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UNITED STATES
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 quarter period ended March 31, 2005

/  / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _ to  

Commission File Number: 33-81890
 
Community Bankshares, Inc.
(Exact name of registrant as specified in its charter)
 

Georgia
  
58-1415887
(State or other jurisdiction of
  
(IRS Employer
incorporation or organization)
  
Identification No.)


   
448 North Main Street,
  
Cornelia, Georgia
30531
(Address of principal executive offices)
(Zip Code)


(706) 778-2265
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal
year, if changed since last report)

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

APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of May 1, 2005; 2,141,275


1
 
 
COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES
INDEX

PART I. FINANCIAL INFORMATION
 
 
Item 1.  Financial Statements  3
     
  3
     
  4
     
  5
     
  Notes to Consolidated Financial Statements  6 
     
Item 2.  10
     
Item 3.  Quantitative and Qualitative Disclosures about Market Risk  14
     
Item 4.  Controls and Procedures   
    15 
PART II.  OTHER INFORMATION    
     
Item 1.  Legal Proceedings 16 
Item 2.  Unregistered Sale of Equity Securities and Use of Proceeds 16 
Item 3.  Defaults Upon Senior Securities  16 
Item 4.  Submission of Matters to a Vote of Security Holders  16 
Item 6.  Exhibits  16 
     
Signatures    17 
     
 

2

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2005 AND DECEMBER 31, 2004
(Dollars in thousands)
(Unaudited)
 
Assets
    
2005
    
2004
  
Cash and due from banks
  
$
38,628
  
$
30,507
  
Interest-bearing deposits in banks
    
718
    
487
  
Federal funds sold
    
23,050
    
0
  
Securities available-for-sale
    
112,336
    
114,883
  
Securities held-to-maturity (fair value
$19,874 and $21,330)
    
18,999
    
20,217
  
Restricted equity securities, at cost
    
2,810
    
2,469
  
Loans, net of unearned income
    
659,582
    
645,500
  
Less allowance for loan losses
    
9,621
    
9,170
  
Loans, net
    
649,961
    
636,330
  
Premises and equipment, net
    
18,483
    
18,330
  
Intangible assets, net
    
742
    
812
  
Goodwill
    
968
    
968
  
Other real estate
    
4,042
    
3,901
  
Other assets
    
14,652
    
14,474
  
Total assets
  
$
885,389
  
$
843,378
  
 
Liabilities, Redeemable Common Stock and Shareholders’ Equity
              
Liabilities:
Deposits:
Noninterest-bearing
  
$
129,009
  
$
119,097
  
Interest-bearing demand
    
206,927
    
197,927
  
Savings
    
41,787
    
39,043
  
Time, $100,000 and over
    
143,568
    
135,940
  
Other time
    
242,461
    
234,968
  
Total deposits
    
763,752
    
726,975
  
Other borrowings
    
30,703
    
25,794
  
Other liabilities
    
10,831
    
11,569
  
Total liabilities
    
805,286
    
764,338
  
               
Redeemable common stock held by ESOP, net of unearned ESOP shares related to
ESOP debt guarantee of $487,971 and $585,218, at March 31, 2005
and December 31, 2004 respectively
    
19,023
    
18,925
  
Shareholders' equity
Common stock, par value $1; 5,000,000 shares authorized;
2,211,330 and 2,211,330 shares issued at March 31, 2005 and
December 31, 2004, respectively
    
2,211
    
2,211
  
Capital surplus
    
6,477
    
6,477
  
Retained earnings
    
55,364
    
53,536
  
Accumulated other comprehensive income
    
39
    
884
  
Less cost of 70,055 and 69,745 shares of treasury stock at March 31, 2005 and
December 31, 2004, respectively
    
(3,011
)
  
(2,993
)
Total shareholders' equity
    
61,080
    
60,115
  
               
Total liabilities, redeemable common stock and shareholders' equity
  
$
885,389
  
$
843,378
  
 
See Notes to Consolidated Financial Statements

3
COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHESIVE INCOME
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands, except per share amounts)
(Unaudited)
   
