SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.10 Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:
yes |X| no |_|
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy of information
statements incorporated by reference to Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2):
yes |_| no |X|
As of March 31, 2003, the aggregate market value of the registrant's voting
stock held by non-affiliates was $27,000,000 based upon a sale price of $10.00
per share on March 31, 2003.
As of March 31, 2003, there were 4,637,314 shares of the registrant's
common stock, $.10 par value shares, outstanding.
PART 1
Item 1 - Business
General
Community Bancshares, Inc. (the "Company") is a Delaware corporation and a bank
holding company registered with the Board of Governors of the Federal Reserve
System (the "Federal Reserve") under the Bank Holding Act of 1956, as amended
(the "Bank Holding Company Act"). The Company was organized in 1983 and
commenced business in 1985. The Company has one bank subsidiary, Community Bank
("Community Bank" or "the Bank"), an Alabama banking corporation which conducts
a general commercial banking business in north and west-central Alabama. At
December 31, 2002, the Company and its subsidiaries had total assets of
approximately $567,596,000, deposits of approximately $459,464,000, and
shareholders' equity of approximately $40,311,000. The Company maintains its
principal executive offices at 68149 Main Street, Blountsville, Alabama 35031,
and its telephone number is (205) 429-1000.
Subsidiary Bank
At December 31, 2002, Community Bank conducted business through 20 locations in
seven counties in north Alabama, and two counties in west-central Alabama. It
offers a wide range of commercial and retail banking services, including savings
and time deposit accounts, personal and commercial loans and personal and
commercial checking accounts. The majority of loans by Community Bank are to
individuals and small to mid-sized businesses in Alabama. Community Bank seeks
to provide superior service to its customers and to become a vital component of
each of the communities it serves.
Community Bank operates in small non-urban communities. At December 31, 2002 the
Bank had locations in Blountsville, Cleveland, Oneonta, Snead and West Blount in
Blount County, Alabama; Rogersville in Lauderdale County, Alabama; Elkmont in
Limestone County, Alabama; Gurley, Meridianville and New Hope in Madison County,
Alabama; Demopolis in Marengo County, Alabama; Hamilton in Marion County,
Alabama; Falkville and Hartselle in Morgan County, Alabama; Uniontown in Perry
County, Alabama; and Double Springs and Haleyville in Winston County, Alabama.
At December 31, 2002, Community Bank operated 18 full service offices as well as
two paying and receiving offices located within Wal-Mart stores, which primarily
open deposit accounts, cash checks and receive deposits and loan payments.
In the first half of 2002, Community Bank sold its two Pulaski, Tennessee
offices, its Rainsville and Ft. Payne, Alabama offices and its Marshall County,
Alabama locations. The Marshall County locations included one banking office in
Boaz, Alabama, one in Albertville, Alabama, two in Arab, Alabama and two in
Guntersville, Alabama. Two of the total ten offices sold were paying and
receiving offices located in Wal-Mart stores, one in Ft. Payne, Alabama and one
in Guntersville, Alabama.
Subsidiaries of Community Bank
1st Community Credit Corporation currently operates 12 finance company offices
in 12 Alabama communities, including Albertville, Arab, Athens, Boaz, Cullman,
Decatur, Gadsden, Hartselle, Huntsville, Fort Payne, Jasper and Oneonta,
Alabama. 1st Community Credit Corporation provides loans to a market segment
traditionally not pursued by Community Bank. These loans have typically
generated higher yields and involved greater risk than standard commercial bank
loans. At December 31, 2002, 1st Community Credit Corporation's loan portfolio
totaled approximately $27,937,000.
Community Insurance Corp. serves as an agent in the sale of title, property,
casualty and life insurance products to individuals and businesses through an
office in Huntsville, Alabama. Community Insurance Corp. owns 100% of the
outstanding shares of capital stock of Southern Select Insurance, Inc., a
managing general agency which brokers agricultural, commercial and personal
insurance products. Both Community Insurance Corp. and Southern Select
Insurance, Inc. are located in Huntsville, Alabama.
1
Community Appraisals, Inc., a subsidiary of Community Bank, operates a real
estate appraisal business through its office located at the Company's
headquarters complex in Blountsville, Alabama. This subsidiary provides
appraisal services in connection with the lending activities of Community Bank
and 1st Community Credit Corporation.
Market Areas
At December 31, 2002, the Company's principal market areas were located in north
Alabama (Blount, Cullman, DeKalb, Etowah, Lauderdale, Limestone, Madison,
Marshall and Morgan Counties), northwest Alabama (Marion and Winston Counties),
and west-central Alabama (Marengo and Perry Counties). All of the Company's
banking and finance company offices are located in relatively rural areas and
place an emphasis on personal service.
With the exception of Blount, Marengo, Marion, Perry and Winston Counties in
Alabama, the markets in which the Company operates share one common
characteristic: each is close enough to Huntsville, Alabama, to share in the
economic and employment benefits of that city. Huntsville is located in Madison
County. Unemployment for Madison County was 3.8% for December 2002 as compared
to 5.8% for Alabama during that period, as reported by the Alabama Department of
Industrial Relations. The Huntsville Metropolitan Statistical Area ("MSA")
possesses a diverse economic base with employers that include the military and
aerospace industries, manufacturers of durable goods, machinery, transportation,
as well as retailers and service industries. Agriculture, in the form of
soybeans, hay, corn, cotton, tobacco, dairy and poultry farming, also makes up a
significant portion of the Huntsville MSA's economy.
Similarly, Blount County is close enough to Birmingham, Alabama, to share in the
economic and employment benefits of that city. Jefferson County, in which
Birmingham is located, had a 4.5% unemployment rate for December 2002, according
to the Alabama Department of Industrial Relations. The Birmingham area still
retains some of the steel and related manufacturers that built the city, but the
economy is now more diverse with the University of Alabama in Birmingham and the
healthcare industry providing many jobs.
Marion and Winston Counties lie in northwest Alabama, near the Mississippi
border. In both counties the manufacturing sector provides more jobs and higher
sales or receipts than the wholesale, retail and service sectors. Manufactured
housing and furniture production are two prominent industries in these counties,
and both industries have experienced recent economic slowdowns. Marion County
was reported to have an unemployment rate of 10.6% for December 2002, according
to the Alabama Department of Industrial Relations. Winston County was reported
to have an unemployment rate of 9.4% for December 2002, according to the Alabama
Department of Industrial Relations.
Marengo and Perry Counties are located in west-central Alabama. Manufacturing
provides more jobs in these counties than the wholesale, retail and service
sectors. In addition, catfish farming and the timber industry are important
components in the economy of these counties. Marengo County's unemployment rate
reported by the Alabama Department of Industrial Relations for December 2002 was
4.4%. Perry County was reported to have an unemployment rate of 10.0% for
December 2002, as reported by the Alabama Department of Industrial Relations.
While certain markets have experienced an economic downturn, overall, the
Company remains optimistic about current economic prospects in its market areas,
and the Company attempts to assist those local economies by returning the
deposits of its customers to the communities from which they come in the form of
loans.
Lending Activities
Community Bank's lending activities include commercial, real estate and consumer
loans. Community Bank's commercial loan services include term-loans, lines of
credit and agricultural loans. A broad range of short to medium term commercial
loans, both secured and unsecured, are made available to businesses for working
capital, business expansion and the purchase of equipment and machinery.
Community Bank's real estate lending activities include fixed and adjustable
rate residential mortgage loans, construction loans, second mortgages, home
improvement loans and home equity lines of credit. Community Bank's consumer
lending services include loans for automobiles, recreation vehicles and boats,
as well as personal (secured and unsecured) and deposit account secured loans.
2
Competition
The banking business in Alabama is highly competitive with respect to loans,
deposits and other financial services and is dominated by a number of major
banks and bank holding companies which have numerous offices and affiliates
operating over wide geographic areas. Community Bank competes for deposits,
loans and other business with these banks as well as with savings and loan
associations, credit unions, mortgage companies, insurance companies and other
local financial institutions. Many of the major commercial banks operating in
Community Bank's service areas offer services such as international banking and
investment and trust services, which are not offered by Community Bank.
Additionally, the competitive environment for both the Company and Community
Bank may be materially affected by the enactment of the Gramm-Leach-Bliley
Financial Services Modernization Act (the "GLBA"). This law modified or
eliminated many barriers between investment banking, commercial banking and
insurance underwriting and sales. See "Supervision and Regulation". These
changes in the law have created and may continue to create greater competition
for the Company and Community Bank by increasing the number and types of
competitors and by encouraging increased consolidation within the financial
services industry.
Employees
At December 31, 2002, the Company and its subsidiaries had approximately 307
full-time equivalent employees. The Company and its subsidiaries provide a
variety of group life, health and accident insurance, retirement and stock
ownership plans and other benefit programs for their employees. The Company
maintains continuing education and training programs for its employees, designed
to prepare the employees for positions of increasing responsibility in
management or operations. Membership and participation by employees in
professional and industry organizations is encouraged and supported by the
Company.
