SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2006 Commission File No. 000-22054
COMMUNITY BANKSHARES, INC.
-------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
South Carolina 57-0966962
--------------------------- ---------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
102 Founders Court
Orangeburg, South Carolina 29118
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(Address of principal executive offices, zip code)
(803) 535-1060
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is shell company (as defined
in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: Common Stock, no par or
stated value, 4,438,158 shares outstanding on August 2, 2006.
COMMUNITY BANKSHARES, INC.
FORM 10-Q
Index
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets ...................................................................... 3
Consolidated Statements of Income ................................................................ 4
Consolidated Statements of Changes in Shareholders' Equity ....................................... 5
Consolidated Statements of Cash Flows ............................................................ 6
Notes to Unaudited Consolidated Financial Statements.............................................. 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk ....................................... 23
Item 4. Controls and Procedures........................................................................... 24
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders............................................... 25
Item 6. Exhibits.......................................................................................... 25
SIGNATURES ......................................................................................................... 26
2
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
COMMUNITY BANKSHARES, INC.
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
2006 2005
---- ----
(Dollars in thousands)
Assets
Cash and due from banks ................................................................. $ 15,437 $ 19,508
Federal funds sold ...................................................................... 16,806 32,483
--------- ---------
Total cash and cash equivalents .................................................. 32,243 51,991
Interest bearing deposits with other banks .............................................. 1,611 1,038
Securities available-for-sale ........................................................... 57,112 58,701
Securities held-to-maturity (estimated fair value $1,802 for 2006
and $1,820 for 2005) ............................................................... 1,850 1,850
Other investments ....................................................................... 2,777 2,980
Loans held for sale ..................................................................... 20,792 12,447
Loans receivable ........................................................................ 419,170 413,984
Less, allowance for loan losses ..................................................... (9,871) (11,641)
--------- ---------
Net loans ........................................................................ 409,299 402,343
Premises and equipment - net ............................................................ 10,290 9,412
Accrued interest receivable ............................................................. 3,136 3,134
Net deferred income tax assets .......................................................... 3,730 3,655
Goodwill ................................................................................ 4,321 4,321
Core deposit intangible assets .......................................................... 2,714 2,837
Prepaid expenses and other assets ....................................................... 2,292 2,127
--------- ---------
Total assets ..................................................................... $ 552,167 $ 556,836
========= =========
Liabilities
Deposits
Noninterest bearing ................................................................. $ 60,184 $ 67,146
Interest bearing .................................................................... 399,059 397,063
--------- ---------
Total deposits ................................................................... 459,243 464,209
Short-term borrowings ................................................................... 12,420 8,975
Long-term debt .......................................................................... 26,192 32,196
Accrued interest payable ................................................................ 1,548 1,212
Accrued expenses and other liabilities .................................................. 1,961 1,252
--------- ---------
Total liabilities ................................................................ 501,364 507,844
--------- ---------
Shareholders' equity
Common stock - no par value; 12,000,000 shares authorized; issued and
outstanding - 4,435,898 for 2006 and 4,404,303 for 2005 ............................. 30,546 30,202
Retained earnings ....................................................................... 20,925 19,325
Accumulated other comprehensive income (loss) ........................................... (668) (535)
--------- ---------
Total shareholders' equity ....................................................... 50,803 48,992
--------- ---------
Total liabilities and shareholders' equity ....................................... $ 552,167 $ 556,836
========= =========
See accompanying notes to unaudited consolidated financial statements.