Three Months Ended
March 31,
  
   
2005
  
2004
  
Interest income:
Loans, including fees
  
$
11,225
  
$
9,904
  
Taxable securities
    
654
    
616
  
Nontaxable securities
    
651
    
691
  
Interest-bearing deposits in other banks
    
4
    
2
  
Federal funds sold
    
94
    
35
  
Total interest income
    
12,628
    
11,248
  
Interest expense:
Deposits
    
3,576
    
2,743
  
Other borrowings
    
269
    
209
  
Total interest expense
    
3,845
    
2,952
  
Net interest income
    
8,783
    
8,296
  
Provision for loan losses
    
713
    
1,129
  
Net interest income after
Provision for loan losses
    
8,070
    
7,167
  
Other income:
Service charges on deposit accounts
    
2,150
    
2,270
  
Other service charges, commissions and fees
    
625
    
530
  
Trust department fees
    
64
    
51
  
Gains on sale of loans
    
106
    
11
  
Nonbank subsidiary income
    
1,850
    
1,494
  
Security gains, net
    
(1
)
  
36
  
Other operating income
    
97
    
97
  
Total other income
    
4,891
    
4,489
  
Other expenses:
Salaries and employee benefits
    
5,585
    
4,866
  
Equipment expense
    
936
    
814
  
Occupancy expense
    
638
    
524
  
Other operating expenses
    
2,955
    
3,185
  
Total other expenses
    
10,114
    
9,389
  
Income before income taxes
    
2,847
    
2,267
  
Income tax expense
    
826
    
544
  
Net income
  
$
2,021
  
$
1,723
  
Other comprehensive income (loss):
Unrealized income (losses) on securities available for sale:
Unrealized gains (losses) arising during
the period, net of taxes
    
(845
)
  
583
  
Reclassification adjustment
for gains realized in net
income, net of taxes
    
0
    
(22
)
Total other comprehensive income (loss)
    
(845
)
  
561
  
Comprehensive income
  
$
1,176
  
$
2,284
  
Basic earnings per common share
  
$
.94
  
$
.81
  
Diluted earnings per common share
  
$
.94
  
$
.80
  
Cash dividends per share of common stock
  
$
.09
  
$
.08
  
 
See Notes to Consolidated Financial Statements.
              
 
4
COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands)
(unaudited)
 
   
2005
  
2004
  
OPERATING ACTIVITIES              
Net income
  
$
2,021
  
$
1,723
  
Adjustments to reconcile net income to
net cash provided by operating
activities: 
              
Depreciation and amortization
    
768
    
708
  
Provision for loan losses
    
713
    
1,129
  
Provision for losses on other real estate owned
    
-
    
10
  
Deferred income taxes
    
(760
)
  
(50
)
Net realized (gains) losses on securities
available-for-sale
    
1
    
(36
)
Decrease in interest receivable
    
169
    
245
  
Decrease in interest payable
    
(51
)
  
(101
)
Increase in taxes payable
    
777
    
933
  
Increase in accounts
receivable of nonbank subsidiary
    
(621
)
  
(324
)
Decrease in work in
Process of nonbank subsidiary
    
4
    
96
  
Increase (decrease) in accruals and
payables of nonbank subsidiary
    
(548
)
  
354
  
Net other operating activities
    
772
    
1,674
  
Net cash provided by
operating activities
    
3,245
    
6,361
  
               
INVESTING ACTIVITIES               
Purchases of securities available-for-sale
    
(16,141
)
  
(409
)
Proceeds from sales of securities
available-for-sale
    
11,071
    
4,314
  
Proceeds from maturities of securities
available-for-sale
    
5,867
    
1,502
  
Proceeds from maturities of securities
held-to-maturity
    
1,218
    
514
  
Net increase in Federal funds sold
    
(23,050
)
  
(5,400
)
Net decrease in interest-bearing
deposits in banks
    
(231
)
  
(230
)
Net increase in loans
    
(14,841
)
  
(34,747
)
Purchase of premises and equipment
    
(849
)
  
(1,121
)
Proceeds from sales of other real estate
    
357
    
520
  
Net cash used in
investing activities
    
(36,599
)
  
(35,057
)
               