Supervision and Regulation
The following is a brief summary of the regulatory environment in which the
Company and its subsidiaries operate and is not designed to be a complete
discussion of all statutes and regulations affecting such operations, including
those federal and state statutes and regulations specifically mentioned herein.
Changes in the laws and regulations applicable to the Company and its
subsidiaries can affect the operating environment of the Company and its
subsidiaries in substantial and unpredictable ways. The Company cannot
accurately predict whether legislation will ultimately be enacted, and, if
enacted, the ultimate effect that it or implementing regulations would have on
its or its subsidiaries financial condition or results of operations.
The Company is a bank holding company and is registered as such with the Federal
Reserve. The Company is subject to regulation and supervision by the Federal
Reserve and is required to file with the Federal Reserve annual reports and such
other information as the Federal Reserve may require. The Federal Reserve also
conducts examinations of the Company.
The Federal Reserve takes the position that a bank holding company is required
to serve as a source of financial and managerial strength to its subsidiary bank
and may not conduct its operations in an unsafe or unsound manner. In addition,
it is the Federal Reserve's position that, in serving as a source of strength to
its subsidiary bank, a bank holding company should stand ready to use available
resources to provide adequate capital funds to its subsidiary bank during
periods of financial stress or adversity and should maintain the financial
flexibility and capital raising capacity to obtain additional resources for
assisting its subsidiary bank.
Community Bank is incorporated under the laws of the State of Alabama and is
subject to the applicable provisions of Alabama banking laws and to regulation
and examination by the Alabama State Banking Department. Examinations include a
review of Community Bank's condition and resources, its mode of conducting and
managing its affairs, the actions of its directors, the investment of its funds,
the safety and prudence of its management, compliance with its charter and law
in the administration of its affairs and other aspects of Community Bank's
operations. State statutes in Alabama relate to such matters as loans,
mortgages, consolidations, required reserves, allowable investments, issuance of
securities, payment of dividends, establishment of branches, filing of periodic
reports and other matters affecting the business of Community Bank.
3
Deposits in Community Bank are insured, up to applicable limits, by the Federal
Deposit Insurance Corporation (the "FDIC") and, therefore, Community Bank is
subject to provisions of the Federal Deposit Insurance Act ("FDIA"). Community
Bank's primary federal regulator is the FDIC, and as a result, Community Bank is
subject to examination and regulation by the FDIC. The FDIC is authorized to
terminate the deposit insurance of any depository institution, such as Community
Bank, whose deposits are insured by the FDIC if the FDIC determines, after a
hearing, that the institution or its directors have engaged or is engaging in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations as an insured institution, or has violated any applicable law,
regulation, order, condition imposed in writing by the FDIC in connection with
the granting of any application or other request by the depository institution
or any written agreement entered into with the FDIC.
Each federal banking regulatory agency is authorized to issue a cease and desist
order to any financial institution or institution-affiliated party for which the
agency is the primary federal banking regulator (which in the case of Community
Bank, is the FDIC and, in the case of the Company, is the Federal Reserve) if
the agency determines, after a hearing, that the institution or
institution-affiliated party has engaged, is engaging or is reasonably believed
to be about to engage, in unsafe or unsound practices, or has violated, is
violating or is reasonably believed to be about to violate a law, rule or
regulation, or any condition imposed in writing by the agency in connection with
the granting of any application or other request by the institution or any
written agreement entered into with the agency. The cease and desist order may
require the institution or institution-affiliated party to cease and desist from
the violation or practice, including requiring the institution or
institution-affiliated party to make restitution or reimbursement against loss,
restrict the institution's growth, dispose of loans or assets, rescind
agreements or contracts, employ qualified officers or employees and take other
actions determined to be appropriate by the agency. The order may also limit the
activities of the institution.
The Company and Community Bank are subject to the provisions of the Federal
Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FDICIA
expanded the regulatory powers of federal banking agencies to permit prompt
corrective actions to resolve problems of insured depository institutions
through the regulation of banks and their affiliates, including bank holding
companies. The provisions are designed to minimize the potential loss to
depositors and to FDIC insurance funds if financial institutions default on
their obligations to depositors or become in danger of default. Among other
things, FDICIA provides a framework for a system of supervisory actions based
primarily on the capital levels of financial institutions.
FDICIA also provides for a risk-based deposit insurance premium structure. The
FDIC is an independent federal agency established originally to insure the
deposits, up to prescribed statutory limits, of federally insured banks and to
preserve the safety and soundness of the banking industry. The FDIC maintains
two separate insurance funds: the Bank Insurance Fund ("BIF") and the Savings
Association Insurance Fund ("SAIF"). Community Bank's deposit accounts are
insured by the FDIC under the BIF to the maximum extent permitted by law.
Community Bank pays deposit insurance premiums to the FDIC based on a risk-based
assessment system established by the FDIC for all BIF-member institutions.
Under FDIC regulations, institutions are assigned to one of three capital groups
for insurance premium purposes (well capitalized, adequately capitalized and
undercapitalized). These three groups are then divided into subgroups which are
based on supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Assessment rates vary depending
upon the assessment classification. In addition, regardless of the potential
risk to the insurance fund, federal law requires the FDIC to establish
assessment rates that will maintain each insurance fund's ratio of reserves to
insured deposits at 1.25%. During 2001 and for the first semiannual assessment
period of 2002, assessment rates for BIF-insured institutions ranged from 0% of
insured deposits for well-capitalized institutions with minor supervisory
concerns to .27% of insured deposits for undercapitalized institutions with
substantial supervisory concerns. The assessment rate schedule is subject to
change by the FDIC and, accordingly, the assessment rate could increase or
decrease in the future.
In addition to deposit insurance assessments, the FDIC is authorized to collect
assessments against insured deposits to be paid to the Finance Corporation
("FICO") to service FICO debt incurred in the 1980s. The FICO assessment rate is
adjusted quarterly. The average annual assessment rate in 2002 was 1.75 cents
per $100 of assessable deposits. For the first quarter of 2003, the FICO
assessment rate for such deposits will be 1.65 cents per $100. Community Bank's
assessment expense for the year ended December 31, 2002 equaled approximately
$631,000.
4
The federal banking regulatory agencies have adopted a set of guidelines
prescribing safety and soundness standards pursuant to FDICIA. The guidelines
establish general standards relating to internal controls and information
systems, internal audit systems, loan documentation, credit underwriting,
interest rate exposure, asset growth and compensation, fees and benefits. In
general, the guidelines require, among other things, appropriate systems and
practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director or principal stockholder. In addition, the agencies
adopted regulations that authorize an agency to order an institution that has
been given notice by an agency that it is not satisfying any of such safety and
soundness standards to submit a compliance plan. If the institution fails to
submit an acceptable compliance plan or fails to implement an accepted plan, the
agency must issue an order directing action to correct the deficiency and may
issue an order directing other actions be taken, including restricting asset
growth, restricting interest rates paid on deposits, and requiring an increase
in the bank's ratio of tangible equity to assets. If an institution fails to
comply with such an order, the agency may seek to enforce such order in judicial
proceedings and to impose civil money penalties.
FDICIA establishes a system of prompt corrective action to resolve the problems
of undercapitalized institutions. Under this system, the federal banking
regulatory agencies are required to rate supervised institutions on the basis of
five capital categories (well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized) and to take certain mandatory supervisory actions, and are
authorized to take other discretionary actions, with respect to institutions in
the three under-capitalized categories, the severity of which will depend upon
the capital category in which the institution is placed. Under certain
circumstances, an institution may be downgraded to a category lower than that
warranted by its capital levels, and subjected to the supervisory restrictions
applicable to institutions in the lower capital category. Generally, subject to
a narrow exception, FDICIA requires a federal banking regulatory agency to
appoint a receiver or conservator for an institution that is critically
undercapitalized. The federal banking regulatory agencies have specified by
regulation the relevant capital level for each category.
FDICIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to
its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to
restrictions on borrowing from the Federal Reserve System. In addition,
undercapitalized depository institutions are subject to growth limitations and
are required to submit capital restoration plans. A depository institution's
holding company must guarantee the capital plan, up to an amount equal to the
lesser of 5% of the depository institution's total assets at the time it becomes
undercapitalized or the amount necessary to bring the institution into
compliance with all applicable capital standards. If a depository institution
fails to submit an acceptable plan, it is treated as if it is significantly
undercapitalized. Significantly undercapitalized depository institutions may be
subject to a number of requirements and restrictions, including orders to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cessation of receipt of deposits from correspondent banks.
Critically undercapitalized depository institutions are subject to appointment
of a receiver or conservator. At December 31, 2002, Community Bank was well
capitalized for prompt corrective action purposes.