3
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Income
(Unaudited)
Period Ended June 30,
---------------------
Three Months Six Months
------------ ----------
2006 2005 2006 2005
---- ---- ---- ----
(Dollars in thousands, except per share)
Interest and dividend income
Loans, including fees .................................... $ 8,156 $ 7,202 $ 15,839 $ 13,918
Interest bearing deposits with other banks ............... 35 11 55 19
Debt securities .......................................... 556 432 1,109 869
Dividends ................................................ 41 34 75 58
Federal funds sold ....................................... 315 95 638 163
-------- -------- -------- --------
Total interest and dividend income ................ 9,103 7,774 17,716 15,027
-------- -------- -------- --------
Interest expense
Deposits
Time deposits $100M and over ......................... 939 630 1,798 1,157
Other deposits ....................................... 2,233 1,361 4,177 2,569
-------- -------- -------- --------
Total interest expense on deposits ................ 3,172 1,991 5,975 3,726
Short-term borrowings .................................... 89 44 190 87
Long-term debt ........................................... 475 468 957 906
-------- -------- -------- --------
Total interest expense ............................ 3,736 2,503 7,122 4,719
-------- -------- -------- --------
Net interest income ........................................... 5,367 5,271 10,594 10,308
Provision for loan losses ..................................... 675 585 1,290 1,035
-------- -------- -------- --------
Net interest income after provision ........................... 4,692 4,686 9,304 9,273
-------- -------- -------- --------
Noninterest income
Service charges on deposit accounts ...................... 862 853 1,694 1,615
Mortgage loan brokerage income ........................... 987 859 1,824 1,551
Net securities gains or (losses) ......................... - - 1 (10)
Other .................................................... 211 254 475 475
-------- -------- -------- --------
Total noninterest income .......................... 2,060 1,966 3,994 3,631
-------- -------- -------- --------
Noninterest expenses
Salaries and employee benefits ........................... 2,753 2,334 5,332 4,612
Premises and equipment ................................... 613 550 1,237 1,085
Other .................................................... 1,266 1,341 2,690 2,647
-------- -------- -------- --------
Total noninterest expenses ........................ 4,632 4,225 9,259 8,344
-------- -------- -------- --------
Income before income taxes .................................... 2,120 2,427 4,039 4,560
Income tax expense ............................................ 747 876 1,465 1,649
-------- -------- -------- --------
Net income .................................................... $ 1,373 $ 1,551 $ 2,574 $ 2,911
======== ======== ======== ========
Per share
Net income ............................................... $ 0.31 $ 0.35 $ 0.58 $ 0.66
Net income - diluted ..................................... 0.30 0.35 0.57 0.65
Cash dividends declared .................................. 0.11 0.10 0.22 0.20
See accompanying notes to unaudited consolidated financial statements.
4
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Changes in Shareholders' Equity
(Unaudited)
Common Stock
------------ Accumulated
Number of Retained Other Comprehensive
Shares Amount Earnings Income (Loss) Total
------ ------ -------- ------------- -----
(Dollars in thousands, except per share)
Balance, January 1, 2005 ....................................... 4,390,784 $ 30,042 $ 20,075 $ (90) $ 50,027
---------
Comprehensive income:
Net income ................................................. - - 2,911 - 2,911
---------
Unrealized holding gains and losses
on available-for-sale securities arising
during the period, net of income taxes of $118 ........... - - - (212) (212)
Reclassification adjustment for losses (gains)
realized in income, net of income taxes of $3 ............ - - - 7 7
---------
Total other comprehensive income ........................... - - - - (205)
---------
Total comprehensive income ............................... - - - - 2,706
---------
Proceeds of sale of common stock ............................... 775 14 - - 14
Exercise of employee stock options ............................. 12,744 146 - - 146
Cash dividends declared, $.20 per share ........................ - - (880) - (880)
--------- --------- --------- --------- ---------
Balance, June 30, 2005 ......................................... 4,404,303 $ 30,202 $ 22,106 $ (295) $ 52,013
========= ========= ========= ========= =========
Balance, January 1, 2006 ....................................... 4,404,303 $ 30,202 $ 19,325 $ (535) $ 48,992
---------
Comprehensive income:
Net income ................................................. - - 2,574 - 2,574
---------
Unrealized holding gains and losses
on available-for-sale securities arising
during the period, net of income taxes of $75 ............ - - - (132) (132)
Reclassification adjustment for losses (gains)
realized in income, net of income taxes of $0 ............ - - - (1) (1)
---------
Total other comprehensive income (loss) .................... - - - - (133)
---------
Total comprehensive income ............................... - - - - 2,441
---------
Proceeds of sale of common stock ............................... 1,000 16 - - 16
Exercise of employee stock options ............................. 30,595 328 - - 328
Cash dividends declared, $.22 per share ........................ - - (974) - (974)
--------- --------- --------- --------- ---------
Balance, June 30, 2006 ......................................... 4,435,898 $ 30,546 $ 20,925 $ (668) $ 50,803
========= ========= ========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
5
COMMUNITY BANKSHARES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
June 30,
--------
2006 2005
---- ----
(Dollars in thousands)
Operating activities
Net income ................................................................................ $ 2,574 $ 2,911
Adjustments to reconcile net income to net
cash (used) provided by operating activities
Provision for loan losses .......................................................... 1,290 1,035
Depreciation and amortization ...................................................... 624 581
Net amortization of securities ..................................................... 9 50
Net securities (gains) or losses ................................................... (1) 10
Proceeds of sales of loans held for sale ........................................... 113,356 96,500
Originations of loans held for sale ................................................ (121,701) (96,488)
Increase in accrued interest receivable ............................................ (2) (295)
(Increase) decrease in other assets ................................................ (165) 409