FINANCING ACTIVITIES               
Net increase in deposits
    
36,777
    
15,147
  
Repayment of other borrowings
    
(91
)
  
(147
)
Purchase of Treasury Stock
    
(18
)
  
(339
)
Increase in FHLB Advances
    
5,000
    
10,075
  
Dividends paid
    
(193
)
  
(172
)
Net cash provided by Financing activities
    
41,475
    
24,564
  
Net increase (decrease) in cash and
due from banks
  
$
8,121
  
$
(4,128
)
Cash and due from banks at beginning of the period
    
30,507
    
44,729
  
Cash and due from banks at end of the period
  
$
38,628
  
$
40,601
  
               
 
5
 
COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(Dollars in thousands)
(Unaudited)
(CONTINUED)
 
     
2005 
 
 
2004 
  
               
SUPPLEMENTAL DISCLOSURES               
Cash paid for:
Interest
  
$
3,896
  
$
3,042
  
Income taxes
  
$
246
  
$
53
  
               
NONCASH TRANSACTIONS               
Principal balances on loans
Transferred to other real estate
  
$
497
  
$
612
  


6

COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. BASIS OF PRESENTATION

The consolidated financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in opinion of management, necessary for a fair statement of results for the interim periods.

The results of operations for the three month period ending March 31, 2005 are not necessarily indicative of the results to be expected for the full year.

NOTE 2. STOCK COMPENSATION PLAN
 
The Company has a stock-based employee compensation plan. The Company accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying stock on the date of grant.

There were no options granted during the three months ended March 31, 2005 and 2004. Therefore, there would be no proforma effect on net income or earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
 
NOTE 3. EARNINGS PER COMMON SHARE
 
The following is a reconciliation of net income (the numerator) and weighted-average shares outstanding (the denominator) used in determining basic and diluted earnings per common share (EPS).
 
   
Three Months Ended March 31, 2005
  
   
 (Dollars and shares in Thousands
except per share amounts)
  
   
Net
Income
(Numerator)
  
Weighted-Average
Shares
(Denominator)
  
Per Share
Amount
  
               
Basic EPS
  
$
2,021
    
2,141
  
$
0.94
  
Effect of Dilutive Securities
Stock options
    
-0-
    
8
    
-
  
Diluted EPS
  
$
2,021
    
2,149
  
$
0.94
  



   
Three Months Ended March 31, 2004
  
   
(Dollars and shares in Thousands,
except per share amounts)
  
   
Net
Income
(Numerator)
  
Weighted-Average
Shares
(Denominator)
  
Per Share
Amount
  
               
Basic EPS
  
$
1,723
    
2,140
  
$
0.81
  
Effect of Dilutive Securities
Stock options
    
-0-
    
7
    
(.01
)
Diluted EPS
  
$
1,723
    
2,147
  
$
0.80
  


7



NOTE 4. SEGMENT INFORMATION
 
Selected segment information by industry segment for the three month periods ended March 31, 2005 and 2004 is as follows:
 
   
 Reportable Segments
(Dollars in thousands)
  
 
For the period ended March 31, 2005
  
 
Banking
  
Financial
Supermarkets
  
All
Other
  
 
Total
  
                   
Revenue from external customers
  
$
15,721
  
$
1,711
  
$
188
  
$
17,620
  
Intersegment revenues (expenses)
    
(52
)
  
108
    
654
    
710
  
Segment profit (loss)
    
2,159
    
309
    
(470
)
  
1,998
  
Segment assets
  
$
884,811
  
$
17,350
  
$
5,114
  
$
907,275
  

   
 Reportable Segments
(Dollars in thousands)
  
 
For the period ended March 31, 2004
  
 
Banking
  
Financial
Supermarkets
  
All
Other
  
 
Total
  
                   
Revenue from external customers
  
$
14,246
  
$
1,374 1,3741
  
$
166
  
$
15,786
  
Intersegment revenues (expenses)
    
(31
)
  
90
    
493
    
552
  
Segment profit (loss)
    
1,963
    
132
    
(396
)
  