The Company is required to comply with the risk-based capital guidelines
established by the Federal Reserve, and other tests relating to capital adequacy
which the Federal Reserve adopts from time to time. Under the risk-based capital
assessment system, assets are weighted by a risk factor and a ratio is
calculated by dividing the qualifying capital by the risk-weighted assets. Tier
I capital generally includes common stock and retained earnings. Total capital
is comprised of Tier I capital and Tier II capital, which includes certain
allowances for loan losses and certain subordinated debt. The Company's Tier I
and total capital ratios exceeded the required minimum levels as of December 31,
2002.
The Company is a legal entity which is separate and distinct from its
subsidiaries. There are various legal limitations on the extent to which
Community Bank may extend credit, pay dividends or otherwise supply funds to the
Company or its affiliates. In particular, Community Bank is subject to certain
restrictions imposed by federal law on any extensions of credit to the Company
or, with certain exceptions, other affiliates.
5
The primary source of funds for dividends paid to the Company's shareholders is
dividends paid to the Company by Community Bank. Various federal and state laws
limit the amount of dividends that Community Bank may pay to the Company without
regulatory approval. Under Alabama law, an Alabama state bank, such as Community
Bank, may not pay a dividend in excess of 90% of its net earnings until the
bank's surplus is equal to at least 20% of its capital. Community Bank is also
required by Alabama law to obtain the prior approval of the Superintendent of
the Alabama State Banking Department in order to pay a dividend if the total of
all the dividends declared by Community Bank in any calendar year will exceed
the total of Community Bank's net earnings (as defined by statute) for that year
and its retained net earnings for the preceding two years, less any required
transfers to surplus. At December 31, 2002, Community Bank could not have
declared or paid any dividend without such approval. In addition, no dividends
may be paid from Community Bank's surplus without the prior written approval of
the Superintendent of the Alabama State Banking Department. Under FDICIA,
Community Bank may not pay any dividends, if after paying the dividend it would
be undercapitalized under applicable capital requirements. The FDIC also has the
authority to prohibit Community Bank from engaging in business practices which
the FDIC considers to be unsafe or unsound, which, depending on the financial
condition of Community Bank, could include the payment of dividends.
In addition, the Federal Reserve has the authority to prohibit the payment of
dividends by a bank holding company, such as the Company, if its actions
constitute unsafe or unsound practices. In 1985, the Federal Reserve issued a
policy statement on the payment of cash dividends by bank holding companies,
which outlined the Federal Reserve's view that a bank holding company that is
experiencing earnings weaknesses or other financial pressures should not pay
cash dividends that exceed its net income, that are inconsistent with its
capital position or that could only be funded in ways that weaken its financial
health, such as by borrowing or selling assets. The Federal Reserve indicated
that, in some instances, it may be appropriate for a bank holding company to
eliminate its dividends.
The federal Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("IBBEA") permits adequately capitalized and managed bank holding companies to
acquire control of banks in states other than their home states, subject to
federal regulatory approval, without regard to whether such a transaction is
prohibited by the laws of any state. IBBEA permits states to continue to require
that an acquired bank have been in existence for a certain minimum time period,
which may not exceed five years. A bank holding company may not, following an
interstate acquisition, control more than 10% of the nation's total amount of
bank deposits or 30% of bank deposits in the relevant state (unless the state
enacts legislation to raise the 30% limit). States retain the ability to adopt
legislation to effectively lower the 30% limit. Federal banking regulators may
approve merger transactions involving banks located in different states, without
regard to laws of any state prohibiting such transactions; except that, mergers
may not be approved with respect to banks located in states that, prior to June
1, 1997, enacted legislation prohibiting mergers by banks located in such state
with out-of-state institutions. Also, states may continue to require that an
acquired bank have been in existence for a certain minimum period of time, which
may not exceed five years. Federal banking regulators may permit an out-of-state
bank to open new branches in another state if such state has enacted legislation
permitting interstate branching. Affiliated institutions are authorized to
accept deposits for existing accounts, renew time deposits and close and service
loans for affiliated institutions without being deemed an impermissible branch
of the affiliate.
The federal Community Reinvestment Act of 1977 ("CRA") and its implementing
regulations are intended to encourage regulated financial institutions to meet
the credit needs of their local community or communities, including low and
moderate income neighborhoods, consistent with the safe and sound operation of
such financial institutions. The regulations provide that the appropriate
regulatory authority will assess CRA reports in connection with applications for
establishment of domestic branches, acquisitions of banks or mergers involving
bank holding companies. An unsatisfactory CRA rating may serve as a basis to
deny an application to acquire or establish a new bank, to establish a new
branch or to expand banking services. At December 31, 2002, the Company had a
"satisfactory" CRA rating.
The federal Gramm-Leach-Bliley Act of 1999 (the "GLBA") eliminated prohibitions
in the Glass-Steagall Act against a bank associating with a company engaged
principally in securities activities. The GLBA also permits a bank holding
company to elect to become a "financial holding company," which would expand the
powers of the bank holding company. The repeal of the Glass-Steagall Act
provisions and the availability of financial holding company powers became
effective on March 11, 2000. Financial holding company powers relate to
financial activities that are determined by the Federal Reserve to be financial
in nature, incidental to an activity that is financial in nature, or
complementary to
6
a financial activity (provided that the complementary activity does not pose a
safety and soundness risk). The GLBA itself defines certain activities as
financial in nature, including lending activities, underwriting and selling
insurance, providing financial or investment advice, underwriting, dealing and
making markets in securities and merchant banking. In order to qualify as a
financial holding company, a bank holding company's depository subsidiaries must
be both well capitalized and well managed, and must have at least a satisfactory
rating under the CRA. The bank holding company must also declare its intention
to become a financial holding company to the Federal Reserve and certify that
its depository subsidiaries meet the capitalization and management requirements.
The GLBA establishes the Federal Reserve as the umbrella regulator of financial
holding companies, with subsidiaries of the financial holding company being more
specifically regulated by other regulatory authorities, such as the Securities
and Exchange Commission, the Commodity Futures Trading Commission and state
securities and insurance regulators, based upon the subsidiaries' particular
activities. The GLBA also provides for minimum federal standards of privacy to
protect the confidentiality of personal financial information of customers and
to regulate use of such information by financial institutions. A bank holding
company that does not elect to become a financial holding company remains
subject to the Bank Holding Company Act. The Company has not determined whether
it will elect to become a financial holding company.
The Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act (the "USA Patriot Act") which was signed
into law by President Bush on October 26, 2001, is designed to deny terrorists
and others the ability to obtain access to the United States financial system.
Title III of the USA Patriot Act is the International Money Laundering Abatement
and Anti-Terrorist Financing Act of 2001. Among its provisions, the USA Patriot
Act mandates or will require financial institutions to implement additional
policies and procedures with respect to, or additional measures, including
additional due diligence and recordkeeping, designed to address any or all of
the following matters, among others: money laundering; suspicious activities and
currency transaction reporting; and currency crimes. The U.S. Department of the
Treasury in consultation with the Federal Reserve Board and other federal
financial institution regulators has promulgated rules and regulations
implementing the USA Patriot Act which (i) prohibit U.S. correspondent accounts
with foreign banks that have no physical presence in any jurisdiction; (ii)
require financial institutions to maintain certain records for correspondent
accounts of foreign banks; (iii) require financial institutions to produce
certain records relating to anti-money laundering compliance upon request of the
appropriate federal banking agency; (iv) require due diligence with respect to
private banking and correspondent banking accounts; (v) facilitate information
sharing between the government and financial institutions; and (vi) require
financial institutions to have in place a money laundering program. In addition,
an implementing regulation under the USA Patriot Act regarding verification of
customer identification by financial institutions has been proposed, although
such regulation has not yet been finalized. The Company has implemented and will
continue to implement the provisions of the USA Patriot Act, as such provisions
become effective. The Company currently maintains and will continue to maintain
policies and procedures to comply with the USA Patriot Act requirements. At this
time, the Company does not expect that the USA Patriot Act will have a
significant impact on the financial position of the Company.
On July 30,2002, President Bush signed into law the Sarbanes-Oxley Act of 2002
(the "Sarbanes-Oxley Act"), which is intended to address systemic and structural
weaknesses of the capital markets in the United States that were perceived to
have contributed to the recent corporate scandals. The Sarbanes-Oxley Act
creates the Public Company Accounting Oversight Board (the "Board") to oversee
the conduct of audits of public companies. The duties of the Board include (i)
registering public accounting firms that prepare audit reports, (ii)
establishing auditing, quality control, ethics, independence and other standards
for the preparation of audit reports, (iii) conducting inspections of registered
public accounting firms and (iv) otherwise promoting high professional standards
among, and improving the quality of audit services offered by auditors of public
companies. The Board will be funded from assessments on public companies and
will be subject to the oversight of the Securities and Exchange Commission. In
addition, the Sarbanes-Oxley Act attempts to strengthen the independence of
public company auditors by, among other things, (i) prohibiting public company
auditors from providing certain non-audit services to their audit clients, (ii)
requiring a company's audit committee to preapprove all audit and non-audit
services being provided by its independent auditor, (iii) requiring the rotation
of audit partners and (iv) prohibiting an auditor from auditing a client that
has as its chief executive officer, chief financial officer, chief accounting
officer or controller a person that was employed by the auditor during the
previous year.
