kennon Patterson
as Chairman, CEO and President of Community Bancshares.
January 23, 2003 - Disclosure of Kennon R. Patterson, Sr.'s filing for
protection under Chapter 11 of the U.S. Bankruptcy code.
23
February 8, 2003 - Disclosure of removal of Kennon R. Patterson, Sr. and
Kennon R. Patterson, Jr. from the Community Bank Board of Directors and
appointment of Stacey Mann as Acting President of Community Bank.
March 4, 2003 - Disclosure of the stipulation and consent to the issuance
of an order to cease and desist with the Federal Deposit Insurance
Corporation.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, hereunto duly authorized, in the city of
Blountsville, State of Alabama, on May 15, 2003.
COMMUNITY BANCSHARES, INC.
By: /s/ Patrick M. Frawley
------------------------------------------------
Patrick M. Frawley
Chairman, Chief Executive Officer, and President
By: /s/ Kerri C. Kinney
------------------------------------------------
Kerri C. Kinney
Chief Financial Officer
25
CERTIFICATIONS
--------------
I, Patrick M. Frawley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bancshares,
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 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.
By: /s/ Patrick M. Frawley
-----------------------------------------
Patrick M. Frawley
Chairman, Chief Executive Officer and
President
May 15, 2003
26
CERTIFICATIONS
--------------
I, Kerri C. Kinney, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Community Bancshares,
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 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.
By: /s/ Kerri C. Kinney
-----------------------------------------
Kerri C. Kinney
Chief Financial Officer
May 15, 2003
Exhibit 11 - Statements Re: Computation of Per Share Earnings
Community Bancshares, Inc.
Computation of Net Income (Loss) per Common Share
The following tabulation presents the calculation of basic and fully diluted
earnings per common share for the three months ended March 31, 2003 and 2002.
For the Three Months Ended March 31,
----------------------------------
2003 2002
--------------- ----------------
Reported income (loss) from continuing operations............................. $ (549,109) $ 13,999
=============== ================
Reported income from discontinued operations.................................. $ - $ 1,218,514
=============== ================
Earnings (losses) on common shares............................................ $ (549,109) $ 1,232,513
=============== ================
Weighted average common shares outstanding - basic............................ 4,640,527 4,625,949
=============== ================
Earnings per common share - basic
Income (loss) from continuing operations................................... $ (0.12) $ 0.01
=============== ================
Income from discontinued operations........................................ $ - $ 0.26
=============== ================
Net income (loss).......................................................... $ (0.12) $ 0.27
=============== ================
Weighted average common shares outstanding - diluted.......................... 4,640,527 4,625,949
=============== ================
Earnings per common share - diluted
Income (loss) from continuing operations................................... $ (0.12) $ 0.01
=============== ================
Income from discontinued operations........................................ $ - $ 0.26
=============== ================
Net income (loss).......................................................... $ (0.12) $ 0.27
=============== ================
[The remainder of this page intentionally left blank]
28
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with Community Bancshares, Inc. ("Company") Quarterly Report on
Form 10-Q for the period ended March 31, 2003 ("Report"), each of the
undersigned certify that:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: May 15, 2003 By: /s/ Patrick M. Frawley
------------- -----------------------------------------------
Patrick M. Frawley
Chairman, Chief Executive Officer and President
29
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with Community Bancshares, Inc. ("Company") Quarterly Report on
Form 10-Q for the period ended March 31, 2003 ("Report"), each of the
undersigned certify that:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: May 15, 2003 By: /s/ Kerri C. Kinney
------------- -----------------------------------------------
Kerri C. Kinney
Chief Financial Officer
30