1,699
  
Segment assets
  
$
798,463
  
$
14,885
  
$
5,797
  
$
819,145
  

   
2005
  
2004
  
 
Net Income
          
           
Total profit for reportable segments
  
$
2,468
  
$
2,095
  
Non-reportable segment loss
    
(470
)
  
(396
)
Elimination of intersegment (gains) losses
    
23
    
24
  
Total consolidated net income
  
$
2,021
  
$
1,723
  

 
 

   
2005
  
 
Total Assets
        
         
Total assets for reportable segments
  
$
902,161
  
Non-reportable segment assets
    
5,114
  
Elimination of intersegment assets
    
(21,886
)
Total consolidated assets
  
$
885,389
  


8


NOTE 5.    REVERSE STOCK SPLIT

On January 13, 2005, the Board of Directors of the Company voted unanimously to declare a one for five-hundred reverse stock split for the primary for the purpose of “Going private” which will relieve the Company from the expense and burden associated with compliance with both current and proposed federal securities laws and regulations. Since the Board of Directors and executive officers, as defined by securities law, do not collectively control more than 50% of the voting shares of the Company’s outstanding stock and since the reverse stock split is subject to regulatory and shareholder approval to amend the Company’s by-laws, we have not restated the equity section of the balance sheet or per share amounts. The following table illustrates the effect on earnings per share if the Company had reflected the one for five-hundred reverse stock split.

   
 Three Months Ended March 31,
  
     
2005
    
2004
  
Earnings per share:
              
Basic - as reported
  
$
.94
  
$
.81
  
Basic - pro forma
  
$
470.00
  
$
405.00
  
Diluted - as reported
  
$
.94
  
$
.80
  
Diluted - pro forma
  
$
470.00
  
$
400.00
  


NOTE 6.    RECENT ACCOUNTING STANDARDS

In December 2004, the FASB published Statement No. 123 (revised 2004), “Share-Based Payment” (“FAS 123(R)” or the “Statement”). FAS 123(R) requires that the compensation cost relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) covers a wide range of share-based compensation arrangements including stock options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. FAS 123(R) is a replacement of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretive guidance (APB 25).

The effect of the Statement will be to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement.

The Company will be required to apply FAS 123(R) as of the beginning of its first interim period that begins after December 15, 2005.

FAS 123(R) allows two methods for determining the effects of the transition: the modified prospective transition method and the modified retrospective method of transition. Under the modified prospective transition method, an entity would use the fair value based accounting method for all employee awards granted, modified, or settled after the effective date. As of the effective date, compensation cost related to the nonvested portion of awards outstanding as of that date would be based on the grant-date fair value of those awards as calculated under the original provisions of Statement No. 123; that is, an entity would not remeasure the grant-date fair value estimate of the unvested portion of awards granted prior to the effective date. An entity will have the further option to either apply the Statement to only the quarters in the period of adoption and subsequent periods, or apply the Statement to all quarters in the fiscal year of adoption. Under the modified retrospective method of transition, an entity would revise its previously issued financial statements to recognize employee compensation cost for prior periods presented in accordance with the original provisions of Statement No. 123.

The Company has not yet completed its study of the transition methods or made any decisions about how it will adopt FAS 123(R).

9



COMMUNITY BANKSHARES, INC.
AND SUBSIDIARIES

ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Our discussion below in this Item 2 is based on the more detailed discussions about our business, operations and financial condition included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, under Item 7. Our discussions here focus on our results during or as of the quarter ended March 31, 2005, and the comparable period of 2004, and, to the extent applicable, any material changes from the information discussed in that Form 10-K or other important intervening developments or information since that time. These discussions should be read in conjunction with that 10-K for more detailed and background information.

Forward Looking Statements

This discussion contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Company believes the assumptions underlying the forward-looking statements contained in the discussion are reasonable, any of the assumptions could be inaccurate, and therefore, no assurance can be made that any of the forward-looking statements included in this discussion will be accurate. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: economic conditions (both generally and in the markets where the Company operates); competition from other providers of financial services; government regulation and legislation; changes in interest rates; and material unforeseen changes in the financial stability and liquidity of the Company’s credit customers; all of which are difficult to predict and which may be beyond the control of the Company. The Company undertakes no obligation to revise forward-looking statements to reflect events or changes after the date of this discussion or to reflect the occurrence of unanticipated events.