7
The Sarbanes-Oxley Act also attempts to enhance the responsibility of corporate
management by, among other things, (i) requiring the chief executive officer and
chief financial officer of public companies to provide certain certifications in
their periodic reports regarding the accuracy of the periodic reports filed with
the Securities and Exchange Commission, (ii) prohibiting officers and directors
of public companies from fraudulently influencing an accountant engaged in the
audit of the company's financial statements, (iii) requiring chief executive
officers and chief financial officers to forfeit certain bonuses in the event of
a misstatement of financial results, (iv) prohibiting officers and directors
found to be unfit from serving in a similar capacity with other public
companies, (v) prohibiting officers and directors from trading in the company's
equity securities during pension blackout periods and (vi) requiring the
Securities and Exchange Commission to issue standards of professional conduct
for attorneys representing public companies. In addition, public companies whose
securities are listed on a national securities exchange or association must
satisfy the following additional requirements: (i) the company's audit committee
must appoint and oversee the company's auditors, (ii) each member of the
company's audit committee must be independent, (iii) the company's audit
committee must establish procedures for receiving complaints regarding
accounting, internal accounting controls and audit-related matters, (iv) the
company's audit committee must have the authority to engage independent advisors
and (v) the company must provide appropriate funding to its audit committee, as
determined by the audit committee.
The Sarbanes-Oxley Act contains several provisions intended to enhance the
quality of financial disclosures of public companies, including provisions that
(i) require that financial disclosures reflect all material correcting
adjustments identified by the company's auditors, (ii) require the disclosure of
all material off-balance sheet transactions, (iii) require the Securities and
Exchange Commission to issue rules regarding the use by public companies of pro
forma financial information, (iv) with certain limited exceptions, including an
exception for financial institutions making loans in compliance with federal
banking regulations, prohibit public companies from making personal loans to its
officers and directors, (v) with certain limited exceptions, require directors,
officers and principal shareholders of public companies to report changes in
their ownership in the company's securities within two business days of the
change, (vi) require a company's management to provide a report of its
assessment of internal controls of the company in its annual report, (vii)
require public companies to adopt codes of conduct for senior financial officers
and (viii) require companies to disclose whether the company's audit committee
has a financial expert as a member.
Under the Sarbanes-Oxley Act, the Securities and Exchange Commission is directed
to adopt rules designed to protect the independence of research analysts and to
require research analysts to disclose conflicts of interest and potential
conflicts of interest. The Sarbanes-Oxley Act also directs that certain studies
be conducted by the Comptroller General and the Securities and Exchange
Commission, including studies regarding the function of credit rating agencies
and the role of investment banks and financial advisors in the manipulation of
earnings. The Sarbanes-Oxley Act imposes criminal liability for certain acts,
including altering documents involving federal investigations, bankruptcy
proceedings and corporate audits and increases the penalties for certain
offenses, including mail and wire fraud. In addition, the Sarbanes-Oxley Act
gives added protection to corporate whistle-blowers. Although the Company
anticipates that it will incur additional expense in complying with the
provisions of the Sarbanes-Oxley Act and the regulations promulgated by the
Securities and Exchange Commission thereunder, the Company does not expect that
such compliance will have a material impact on the Company's financial condition
or results of operations.
Community Bank is subject to regulatory oversight under various consumer
protection and fair lending laws. These laws govern, among other things,
truth-in-lending disclosure, equal credit opportunity and fair credit reporting.
Community Insurance Corp. is a licensed insurance agent and broker for various
insurance companies, and is subject to regulation by the Alabama Insurance
Commission.
The Federal Reserve regulates money, credit and interest rate conditions in
order to influence general economic conditions, primarily through open market
operations in U.S. Government securities, changes in the discount rate, reserve
requirements on member banks' deposits and funds availability regulations. The
earnings and growth of the Company and its subsidiaries are subject to the
influence of economic conditions generally and to the monetary and
8
fiscal policies of the United States and its agencies, particularly the Federal
Reserve. The nature and timing of any changes in such conditions and policies
and their impact on the Company cannot be predicted.
On April 9, 2001, the Company's Board of Directors entered into a Memorandum of
Understanding (the "Memorandum") with the Federal Reserve Bank of Atlanta (the
"Reserve Bank"), which outlines actions to be taken by the Company to address
concerns identified by the Reserve Bank. In the Memorandum, the Company agreed
that, without the prior written approval of the Reserve Bank, it would not
declare or pay any dividends, repurchase shares of its common stock, incur any
additional indebtedness, alter the terms of existing indebtedness or increase
the amount of management fees paid to the Company by Community Bank. In
addition, the Company agreed to maintain a quarterly Tier I leverage ratio (the
ratio of Tier I capital to average assets, less goodwill) of at least 6.5%
during the period in which the Memorandum is in effect, and to periodically
update the Company's plan for maintaining capital and earnings at adequate
levels. The Company also agreed to establish a policy that provides for target
levels of capital and guidelines for payment of dividends and a plan to
strengthen the Company's internal audit program. The Company further agreed that
a committee of non-employee directors of the Company would review and report on
the appropriateness of the compensation provided under the employment agreement
of Kennon R. Patterson, Sr., who was then the Chairman of the Board, Chief
Executive Officer and President of the Company. In addition, the Company agreed
to provide the Reserve Bank with a contingency plan for conserving or raising
cash and information about loans extended by Community Bank to facilitate
purchases of the Company's common stock, and to periodically provide the Reserve
Bank with certain financial and other information and a report of actions taken
by the Company to ensure compliance with the Memorandum. On March 8, 2002, the
Reserve Bank requested that the Company agree to an amendment of the Memorandum
that would disallow the Company from making any distributions of interest,
principal or other sums on subordinated debentures or trust preferred securities
without the prior written approval of the Reserve Bank. The Company agreed to
the amendment. The Company elected to defer the March and September 2002
interest payments on its junior subordinated deferrable interest debentures. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations, Borrowed Funds - Maturities of Long-term Debt". Management of the
Company cannot currently estimate the period during which the Company will
remain subject to the terms of the Memorandum, or the effect of the Memorandum
on the Company's financial condition, liquidity and results of operations.
On April 18, 2001, the Board of Directors of Community Bank entered into a
Memorandum of Understanding (the "Bank Memorandum") with the Regional Director
of the FDIC's Atlanta Regional Office and the Alabama State Banking Department.
Major provisions of the Bank Memorandum include requirements to reduce
classified assets, restrict expansion, adopt revised policies in the areas of
lending, liquidity, interest rate risk, loan documentation, asset/liability
management and ethics, review duties and responsibilities of key officers,
review compliance with investment, liquidity and funds management policies,
reconstitute membership of its Board of Directors, develop internal loan review
and internal audit functions, maintain capital ratio requirements, restrict
dividend payments, provide to the regulators updates on the status of
litigation, other financial and managerial information and quarterly progress
reports detailing efforts to comply with the requirements of the Bank
Memorandum.
Based on an examination as of June 30, 2001, the FDIC and the Alabama State
Banking Department requested the Community Bank Board of Directors to adopt a
Safety and Soundness Compliance Plan ("Plan"). The Board adopted the Plan on
March 5, 2002. The Plan (initiated by the FDIC) replaced the Bank Memorandum
(initiated by the Alabama State Banking Department).
Pursuant to the terms of the Plan, the Board must review the Bank's
organizational structure and staffing requirements and hire and train any
additional personnel needed to comply with the Plan. Also the Board must review
and revise the bank's loan policy and underwriting standards, loan collection
plan, allowance for loan losses methodology, interest rate risk policy and asset
liability management policy. The Plan also provides that the Board must adopt an
internal audit program, an internal controls program, a plan to reduce
classified assets and internal and external loan documentation review
procedures. Also, pursuant to the Plan, the Board must engage an outside firm to
perform the loan review function and must adopt an internal loan review program.
The Plan also places restrictions on extending credit to borrowers who have
classified loans with the bank. Under the Plan, prior to submission of Reports
of Condition and Income, the Board must review the adequacy of the allowance for
loan losses and provide for an adequate balance. Under the Plan, the Board
committed to maintaining a Tier I capital ratio of at least 7% and to obtain the
prior approval of the regulators before paying dividends. In addition, the Plan
requires the submission of a budget and profit plan and the engagement of an
outside accounting firm to perform the bank's internal audit function and the
formation of a bank administration department to strengthen internal controls.
Finally, the Plan requires management to make monthly reports to the Board of
Directors regarding the status in meeting the requirements of the Plan, and to
submit quarterly progress reports to the regulators.
9
On December 10, 2002, the Board of Directors of Community Bank entered into an
agreement with the Alabama State Banking Department. The agreement provided that
the Board of Directors would take certain actions regarding (i) an investigation
into payments made in connection with several construction projects of the Bank,
(ii) approval and management of payments and loans involving directors, officers
and employees and (iii) expense controls and review of financial statements.