Gains on sales of other real estate ................................................ - (24)
Increase in accrued interest payable ............................................... 336 365
Increase in other liabilities ...................................................... 709 307
--------- ---------
Net cash (used) provided by operating activities ............................... (2,971) 5,361
--------- ---------
Investing activities
Net (increase) decrease in interest bearing deposits with other banks ..................... (573) 393
Purchases of available-for-sale securities ................................................ (6,499) (5,745)
Maturities, calls and paydowns of available-for-sale securities ........................... 7,872 4,242
Proceeds of sales of available-for-sale securities ........................................ - 4,412
Net decrease (increase) in other investments .............................................. 203 (248)
Net increase in loans made to customers ................................................... (8,246) (20,796)
Purchases of premises and equipment ....................................................... (1,379) (542)
Proceeds from sales of other real estate .................................................. - 224
--------- ---------
Net cash used by investing activities .......................................... (8,622) (18,060)
--------- ---------
Financing activities
Net (decrease) increase in deposits ....................................................... (4,966) 9,960
Net increase in short-term borrowings ..................................................... 3,445 1,206
Proceeds from issuing long-term debt ...................................................... - 3,000
Repayment of long-term debt ............................................................... (6,004) (4)
Exercise of employee stock options ........................................................ 328 146
Sale of common stock ...................................................................... 16 14
Cash dividends paid ....................................................................... (974) (880)
--------- ---------
Net cash (used) provided by financing activities ............................... (8,155) 13,442
--------- ---------
(Decrease) increase in cash and cash equivalents ............................................... (19,748) 743
Cash and cash equivalents, beginning of period ................................................. 51,991 26,968
--------- ---------
Cash and cash equivalents, end of period ....................................................... $ 32,243 $ 27,711
========= =========
Supplemental Disclosures of Cash Flow Information
Cash payments for interest ................................................................ $ 6,786 $ 4,354
========= =========
Cash payments for income taxes ............................................................ $ 631 $ 1,690
========= =========
Supplemental Disclosures of Non-cash Activities
Transfer to net deferred income tax assets from prepaid current income taxes .............. $ - $ 297
========= =========
See accompanying notes to unaudited consolidated financial statements.
6
COMMUNITY BANKSHARES, INC.
Notes to Unaudited Consolidated Financial Statements
Accounting Principles - A summary of significant accounting policies and the
audited financial statements for 2005 are included in Community Bankshares,
Inc.'s (the "Company" or "CBI") Annual Report on Form 10-K for the year ended
December 31, 2005 filed with the Securities and Exchange Commission. Certain
amounts in the 2005 financial statements have been reclassified to conform to
the current presentation.
Management Opinion - The interim financial statements in this report are
unaudited. In the opinion of management, all the adjustments necessary to
present a fair statement of the results for the interim period have been made.
Such adjustments are of a normal and recurring nature. The results of operations
for any interim period are not necessarily indicative of the results to be
expected for an entire year. These interim financial statements should be read
in conjunction with the annual financial statements and notes thereto contained
in the 2005 Annual Report on Form 10-K.
Nonperforming Loans - As of June 30, 2006, there were $11,151,000 in nonaccrual
loans and $202,000 of loans 90 or more days past due and still accruing
interest.
Earnings Per Share - Basic earnings per share is computed by dividing net income
applicable to common shares by the weighted average number of common shares
outstanding. Diluted earnings per share is computed by dividing applicable net
income by the weighted average number of shares outstanding and any dilutive
potential common shares and dilutive stock options. It is assumed that all
dilutive stock options are exercised at the beginning of each period and that
the proceeds are used to purchase shares of the Company's common stock at the
average market price during the period. Net income per share and net income per
share, assuming dilution, were computed as follows:
7
(Unaudited)
Period Ended June 30,
---------------------
Three Months Six Months
------------ ----------
2006 2005 2006 2005
---- ---- ---- ----
(Dollars in thousands, except per share amounts)
Net income per share, basic
Numerator - net income ............................... $ 1,373 $ 1,551 $ 2,574 $ 2,911
========== ========== ========== ==========
Denominator
Weighted average common shares
issued and outstanding ........................... 4,434,012 4,404,045 4,424,091 4,399,089
========== ========== ========== ==========
Net income per share, basic ............................ $ .31 $ .35 $ .58 $ .66
========== ========== ========== ==========
Net income per share, assuming dilution
Numerator - net income ............................... $ 1,373 $ 1,551 $ 2,574 $ 2,911
========== ========== ========== ==========
Denominator
Weighted average common shares
issued and outstanding ........................... 4,434,012 4,404,045 4,424,091 4,399,089
Effect of dilutive stock options ................... 69,624 100,142 70,690 101,360
---------- ---------- ---------- ----------
Total shares ............................ 4,503,636 4,504,187 4,494,781 4,500,449
========== ========== ========== ==========
Net income per share, assuming dilution ................ $ .30 $ .35 $ .57 $ .65
========== ========== ========== ==========
Stock Based Compensation - Effective January 1, 2006, the Company began
accounting for compensation expenses related to stock options granted to
employees and directors under the recognition and measurement principles of
Statement of Accounting Standards No. 123(R) "Share-Based Payment" ("SFAS
123(R)") using the modified prospective application method. The Company had
previously elected to continue using the methodology of Accounting Principles
Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees,"
to account for compensation expenses related to stock-based compensation until
the mandatory effective date for SFAS 123(R).