Critical Accounting Policies

The accounting principles the Company follows and its methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. In connection with the application of those principles, the Company has made judgments and estimates that, in the case of the determination of the allowance for loan losses have been critical to the determination of the Company’s financial position, results of operations and cash flows.

Management’s judgment in determining the adequacy of the allowance for loan losses is based on evaluations of the collectibility of loans in the portfolio. The allowance is an amount that management believes will be adequate to absorb estimated losses in the loan portfolio. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, particular circumstances that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Banks to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

Financial Condition

For the quarter ended March 31, 2005, we experienced growth in total assets, total loans and total deposits as compared to December 31, 2004. Total assets, loans, and deposits increased by 4.98%, 2.18% and 5.06% respectively. The growth in deposits is attributed to our expanding markets and increased efforts to grow our deposit base to help fund our increased loan demand. The growth in loans was funded by the maturity and sale of securities, advances from Federal Home Loan Bank, the growth of deposits and retention of earnings.

Liquidity

As of March 31, 2005, the liquidity ratio was 18.14% which is within our target range of 15 - 20%. Liquidity is measured by the ratio of net cash, short term and marketable securities to net deposits and short term liabilities.




10

 
Interest Rate Risk

Our guideline is to allow no more than an 8% change in net interest income when interest rates rise or fall 200 basis points or more. Our overall interest rate risk was less than 4% of net interest income; therefore, we are within policy guidelines. We have attempted to position ourselves to minimize the impact of further changes in rates in either direction.

Capital

Banking regulation requires the Company and the banks to maintain capital levels in relation to our assets. At March 31, 2005, the banks' capital ratios were considered well capitalized based on regulatory minimum capital requirements. The minimum capital requirements for the Company and the actual consolidated capital ratios were as follows:
 
   
Actual
  
Regulatory Minimum
  
Leverage
    
   9.08% 
 
  
4.00%
 
Core Capital
    
11.62% 
 
  
4.00%
 
Total Capital
    
12.87% 
 
  
8.00%
 


Off Balance Sheet Arrangements

Our financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of business. These off-balance sheet financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are included in the financial statements when funds are distributed or the instruments become payable. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments as we do for on- balance sheet instruments. Although these amounts do not necessarily represent future cash requirements, a summary of our commitments as of March 31, 2005 and December 31, 2004 are as follows:
 
   
March 31, 2005
  
December 31, 2004
  
   
(Dollars in Thousands)
  
(Dollars in Thousands)
  
Commitments to extend credit
 
$
67,559
  
$
72,568
  
Financial standby letters of credit
   
3,853
    
4,104
  

A. Results of Operation

Net Income

Net income for the three month period ended March 31, 2005, was $2,021,000 or an increase of 17.30% over the same period for 2004.

Net Interest Income
 
Net interest income for the three month period ended March 31, 2005 was up 5.87% over the same period for 2004, from $8,296,000 to $8,783,000. Interest income was up by 12.27% for the three month period ending March 31, 2005 from $11,248,000 to $12,628,000. The increase was primarily caused by the increase in the volume of earning assets. Earning assets increased by 12.37% or $89,984,000 at March 31, 2005 as compared to March 31, 2004. The largest increase in earning assets since March 31, 2004 was the increase in loans of $80,107,000 or 13.82%. Securities increased by $11,767,000 while federal funds sold decreased by $1,950,000.
 
Interest expense was up 30.25% or $893,000 for the three month period ended March 31, 2005, over the same period in 2004. This increase was related to the increase in interest bearing deposits and the increase in Federal Home Loan Bank advances.

The Company’s net interest margin was 4.64% for the three month period ended March 31, 2005 compared to 4.80% for the same period in 2004. Management anticipates a stable net interest margin over the next twelve months. Any increase in rates would have a slight positive effect on our net interest margin.