With respect to the investigation of construction payments, the Bank's Audit
Committee, with the assistance of independent accountants and counsel, must
determine whether any directors, officers or employees improperly benefited from
payments made by the Bank for construction projects. If improper benefits were
received, the Audit Committee must determine the amount of such benefits, fix an
appropriate rate of interest due to the Bank on the principal amount of any
benefit, require restitution of the amount of the benefit, plus accrued interest
and investigate any apparent negligence on the part of Bank employees with
regard to improper payments. The Bank has reported the Audit Committee's
progress and findings to the Alabama State Banking Department for its review.
The Board has agreed, among other things, to require Board approval of all
extensions of credit to insiders, as defined in Regulation O of the Board of
Governors of the Federal Reserve System. The Board has also agreed to implement
certain procedures for managing existing loans to insiders, including
limitations on renewals, methods of collection of adversely classified loans to
certain insiders and obtaining current appraisals on collateral securing such
adversely classified loans. In addition, the Board has agreed to limit future
extensions of credit and any payments other than ordinary compensation to any
director, officer or employee who, after investigation, is deemed to owe
restitution to the Bank or whose loans have been adversely classified, to
consult with the Alabama State Banking Department regarding settlement of
litigation and to obtain prior approval for sales or transfers of the Bank's
assets benefiting any director, officer or employee deemed to owe restitution.
As a part of an effort to control the Bank's expenses, the Board has directed
the Audit Committee to review for adequacy and appropriateness bills paid by the
Bank for professional services from 1998 to the present, to recover fees
improperly paid, if any, for the benefit of third parties and to establish
additional internal controls for the payment of future bills.
On March 4, 2003, the Board of Directors of Community Bank and the FDIC entered
into a Stipulation and Consent to the Issuance of an Order to Cease and Desist
(the "Consent Agreement"). The Order was effective 10 days after March 12, 2003,
the date of its issuance. The FDIC alleged in the Order to Cease and Desist (the
"Order") deficiencies relating to the Board's supervision over active management
of Community Bank, supervision and control of lending to insiders and accurate
maintenance of Community Bank's books and records. The FDIC characterizes these
deficiencies as unsafe and unsound banking practices. The Board consented to the
Order without admitting or denying those allegations. Pursuant to the Order, the
Board of Community Bank agreed to cease and desist from conduct giving rise to
the noted deficiencies and to:
(i) develop within 30 days of the effective date of the Order a written
plan specifying the responsibilities and lines of authority for
Community Bank's executive officers and outlining internal controls to
ensure compliance with the plan;
(ii) refrain from making, renewing or modifying any loans to current or
former executive officers or directors without prior approval of the
FDIC and the Alabama State Banking Department;
(iii)amend Community Bank's books and records to reflect the actual value
of bank premises and fixed assets; and
(iv) supply a copy of the Order to the Company and provide the Company with
a summary of the Order for inclusion in the Company's next shareholder
communication.
10
Statistical Disclosure
Statistical and other information regarding the following items are set forth in
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" on the pages indicated below.
Page(s)
Loan Portfolio and Selected Loan Maturity........................................................ 21
Investment Portfolio............................................................................. 22
Investment Portfolio Maturity Schedule........................................................... 23
Average Deposit Balances and Rates Paid.......................................................... 24
Maturities of Large Time Deposits................................................................ 24
Short-term Borrowings............................................................................ 25
Maturities of Long-term Debt..................................................................... 26
Interest Sensitivity............................................................................. 28
Capital Adequacy Ratios and Capital Growth "Reduction Ratios".................................... 29
Yields, Rates, Interest Rate Spread and Net Interest Margin...................................... 31
Consolidated Average Balances, Interest Income/Expense and Yields/Rates.......................... 32
Rate/Volume Variance Analysis.................................................................... 33
Summary of Loan Loss Experience.................................................................. 35
Allocation of the Allowance for Loan Losses...................................................... 36
Nonperforming Assets............................................................................. 37
Noninterest Income............................................................................... 38
Noninterest Expense.............................................................................. 39
Item 2 - Properties
The corporate headquarters of the Company is owned by Community Bank and located
at 68149 Main Street (U.S. Highway 231) in Blountsville, Alabama. Community
Bank's administrative, operational, accounting and legal functions are housed in
three buildings constructed in 1997, all of which are located on the same
property as the corporate headquarters.
The main banking office of Community Bank is located at 69156 Main Street,
Blountsville, Alabama. The premises are owned by Community Bank.
At December 31, 2002, Community Bank owned or leased buildings that were used in
the normal course of business in nine counties in Alabama, including Blount,
Lauderdale, Limestone, Madison, Marengo, Marion, Morgan, Perry and Winston
Counties. 1st Community Credit Corporation owned or leased buildings that were
used in the normal course of business in ten counties in Alabama, including
Blount, Cullman, Marshall, Morgan, Limestone, Lawrence, Etowah, Madison, DeKalb
and Walker Counties. Community Insurance Corp. and its subsidiary, Southern
Select Insurance, Inc., owned a building that is used in the normal course of
business in Madison County, Alabama.
For information about the amounts at which bank premises, equipment and other
real estate are recorded in the Company's financial statements and information
relating to commitments under leases, see the Company's Consolidated Financial
Statements and the accompanying notes to Consolidated Financial Statements
included elsewhere in this Report.
Item 3 - Legal Proceedings
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
11
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
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.
12
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 December, 2002, but was not carried through and is
unlikely to be under present circumstances. One of the subcontractors named as a
defendant in this action, Morgan City Construction, Inc., and its principals,
Mr. and Mrs. Dewey Hamaker, have been tried and convicted in the United States
District Court for the Northern District of Alabama and are awaiting sentencing.
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, Stacey 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.]
The time for answering the complaint in this case has not yet expired. 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.
Towns Derivative Litigation
The lawsuit filed by Mr. William Towns, a shareholder of the Company, on
November 19, 1998, as a shareholder derivative action against the directors of
the Company in the Circuit Court of Blount County, Alabama, was settled and
dismissed during 2002. The settlement did not have a material effect on the
financial condition of the company.
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.
13
Auto Loan Litigation
The action filed by the Company in the United States District Court for the
Northern District of Alabama against Carl Gregory Ford L-M, Inc., an automobile
dealership located in Ft. Payne, Alabama, Carl Gregory and Doug Broaddus, the
owners of the dealership, several employees and former employees of the
dealership and Gerald Scot Parrish, a former employee of Community Bank, with
respect to certain loans originated during 1998 in Community Bank's Wal-Mart
office in Ft. Payne, Alabama, has been settled as to all defendants other than
G. S. Parrish, the former employee of the Bank. The Bank has one year within
which to re-file its claims against Mr. Parrish.
Employee Litigation
The lawsuit filed by Messrs. Michael W. Alred and Michael A. Bean, two former
directors and executive officers of Community Bank, against Community Bank in
the United States District Court for the Northern District of Alabama alleging
that their employment was wrongfully terminated for allegedly providing
information to bank regulatory and law enforcement authorities concerning
possible violations of laws and regulations, gross mismanagement, gross waste of
funds and abuse of authority by Community Bank, its directors, officers and
employees was settled and dismissed during 2002. The terms of the settlement of
this litigation were deemed confidential and are included in the statement of
income as an increase to litigation expense.
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 Influnced and Corrupt Organization 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.
Conspiracy Litigation
On November 6, 2001 the Company and Community Bank filed a lawsuit in the United
States District Court for the Northern District of Alabama against Bryan A.
Corr, Doris J. Corr, individually and as executrix of the Estate of R. C. Corr,
Jr., Tina M. Corr, Corr, Inc., George M. Barnett, Michael A. Bean, Michael W.
Alred, R. Wayne Washam, M. Lewis Benson, Doris E. Benson, John M. Packard and
Andy Mann seeking damages in excess of $50 million. The complaint alleges that,
by knowingly making false statements and unsupported allegations to regulatory
and law enforcement authorities and in certain lawsuits discussed above, the
defendants abused the civil legal process to further their plan to discredit and
dislodge the directors and management of the Company and Community Bank and gain
control of those companies. The complaint further alleges that certain of the
defendants who are former directors and/or executive officers of Community Bank
breached their fiduciary duties to Community Bank by participating in, and
taking action in the furtherance of, the conspiracy. Finally, the complaint
alleges that the defendants failed to make filings that are required by the
Federal securities laws to disclose that the group is acting in concert to
acquire control of the Company. The complaint seeks compensatory and punitive
damages as well as an order barring the defendants from voting their shares of
Company stock, purchasing additional Company stock, soliciting proxies and
submitting shareholder proposals for at least three years.
14
On December 5, 2001, the Company, Community Bank and R. Wayne Washam entered
into a stipulation pursuant to which Mr. Washam would be dismissed as a
defendant. The court granted the stipulation on December 6, 2001. During the
time between December 3 and December 7, 2001 the other defendants filed various
motions to dismiss, abate or stay the lawsuit. On January 29, 2002 the Company
and Community Bank filed an amended complaint to reflect the dismissal of Wayne
Washam as a defendant and to add a claim for defamation against two of the
defendants. The lawsuit presently is in the discovery phase. As a result 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. Regardless of the outcome,
however, this lawsuit 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. 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.