Options previously issued under the Company's plans had no intrinsic value at
the grant date and no compensation cost was recognized in accordance with APB
No. 25. Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"),
"Accounting for Stock-Based Compensation," required entities to provide pro
forma disclosures of net income, and earnings per share, as if the fair value
based method of accounting promulgated by that standard had been applied. Under
the modified prospective application method of SFAS 123(R), the Company is
required to apply SFAS 123(R) only to new awards and to awards modified,
repurchased or cancelled after the required effective date. Also, compensation
cost would be recognized for the portions of previously granted awards
outstanding which had not vested on the effective date. The Company had no such
awards outstanding as of January 1, 2006.
Variable Interest Entity - On March 8, 2004, CBI sponsored the creation of a
Variable Interest Entity ("VIE"), SCB Capital Trust I (the "Trust"), and is the
sole owner of the common securities issued by the Trust. On March 10, 2004, the
Trust issued $10,000,000 in floating rate capital securities. The proceeds of
this issuance, and the amount of CBI's capital investment, were used to acquire
$10,310,000 principal amount of CBI's floating rate junior subordinated
deferrable interest debt securities ("Debentures") due April 7, 2034, which
securities, and the accrued interest thereon, now constitute the Trust's sole
assets. The interest rate associated with the debt securities, and the
distribution rate on the common securities of the Trust, was established
8
initially at 3.91% and is adjustable quarterly at 3 month LIBOR plus 280 basis
points. The index rate (LIBOR) may not be lower than 1.11%. CBI may defer
interest payments on the Debentures for up to twenty consecutive quarters, but
not beyond the stated maturity date of the Debentures. In the event that such
interest payments are deferred by CBI, the Trust may defer distributions on the
common securities. In such an event, CBI would be restricted in its ability to
pay dividends on its common stock and to perform under other obligations that
are not senior to the junior subordinated Debentures.
The Debentures are redeemable at par at the option of CBI, in whole or
in part, on any interest payment date on or after April 7, 2009. Prior to that
date, the Debentures are redeemable at 105% of par upon the occurrence of
certain events that would have a negative effect on the Trust or that would
cause it to be required to be registered as an investment company under the
Investment Company Act of 1940 or that would cause trust preferred securities
not to be eligible to be treated as Tier 1 capital by the Federal Reserve Board.
Upon repayment or redemption of the Debentures, the Trust will use the proceeds
of the transaction to redeem an equivalent amount of trust preferred securities
and trust common securities. The Trust's obligations under the trust preferred
securities are unconditionally guaranteed by CBI.
The Company's investment in the Trust is carried at cost in other
assets and the debentures are included in long-term debt in the consolidated
balance sheet.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
Statements included in this report which are not historical in nature
are intended to be, and are hereby identified as "forward-looking statements"
for purposes of the safe harbor provided by Section 21E of the Securities
Exchange Act of 1934, as amended. Forward-looking statements include statements
concerning plans, objectives, goals, strategies, future events or performance
and underlying assumptions and other statements which are other than statements
of historical facts. Such forward-looking statements may be identified, without
limitation, by the use the of the words "anticipates," "believes," "estimates,"
"expects," "intends," "plans," "predicts," "projects," and similar expressions.