11



Other Income

Other income increased by $402,000 or 8.96% during the three month period ended March 31, 2005 as compared to the same period for 2004. This increase is primarily due to increased sales by Financial Supermarkets, Inc. (“FSI”), a nonbank subsidiary, of $326,000 or 24.26% for the three month period ended March 31, 2005 as compared to the same period in 2004. In addition, gain on sale of loans increase by $95,000 or 863.64% as compared to same period in 2004.

Non Interest Expenses

Non interest expenses increased by 7.72% or $725,000 for the three month period ending March 31, 2005 compared to the same period in 2004. Full time equivalent employees increased from 397 at the end of March 2004 to 429 at the end of March 2005. The increase in full time equivalent employees was due to the overall growth of the Company’s banking operations. In addition, the incentive commissions related to sales activity at FSI have increased due to increased sales over the previous year. These increases caused salaries and benefits to increase by 14.77% or $719,000 for the three month period ended March 31, 2005 as compared to the same period in 2004.

Also attributable to the overall growth of the Company, equipment and occupancy expenses were up by 17.64% or $236,000 for the three month period ending March 31, 2005 as compared to the same period in 2004.

Other operating expenses decreased by 7.22% or $230,000 for the three month period ending March 31, 2005 as compared to the same periods in 2004. The single largest item included in this decrease is attributed to the $447,000 expenses associated with the new carefree check program that was started in 2004. In addition, legal fees increased by $6,000 or 4.05% as compared to the same period in 2004 due to legal services related to past due loans and other real estate owned and the class action lawsuit described in Part II, Item 1 of this Quarterly Report. Advertising and marketing increased by $62,000 or 27.93%, as compared to the same period in 2004. This increase is attributed to the increased marketing and sales activity of FSI. Director and advisory director fees increased by 36,000 or 37.11% as of March 31, 2005, as compared to the same period in 2004. The Board of Directors added advisory directors for most of the counties that we have significant banking activity.

Income Taxes

We incurred income tax expenses of $826,000 which represents an effective rate of 29.01% for the three month period ended March 31, 2005 as compared to $544,000 which represents an effective tax rate of 24.00% for the same period in 2004. The effective rate increase is due to a larger percentage of our income being fully taxable as a result of our increased taxable income.
 
Liquidity
 
We are not aware of any other known trends, events or uncertainties, that will have or that are reasonably likely to have a material effect on its liquidity, capital resources or operations. We are also not aware of any current recommendations by the regulatory authorities which, if they were implemented, would have such an effect.

B. Asset Quality 
 
Provision for Loan Losses
 
The provision for loan losses was $713,000 and $1,129,000 for the first three months of 2005 and 2004 respectively. The reserve at March 31, 2005 represented 136% of non-accrual loans while the reserve at March 31, 2004 represented 184% of non-accrual loans. Non accrual loans have increased from $4,659,000 to $7,062,000, past due loans greater than 90 days and accruing interest have increased from $2,741,000 to $2,956,000 and net charge-offs have increased from $127,000 to $262,000 at March 31, 2004 and March 31, 2005, respectively. The increase in non-accrual loans was made up of six new lines, from which management expects no losses.

Repossessed real estate owned by the bank decreased 24.46% from $5,351,000 in March 2004 to $4,042,000 in March 2005. Other real estate is carried in the books at the lesser of cost or fair market value, less estimated costs to sell, with no significant losses anticipated.

Management has reviewed the non-accrual loans individually and determined that the likelihood of any significant loss of principal is mitigated due to the value of the collateral securing these loans. As of March 31, 2005, non-accrual loans and other real estate owned totaled approximately $11,104,000 as compared to $10,010,000 as of March 31, 2004. The ratio of the loan loss reserve balance to the total loan balance at March 31, 2005 was 1.46% as compared to 1.48% at March 31, 2004. As of March 31, 2005, management considered our allowance for loan losses adequate to cover any anticipated losses.