Indemnification and Routine Proceedings
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.
The Company and its subsidiaries are from time to time parties to other legal
proceedings arising from 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.
Item 4 - Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders by solicitation of proxies
or otherwise during the fourth quarter of 2002.
15
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, their ages, the positions held by them
with the Company and certain of its subsidiaries and their principal occupations
for the last five years are as follows:
Name, Age and Position Currently Held with the
Company and its Subsidiaries Principal Experience During Past Five Years
Patrick M. Frawley (51) Chairman, President, and Chief Executive Officer of the
Chairman, President and Chief Executive Officer of the Company (2003 - Present); Chairman and Chief Executive
Company; Chairman and Chief Executive Officer of Officer of Community Bank (2003 - Present); Senior Vice
Community Bank; Chairman of 1st Community Credit Corporation, President of Community Bank (2002 - 2003); Director
Community Appraisals, Inc., Community Insurance Corporation, and of Regulatory Relations for Bank of America
Southern Select Insurance, Inc. (1991 - 2002)
Kerri C. Kinney (33) * Chief Financial Officer of the Company and Community
Chief Financial Officer of the Company and Community Bank Bank (2001-Present); Senior Risk Consultant for Compass
Bank, Birmingham, Alabama (2001); Chief Accounting
Officer of Frontier National Corporation, Sylacauga,
Alabama (1998-2000); Chief Financial Officer of Frontier
National Bank, Lanett, Alabama (1997-2000); Vice President
and Controller of The County Bank, Greenwood, South
Carolina (1993-1997)
Kennon R. Patterson, Sr. (60) ** Chairman, President and Chief Executive Officer of the
Chairman, President and Chief Executive Officer of the Company (1985-2003); Chairman and Chief Executive
Company; Chairman and Chief Executive Officer of Officer of Community Bank (1993-2003)
Community Bank; Chairman of 1st Community Credit Corporation;
Vice Chairman of Community Appraisals, Inc.;
Director of Community Insurance Corp., and Southern
Select Insurance, Inc.
Loy McGruder (61) *** President of Community Bank (2002-Present);
Director of the Company; Director and President of Community Bank Executive Vice President of Community Bank (1994-2002);
City President of Community Bank-Blountsville (1994-1997);
Senior Vice President of Community Bank (1993-1994)
* On April 14, 2003, Jim Kinney, Ms. Kinney's husband, will become an
employee of Community Bank at an annual salary of $75,000. Mr. Kinney will
be the project manager of a specific project for the operations division.
It is anticipated that Mr. Kinney's employment will terminate upon
completion of the project in approximately 12 months.
** In January 2003, the Board of Directors terminated Mr. Patterson's
employment with the Company and Community Bank, and appointed Mr. Frawley
to replace him. On February 8, 2003, the Board of Directors announced that
Mr. Patterson would no longer serve on the Board of Directors of Community
Bank. The Board of Directors of the Company does not have the legal
authority to remove a director of the Company, although a director may
resign. Mr. Patterson has not resigned as a director of the Company and is
currently a director of the Company.
*** Mr. McGruder began a medical leave of absence on February 3, 2003 and will
retire on June 6, 2003. Stacey W. Mann (50), Executive Vice President of
Community Bank since 1997 and Chief Operating Officer since 2001, has been
appointed by the Board of Directors as Interim President pending regulatory
approval.
The Company's Bylaws provide that the term of office of an executive officer of
the Company is as provided in the officer's employment agreement with the
Company or, if the officer is not a party to an employment agreement or if the
officer's employment agreement does not specify a term of office, as determined
by the Company's Board of Directors and until the officer's successor is elected
and qualified or until the officer's earlier resignation or removal.
16
PART II
Item 5 - Market for Registrant's Common Equity and Related Shareholder Matters
Shares of the common stock (the "Common Stock") of the Company were held by
approximately 2,325 shareholders of record as of March 10, 2003. There is no
established trading market for the Common Stock, which has been purchased and
sold infrequently in private transactions. Therefore, no reliable information is
available as to trades of the Common Stock, or as to the prices at which such
Common Stock has traded. Management has reviewed the limited information
available to the Company as to the ranges at which shares of the Common Stock
has been sold. The following data regarding the Common Stock are provided for
information purposes only, and should not be viewed as indicative of the actual
or market value of the Common Stock.
Estimated Price Range
Per Share
High Low
2002:
First Quarter.......................................................... $ 15.00 $ 15.00
Second Quarter......................................................... 20.00 15.00
Third Quarter ......................................................... 15.00 15.00
Fourth Quarter......................................................... 15.00 15.00
2001:
First Quarter.......................................................... $ 22.00 $ 15.00
Second Quarter......................................................... 22.00 15.00
Third Quarter.......................................................... 15.00 15.00
Fourth Quarter......................................................... 18.00 12.00
2000:
First Quarter.......................................................... $ 25.00 $ 24.00
Second Quarter......................................................... 25.00 19.00
Third Quarter.......................................................... 25.00 20.00
Fourth Quarter......................................................... 26.00 20.00
Annual dividends were neither declared nor paid in 2002. Generally, the payment
of dividends on the Common Stock is subject to the prior payment of principal
and interest on the Company's long-term debt, the retention of sufficient
earnings and capital in the Company's operating subsidiaries and regulatory
restrictions. Currently, the Company is under a memorandum of understanding with
the Federal Reserve that, among other restrictions, disallows the declaration or
payment of any dividends without the prior written approval of the Federal
Reserve. The Board of Directors does not currently anticipate declaring or
paying a dividend in 2003. There can be no assurance that the Company will pay
any dividends in the foreseeable future. See "Item 1 - Business - Supervision
and Regulation," "Item 7 - Management's Discussion of Financial Condition and
Results of Operations - Liquidity Management" and Note 12 in the Notes to
Consolidated Financial Statements included elsewhere in this Report.
17
Item 6 - Selected Financial Data
The following table sets forth selected financial data for the last five years.
All averages are daily averages.
Years ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
(Dollars in thousands except per share data)
Net interest income........................ $ 23,504 $ 22,853 $ 22,418 $ 26,672 $ 21,672
Provision for loan losses.................. 10,033 6,096 7,573 4,459 885
Net income (loss) from continuing operations (5,023) (2,381) (2,853) ** **
Net income (loss) from discontinued operations. 5,927 958 (167) ** **
Net income (loss).......................... 904 (1,423) (3,019) 1,658 3,579
Per Share Data:
Earnings (loss) per share from
continuing operations - basic......... $ (1.08) $ (0.52) $ (0.64) $ ** $ **
Earnings (loss) per share from
continuing operations - diluted....... (1.08) (0.52) (0.61) ** **
Earnings per share - basic.............. 0.19 (0.31) (0.68) 0.37 0.90
Earnings per share - diluted............ 0.19 (0.31) (0.65) 0.36 0.88
Cash dividends.......................... - - 0.75 0.60 0.50
Balance Sheet:
Loans, net of unearned income........... $ 359,184 $ 501,520 $ 528,316 $ 498,726 $ 433,853
Deposits................................ 459,464 617,706 600,901 573,261 538,586
FHLB long-term debt..................... 38,000 38,000 38,000 40,000 -
Other long-term debt.................... 3,578 4,667 5,675 6,637 7,569
Trust preferred securities.............. 10,000 10,000 10,000 - -
Average equity.......................... 42,848 42,938 41,776 44,203 37,318
Average assets.......................... 629,481 725,461 710,915 632,713 538,470
Ratios:
Return on average assets................ 0.14% (0.20)% (0.42)% 0.26% 0.67%
Return on average equity................ 2.11 (3.31) (7.23) 3.75 9.59
Average equity to average assets........ 6.81 5.92 5.88 6.99 6.93
** 1999 and 1998 data do not reflect separate net income components for
discontinued operations of certain branches divested in 2002.
18
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Item 7a - Quantitative and Qualitative Disclosures about Market Risk
The purpose of this discussion is to focus on the significant changes in the
financial condition and results of operations of the Company and its
subsidiaries during 2000, 2001 and 2002. This discussion and analysis is
intended to supplement and highlight information contained in the Company's
consolidated financial statements and related notes and the selected financial
data presented elsewhere in this Report.
Forward-Looking Statements
This report, including Management's Discussion and Analysis of Financial
Condition and Results of Operations, and documents incorporated herein by
reference, may contain certain statements relating to the future results of the
Company based upon information currently available. These "forward-looking
statements" (as defined in Section 21E of The Securities and Exchange Act of
1934) are typically identified by words such as "believes", "expects",
"anticipates", "intends", "estimates", "projects", and similar expressions.
These forward-looking statements are based upon assumptions the Company believes
are reasonable and may relate to, among other things, the allowance for loan
loss adequacy, simulation of changes in interest rates and litigation results.