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Non-accrual, Past Due and Restructured Debt
 
The following table, dollars in thousands, is a summary of Non Accrual, Past due and Restructured Debt
 
   
March 31, 2005
  
   
Non-accrual
Loans
  
 
Past Due
90 days
Still accruing
  
Restructured
Debt
  
               
Commercial Loans
  
$
732
  
$
440
  
$
248
  
Real Estate Loans
    
5,895
    
2,270
    
626
  
Consumer Loans
    
435
    
246
    
25
  
 Total
     7,062     2,956     899  

 
   
 March 31, 2004
  
   
Non-accrual
Loans
  
 
Past Due
90 days
Still accruing
  
Restructured
Debt
  
               
Commercial Loans
  
$
544
  
$
157
  
$
14
  
Real Estate Loans
    
3,909
    
2,076
    
870
  
Consumer Loans
    
206
    
508
    
--
  
Total
  
$
4,659
  
$
2,741
  
$
884
  
 
 
The Bank’s policy is to discontinue the accrual of interest income when, in the opinion of management, collection of such interest becomes doubtful. This status is accorded such interest when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected and (2) the principal or interest is more than ninety days past due, unless the loan is both well-secured and in the process of collection. Accrual of interest on such loans is resumed, in management’s judgment, when the collection of interest and principal become probable. Loans classified for regulatory purposes as substandard, or special mention that have not been included in the table above do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. These classified loans do not represent material credits about which management is aware and which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

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Allowance for Loan Loss

The following table, dollars in thousands, furnishes information on the loan loss reserve for the current three month reporting period and the same period for 2004.
 
     
2005
    
2004
  
     
(Dollars in Thousands)
  
               
Beginning Balance
  
$
9,170
  
$
7,561
  
Less Charge Offs:
Commercial Loans
    
(32
)
  
(89
)
Real Estate Loans
    
(169
)
  
(4
)
Consumer Loans
    
(155
)
  
(159
)
     
(356
)
  
(252
)
Plus Recoveries:
Commercial Loans
    
10
    
45
  
Real Estate Loans
    
49
    
48
  
Consumer Loans
    
35
    
32
  
     
94
    
125
  
Net Charge-offs
    
(262
)
  
(127
)
Provision for loan loss
    
713
    
1,129
  
Ending Balance
  
$
9,621
  
$
8,563
  
 
Our Company operates in three distinct markets, northeast Georgia, midwest Georgia and mideast Alabama. Each of these markets has seen a modest increase in unemployment and bankruptcy filings.
 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed only to U.S. dollar interest rate changes and accordingly, the Company manages exposure by considering the possible changes in the net interest margin. The Company does not have any trading instruments nor does it classify any portion of the investment portfolio as held for trading. The Company does not engage in any hedging activities or enter into any derivative instruments other than mortgage backed securities, which are commonly pass through securities. Finally, the Company has no exposure to foreign currency exchange rate risk, commodity price risk, and other market risks.

Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as “interest rate risk”. The repricing of interest earning assets and interest-bearing liabilities can influence the changes in net interest income. As part of the Company’s asset/liability management program, the timing of repriced assets and liabilities is referred to as Gap management.

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The Company’s objective in Gap management is to manage assets and liabilities to maintain satisfactory and consistent profitability. Officers of each bank are charged with monitoring policies and procedures designed to ensure an acceptable asset/liability mix. Management’s philosophy is to support asset growth primarily through growth of core deposits within the banks’ market areas.

The Company’s asset/liability mix is monitored regularly with a report reflecting the interest rate sensitive assets and interest rate sensitive liabilities that is prepared and presented to the Board of Directors of each bank on at least a quarterly basis. Management’s objective is to monitor interest rate sensitive assets and liabilities so as to minimize the impact on earnings of substantial fluctuations in interest rates. An asset or liability is considered to be interest rate-sensitive if it will reprice or mature within the time period analyzed, usually one year or less. The interest rate-sensitivity gap is the difference between the interest-earning assets and interest-bearing liabilities scheduled to mature or reprice within the relevant period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the interest rate-sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. If the Company’s assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would be minimal.

A simple interest rate “gap” analysis by itself may not be an accurate indicator of how net interest income will be affected by changes in interest rates. For example, while interest-bearing transaction accounts are by their terms immediately repricable, competitive conditions and other circumstances usually preclude repricing such deposits proportionately with changes in rates affecting interest-earning assets.