Such forward-looking statements are subject to risks and uncertainties, which
could cause the Company's actual results to differ materially from those
included in these statements. These risks and uncertainties include, but are not
limited to, the following: (1) changes in political and economic conditions; (2)
interest rate fluctuations; (3) competitive product and pricing pressures within
the Company's markets; (4) equity and fixed income market fluctuations; (5)
personal and corporate customers' bankruptcies; (6) inflation; (7) acquisitions
and integration of acquired businesses; (8) technological changes; (9) changes
in law; (10) changes in fiscal, monetary, regulatory and tax policies; (11)
monetary fluctuations; (12) success in gaining regulatory approvals when
required; and (13) other risks and uncertainties listed from time to time in the
Company's SEC reports and announcements.
Critical Accounting Policies
The Company's significant accounting policies are presented in Note 1 to the
consolidated financial statements. 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 Bank'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. Further discussion
regarding the Company's accounting for allowance for loan losses is included in
Notes 1 and 4 to the consolidated financial statements.
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. Further discussion regarding the
Company's accounting for income taxes is included in Notes 1 and 20 to the
consolidated financial statements.
19
Net Income and Earnings per share
The Company's net income of approximately $904,000 for 2002 represented a
$2,327,000 increase from its net loss of approximately $1,423,000 for 2001 which
represented a $1,596,000 increase from 2000's net loss of approximately
$3,019,000. When stated as changes in basic earnings per share, the 2002 basic
earnings per share of $0.19 represented a $0.50 increase from the 2001 basic
loss per share of $0.31, which represented a $0.37 increase from the 2000 basic
loss per share of $0.68.
Both 2000 and 2001 Consolidated Statements of Income have been restated to
appropriately reflect earnings and losses from both continuing and discontinued
operations as a result of branch divestitures that occurred in 2002. These
statements have also been restated to reflect results of an investigation that
commenced in the fourth quarter of 2002 into allegations that the Company had
been overcharged on various construction projects. The Company has appropriately
recorded impairment losses on premises and equipment and charged them to the
period in which the overcharge occurred. Any overcharge which occurred prior to
the year ended December 31, 2000 has been appropriately reflected as a prior
period adjustment in Retained Earnings. See Note 22 - Prior Period Adjustments
in the Notes to Consolidated Financial Statements.
Loss from continuing operations increased approximately $2,642,000 to
approximately $5,023,000 at December 31, 2002 from approximately $2,381,000 at
December 31, 2001 which was a decrease in loss from continuing operations of
approximately $472,000 from approximately $2,853,000 at December 31, 2000.
Although net interest income increased approximately $652,000 to approximately
$23,505,000 at December 31, 2002 from approximately $22,853,000 at December 31,
2001, an increase in provision for loan losses of approximately $3,937,000 more
than offset that positive and was the primary cause for increased losses from
continuing operations for 2002. Basic loss from continuing operations per common
share was $1.08 for the year ended December 31, 2002 as compared to a basic loss
from continuing operations per common share for the year ended December 31, 2001
of $0.52. Discontinued operations, net of tax, provided approximately $5,927,000
of net income for the year ended December 31, 2002 or $1.27 basic earnings per
share. This includes a pretax gain of approximately $8,072,000 on the divested
branches. Discontinued operations, net of tax, provided approximately $958,000
of income for the year ended December 31, 2001, but lost approximately $167,000
during the year ended December 31, 2000.
Earning Assets
The Company's average total assets in 2002 decreased 13.2% below that for 2001,
primarily as a result of branch divestitures. Earning assets accounted for
approximately 83.6% of the Company's average total assets for 2002.
Average loans, excluding those associated with discontinued operations, net of
unearned income, represented 72.6%, 75.1% and 78.6% of average earning assets
during 2002, 2001 and 2000, respectively. Average investment securities
represented 22.2% of average earning assets in 2002, compared to 21.5% in 2001
and 20.5% in 2000. The change in the mix of loans and securities has been
attributable to a decrease in loans. Average federal funds sold as a percent of
average earning assets was 4.6%, 3.4% and 0.7% for 2002, 2001 and 2000,
respectively. The other earning asset categories accounted for less than 3.0% of
average earning assets for all three periods.
Loans
Total loans, net of unearned income, decreased approximately $142,335,000, or
28.4%, to approximately $359,184,000 at December 31, 2002, from $501,519,000 at
December 31, 2001, which represented an increase of $26,796,000, or 5.1%, from
$528,316,000 at December 31, 2000. Commercial, financial and agricultural loans
decreased by approximately $44,369,000, or 30.3%, to approximately $101,841,000
at December 31, 2002, from approximately $146,210,000 at December 31, 2001,
which represented a decrease of approximately $5,437,000, or 3.9%, from
approximately $140,773,000 at December 31, 2000. Commercial, financial and
agricultural loans represented 28.3% of total loans at December 31, 2002,
compared to 29.1% at December 31, 2001 and 26.6% at December 31, 2000. Real
estate - mortgage loans decreased by approximately $58,441,000, or 25.1%, to
approximately $174,775,000 at December 31, 2002, from $233,216,000 at December
31, 2001, which represented a decrease of approximately $3,376,000, or 1.4%,
from approximately $236,592,000 at December 31, 2000. As a percentage of total
loans, real
20
estate - mortgage loans increased to 48.7% at December 31, 2002, from 46.5% at
December 31, 2001 and 44.8% at December 31, 2000. Consumer loans decreased by
approximately $38,435,000, or 32.3%, to approximately $80,596,000 at December
31, 2002, from approximately $119,031,000 at December 31, 2001, which
represented a decrease of approximately $26,642,000, or 18.3%, from
approximately $145,673,000 at December 31, 2000. As a percentage of total loans,
consumer loans decreased to 22.4% at December 31, 2002, from 23.8% at December
31, 2001 and 27.6% at December 31, 2000. Real estate - construction loans
decreased by approximately $1,109,000, or 35.5%, to approximately $2,017,000 at
December 31, 2002, from approximately $3,126,000 at December 31, 2001, which
represented a decrease of approximately $2,302,000, or 42.4%, from approximately
$5,429,000 at December 31, 2000. As a percentage of total loans, real estate -
construction loans stayed level at 0.6% at December 31, 2002, from 0.6% at
December 31, 2001 and decreased from 1.0% at December 31, 2000. The Company has
experienced general decreases in loans because of economic downturns, the
tightening of the Company's credit standards and increased charge-offs of loans
originated in previous years, but has specifically experienced a large decline
in loans in 2002 due to the sale of branches earlier in the year.
The following table shows the classification of loans by major category at
December 31, 2002, and at the end of each of the preceding four years.
LOAN PORTFOLIO
December 31,
------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
(Dollars in Thousands)
Commercial, financial and
agricultural....... $ 101,841 28.3% $ 146,210 29.1% $ 140,773 26.6% $ 124,245 24.9% $ 94,057 21.7%
Real estate - construction 2,017 0.6 3,126 0.6 5,429 1.0 6,470 1.3 6,153 1.4
Real estate -mortgage. 174,775 48.7 233,216 46.5 236,592 44.8 224,129 44.9 205,457 47.4
Consumer.............. 80,596 22.4 119,031 23.8 145,673 27.6 144,453 28.9 129,334 29.8
Less: unearned income. 45 - 64 - 151 - 571 - 1,148 .3
---------- ------- ---------- ------- ---------- ------- ---------- ------- ---------- -------
Loans, net of
unearned income 359,184 100.0% 501,519 100.0% 528,316 100.0% 498,726 100.0% 433,853 100.0%
Allowance for loan losses 9,784 7,292 7,107 2,603 2,971
---------- ---------- --------- ---------- ----------
Net loans............. $ 349,400 $ 494,227 $ 521,209 $ 496,123 $ 430,882
========== ========== ========= ========== ==========
The following table provides maturities of certain loan classifications and an
analysis of these loans maturing in over one year as of December 31, 2002.
SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY
Rate Structure for Loans
Maturity Maturing Over One Year
-------------------------------------- -------------------------
Over One
One Year Over Predetermined Floating or
Year or Through Five Interest Adjustable
Less Five Years Years Total Rate Rate
----------- ----------- ----------- ----------- ------------ -----------
(In thousands)
Commercial, financial and
agricultural................ $ 38,891 $ 20,309 $ 42,642 $ 101,842 $ 21,279 $ 41,672
Real estate - construction..... 1,414 119 483 2,016 119 483
----------- ----------- ----------- ----------- ----------- -----------
Total....................... $ 40,305 $ 20,428 $ 43,125 $ 103,858 $ 21,398 $ 42,155
=========== =========== =========== =========== =========== ===========
Investment Portfolio
The composition of the Company's investment securities portfolio reflects the
Company's investment strategy of maximizing portfolio yields subject to risk and
liquidity considerations. The Company's entire portfolio is classified as
21
available for sale. The primary objectives of the Company's investment strategy
are to maintain an appropriate level of liquidity and provide a tool to assist
in controlling the Company's interest rate position while at the same time
producing adequate levels of interest income. Management of the maturity of the
portfolio is necessary to provide liquidity and to control interest rate risk.
During 2002, gross investment securities sales, calls and pay downs were
approximately $88,623,000 and maturities were approximately $15,000,000,
compared to gross investment securities sales of $86,418,000 in 2001 and
approximately $16,230,000 in 2000 and maturities of approximately $2,500,000 in
2001 and approximately $25,210,000 in 2000. Net gains realized on the sales
totaled approximately $653,000 during 2002, compared to approximately $1,284,000
in 2001 and approximately $5,000 in 2000. At December 31, 2002, gross unrealized
gains in the portfolio were approximately $2,749,000, compared to approximately
$486,000 at December 31, 2001 and approximately $1,419,000 at December 31, 2000,
while gross unrealized losses amounted to approximately $227,000 at December 31,
2002, compared to approximately $893,000 at December 31, 2001 and approximately
$756,000 at December 31, 2000. These fluctuations in the gross unrealized gains
and losses in the Company's investment portfolio resulted primarily from
changing bond prices.
Mortgage-backed securities have varying degrees of risk of impairment of
principal, as opposed to U.S. Treasury and U.S. government agency obligations,
which are considered to contain virtually no default or prepayment risk.
Impairment risk is primarily associated with accelerated prepayments,
particularly with respect to longer maturities purchased at a premium and
interest-only strip securities. The Company's mortgage-backed securities
portfolio as of December 31, 2002 and 2001 contained no interest-only strips and
the amount of unamortized premium on mortgage-backed securities at December 31,
2002, was approximately $1,672,000, compared to approximately $929,000 at
December 31, 2001. The recoverability of the Company's investment in
mortgage-backed securities is reviewed periodically by management, and if
necessary, appropriate adjustments for impaired value are made to income.
The carrying amount of investment securities at the end of each of the last
three years is set forth in the following table:
INVESTMENT PORTFOLIO
December 31,
2002 2001 2000
------------- ------------- -------------
(In thousands)
U. S. Treasury and U.S. Government agencies............... $ 6,523 $ 16,948 $ 46,830
Mortgage-backed securities................................ 107,534 90,647 31,341
State and municipal securities............................ 7,056 11,684 19,499
Federal Home Loan Bank Stock.............................. 2,788 2,400 3,900
------------- ------------- -------------
Total investment securities............................ $ 123,901 $ 121,679 $ 101,570
============= ============= =============
Total investment securities increased approximately $2,222,000, or 1.83%, to
approximately $123,901,000 at December 31, 2002, compared to approximately
$121,679,000 at December 31, 2001 and approximately $101,570,000 at December 31,
2000. During 2002, non-taxable investment securities decreased $4,628,000, or
39.6%, to approximately $7,056,000 from $11,684,000 at December 31, 2001, which
represented an increase of $7,815,000 or 40.1%, from $19,499,000 at December 31,
2000. Taxable investment securities increased approximately $6,850,000, or 6.2%
during 2002 to $116,845,000 from approximately $109,995,000 at December 31,
2001, which represented an increase of $27,924, or 34.0%, from approximately
$82,071,000 at December 31, 2000. The Company saw increases in the investment
portfolio in 2002 as loan volumes continued to decline and excess funds were
invested in securities. The composition of the investment securities portfolio
changed during 2001 primarily as excess funds were invested in mortgage-backed
securities. At December 31, 2002, U.S. government and agency securities
represented 92.1% of the total investment securities portfolio compared to 88.4%
at year-end 2001, while state and municipal securities represented 5.7% and 9.6%
of the investment securities portfolio at year-end 2002 and 2001, respectively.
In 2002 and 2001, as investable funds increased due to diminished loan demand
and bonds redeemed prior to maturity, Community Bank invested more heavily in
mortgage-backed securities to enhance cash flow and maximize yield.
The maturities and weighted average yields of the investments in the year-end
2002 portfolio of investment securities are presented below. The average
maturity of the investment portfolio was 6.21 years at year-end 2002 compared to
5.20 years at year-end 2001 with an average yield of 5.54% and 6.22% at December
31, 2002 and 2001, respectively.
22
Mortgage-backed securities have been included in the maturity table based upon
the guaranteed payoff date of each security.
INVESTMENT PORTFOLIO MATURITY SCHEDULE
Maturing
-------------------------------------------------------------------------------
Within After One But After Five But After
One Year Within Five Years Within Ten Years Ten Years
----------------- ----------------- ------------------ ------------------
Amount Yield Amount Yield Amount Yield Amount Yield
-------- ------- -------- ------- -------- ------- -------- -------
December 31, 2002: (Dollars in thousands)
SECURITIES - ALL AVAILABLE-FOR-SALE:
U. S. Government agencies..... $ 206 5.05% $ - -% $ 6,317 5.70% $107,535 5.41%
State and municipal securities 239 4.92 180 5.90 369 4.43 6,267 5.07
Equity securities ............ - - - - - - 2,788 -
-------- -------- -------- --------
$ 445 4.98 $ 180 5.90 $ 6,686 5.63 $116,590 5.39
======== ======== ======== ========
With the exception of some securities issued by U.S. Government agencies, the
Company held one municipal bond issued by Hartselle Utilities, whose amortized
cost of $4,680,547 exceeded 10% of the Company's consolidated shareholders'
equity on December 31, 2002.
Federal funds sold decreased 19.9% during 2002, from $30,000,000 at December 31,
2001 to $24,030,000 at December 31, 2002. This decrease resulted mostly from the
branch divestitures.
The balance of interest-bearing deposits with other banks remained at $200,000
at December 31, 2002 and 2001.
Deposits
Community Bank's primary source of funds is its deposits. Dividends from
Community Bank are the Company's primary source of funds. Historically,
continued enhancement of existing products, emphasis upon better customer
service and expansion into new market areas have fueled the growth in Community
Bank's deposit base. The Company does not presently anticipate further
geographic expansion. Rather emphasis has been placed upon attracting consumer
deposits and the Company's intent is to expand its consumer base in its market
areas in order to continue to fund future asset growth.
During 2002, the Company's average total deposits increased approximately
$4,435,000, or 1.0%, to approximately $467,538,000 from approximately
$463,103,000 in 2001, which represented an increase of approximately $1,088,000,
or 0.2%, from approximately $462,015,000 in 2000. At December 31, 2002, the
Company's total deposits were approximately $459,464,000, a decrease of
approximately $158,242,000, or 25.6%, from approximately $617,706,000 at
December 31, 2001.
23
The following table presents the average deposit balances and the average rates
paid for each of the major classifications of deposits for the 12 month periods
ending December 31, 2002, 2001 and 2000 and excludes averages associated with
discontinued operations:
Average Deposit Balances and Rates Paid
-----------------------------------------------------------------------
2002 2001 2000
--------------------- --------------------- --------------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
---------- -------- --------- -------- --------- --------
(Dollars in thousands)
Noninterest-bearing demand.............. $ 56,994 0.00% $ 57,347 0.00% $ 56,674 0.00%
Interest-bearing demand................. 79,386 2.17 73,301 4.42 81,920 4.82
Savings................................. 56,606 2.04 48,884 4.14 46,586 4.55
Time.................................... 274,552 3.81 283,571 5.37 276,835 5.90
---------- --------- ---------
Total (1)............................ $ 467,538 3.25 $ 463,103 5.05 $ 462,015 5.52
========== ========= =========
- ------------------
(1) The rate paid on total average deposits represents the rate paid on total
average interest-bearing deposits only.
The Company's average interest-bearing deposits increased by 1.2% and 0.1% in
2002 and 2001, respectively. Average interest-bearing demand deposits increased
8.3% compared to a decrease of 10.5% during 2001 from an average of
approximately $81,920,000 in 2000. Average savings and average time deposits
increased 15.8% and decreased 3.2%, respectively, during 2002 compared to
increases of 4.9% and 2.4%, respectively, during 2001. Average
noninterest-bearing demand deposits decreased 0.6% during 2002 compared to an
increase of 1.2% during 2001 from an average of $56,674,000 during 2000. Total
average deposits increase 1.0% in 2002 and 0.2% in 2001. The two categories of
lowest cost deposits, noninterest-bearing demand deposits and interest-bearing
demand deposits, comprised the following percentages of total average deposits
during 2002, 2001 and 2000, respectively: (i) Average noninterest-bearing demand
deposits - 12.2%, 12.4%, and 12.3%; and (ii) average interest-bearing demand
deposits - 17.0%, 15.8% and 17.7%. Community Bank experienced a slight shift in
its deposit mix during 2002 as interest-bearing demand deposits and savings
increased while certificates of deposits decreased $9,019,000, or 3.2%. Of total
time deposits at December 31, 2002, approximately 31.3% were large denomination
certificates of deposit and other time deposits of $100,000 or more, up from
31.5% at December 31, 2001.
The maturities of the time certificates of deposit and other time deposits of
$100,000 or more issu