Accordingly, the Company also evaluates how changes in interest rates impacts the repayment of particular assets and liabilities. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may significantly affect net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. In addition, certain assets have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Also, prepayments and early withdrawal levels could deviate significantly from those reflected in the interest rate gap. The Company prepares a report monthly that measures the potential of the banks’ impact on net interest margin by rising or falling rates. This report is reviewed monthly by the Asset/Liability Committee and quarterly by each Board of Directors.

At March 31, 2005, the Company’s cumulative interest rate sensitivity gap ratio for the next twelve months was 113% which was within its targeted range of 80% to 120%.

Gap management alone is not enough to properly manage interest rate sensitivity because interest rates do not respond at the same speed or at the same level to market rate changes. For example, savings and money market rates are more stable than loans tied to a “Prime” rate and thus respond with less volatility to a market rate change. Thus, the Company uses a simulation model to monitor changes in net interest income due to changes in market rates. The model of rising, falling and stable interest rate scenarios allows management to monitor and adjust interest rate sensitivity to minimize the impact of market rate swings. The analysis of impact on net interest margins as well as market value of equity over a twelve month period is subjected to a 200 basis point increase and decrease in rate. The March 2005 model reflects an increase of 3.89% in net interest income and a 5.25% decrease in market value equity for a 200 basis point increase in rates. The same model shows a 3.85% decrease in net interest income and a .72% decrease in market value equity for a 200 basis point decrease in rates. The Company’s policy is to allow no more than +/-8% change in net interest income and no more than +/-25% change in market value equity for these scenarios. Therefore, the Company is within its policy guidelines.

ITEM 4. CONTROLS & PROCEDURES

Our management, including the chief executive and chief financial officers, supervised and participated in an evaluation of our disclosure controls and procedures (as defined in federal securities rules) as of the end of the period covered by this report. Based on, and as of the date of, that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective in accumulating and communicating information to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures of that information under the Securities and Exchange Commission rules and forms and that our disclosure controls and procedures are designed to ensure that the information we are required to disclose in reports that we file or submit under all applicable federal securities laws is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.


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PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings
 
The Company was named in a lawsuit in the Superior Court of Greene County, Georgia on May 18, 2004. The case was removed to the Middle District of Georgia in June 2004. The plaintiff in the case is seeking class action certification for owners of self-directed individual retirement accounts at the Company’s Georgia bank subsidiaries that included investments in securities issued by Stewart Finance Company, National Finance Company or D&E Acquisitions, Inc. These issuing companies are bankrupt and have defaulted on the securities. The plaintiff claims that the Company aided and abetted and conspired with the issuing companies in issuing unregistered securities, committing acts in violation of the Georgia racketeering statute and in committing common law fraud. Although the plaintiff has not made a specific claim for damages, he is claiming that the proposed class is entitled to the amount of the lost investment in the securities and treble and punitive damages. The Company has denied liability in this case and does not believe the case will have a material adverse effect on the Company.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
Issuer Purchases of Equity Securities in the quarter ended March 31, 2005:
 
 
Period 
  
Total Number of
Shares Purchased (1) 
  
Average Price
Paid Per Share 
  
Total Number of
Shares
Purchased as
Part of Publicly
Announced
Plans or Programs 
  
Maximum
Number of
Shares that May
Yet Be
Purchased
Under the Plans
or Programs
  
                   
January 1-31      60   $ 58.10          
February 1-28     -     -          
March 1-31      250     58.14                
Total      310    
58.13
              
 
___________________
(1) The shares purchased during the first quarter of 2005 were purchased as treasury stock.

ITEM 3.    Defaults upon Senior Securities - None

ITEM 4.   Submission of Matters to a vote of Security Holders - None
 
ITEM 5.    Other Information - None
 
ITEM 6.    EXHIBITS
 
31.1 and 31.2 - Rule 13a-15(e) and 15d-15(e) Certifications

32 - Certification of Chief Executive Officer and Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant To Section 906 of the Sarbanes- Oxley Act of 2002.

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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.
 
 
 
     
  COMMUNITY BANKSHARES, INC.
 
 		  
 		  
 
DATE:  May 13, 2005 By:   /s/  Harry L. Stephens
 
Harry L. Stephens,
Executive Vice President and Chief Financial Officer
 
 
 
 
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