The Company's expectations, beliefs, estimates and projections are expressed in
good faith and are believed by the Company to have a reasonable basis, including
without limitation, management's examination of historical operating trends,
data contained in the Company's records and other data available from third
parties, but there can be no assurance that management's expectations, beliefs,
estimates or projections will result or be achieved or accomplished. The Company
cautions readers that forward-looking statements, including without limitation,
those relating to the Company's recent and continuing expansion, its future
business prospects, revenues, working capital, liquidity, capital needs,
interest costs, income, and adequacy of the allowance for loan losses, are
subject to risks and uncertainties that could cause actual results to differ
materially from those indicated in the forward-looking statements, due to
several important factors herein identified, among others, and other risks and
factors identified from time to time in the Company's reports filed with the
Securities and Exchange Commission. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
9
References to our Website Address
References to our website address throughout this Quarterly Report on
Form 10-Q and in any documents incorporated into this Form 10-Q by reference are
for informational purposes only, or to fulfill specific disclosure requirements
of the Securities and Exchange Commission's rules or the American Stock Exchange
listing standards. These references are not intended to, and do not, incorporate
the contents of our website by reference into this Form 10-Q or the accompanying
materials.
Critical Accounting Policies
CBI has adopted various accounting policies, which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of CBI's financial statements. The significant
accounting policies of CBI are described in detail in the notes to CBI's audited
consolidated financial statements included in CBI's 2005 Annual Report on Form
10-K filed with the Securities and Exchange Commission.
Certain accounting policies involve significant judgments and estimates
by management, which have a material impact on the carrying value of certain
assets and liabilities. Management considers such accounting policies to be
critical accounting policies. The judgments and estimates used by management are
based on historical experience and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the judgments and
assumptions made by management, actual results could differ from these judgments
and estimates, which could have a material impact on the carrying values of
assets and liabilities and the results of operations of CBI.
CBI is a holding company for four community banks and a mortgage
company and, as a financial institution, believes the allowance for loan losses
is a critical accounting policy that requires the most significant judgments and
estimates used in preparation of its consolidated financial statements. Refer to
the sections "Allowance for Loan Losses" and "Provision for Loan Losses" in the
Annual Report on Form 10-K for 2005 for a detailed description of CBI's
estimation process and methodology related to the allowance for loan losses.
CHANGES IN FINANCIAL CONDITION
During the six months ended June 30, 2006, loans held for sale
increased by $8,345,000, or 67.0% and loans increased by $5,186,000, or 1.3%,
over the respective amounts as of December 31, 2005. The growth in these earning
asset categories was funded largely by reducing cash and due from banks and
federal funds sold since the aggregate amounts of deposits and short-term and
long-term borrowings decreased by $7,525,000, or 1.5%, from the December 31,
2005 amounts. Also during the first six months of 2006, charge-offs of loans
totaled $3,847,000, including $2,649,000 in the second quarter. Those
charge-offs decreased both loans and the allowance for loan losses.
Management expects that the Company will solicit deposit accounts more
aggressively in order to fund anticipated growth. However, given the recent
increases in interest rates, such a strategy would significantly increase the
probability that the Company's net interest margin in future reporting periods
would be affected adversely.
10
RESULTS OF OPERATIONS
Earnings Performance
Three Months Ended June 30, 2006 and 2005
For the quarter ended June 30, 2006, CBI recorded consolidated net
income of $1,373,000, compared with $1,551,000 for the comparable period of
2005. This represents a decrease of $178,000 or 11.5%. Basic earnings per share
were $.31 in the 2006 period, compared with $.35 for the 2005 quarter. Diluted
earnings per share were $.30 for the 2006 period and $.35 for the 2005 period.
Compared with the second quarter of 2005, operating results for the
second quarter of 2006 were affected primarily by higher noninterest expenses
and provision for loan losses in the 2006 period, increased mortgage loan
brokerage income, and an increase in net interest income resulting primarily
from growth in loans. Generally, market interest rates, as well as the rates
associated with the Company's interest earning assets and its interest-bearing
liabilities were higher in the 2006 period as a result of continued Federal
Reserve efforts to slow the U. S. economy and control inflation.
Higher noninterest expenses and provision for loan losses more than
offset the gains made in net interest income and noninterest income. The
provision for loan losses continues to be affected by high levels of
non-performing and potential problem loans, and by growth in the Company's loan
portfolio. During the second quarter of 2006, net charge-offs were $1,898,000
compared with $495,000 during the same period of 2005.
Noninterest expenses increased in part because of changes in the
corporate management structure designed to enhance controls and risk management
activities, particularly in the lending function, and due to higher expenses
associated with the commission-based salary structure used in the
mortgage-brokerage subsidiary. Also, in 2006, the Company increased its formula
for matching employees' contributions to the 401(k) defined contribution
retirement plan. This resulted in higher levels of employee participation in the
plan. In addition, expenses of premises and equipment increased in the 2006
quarter due to the Company's moving into its newly constructed headquarters and
operations center in the first quarter of 2006 and the leasing of other office
space for certain management personnel who are located away from the corporate
headquarters.
Summary Income Statement
------------------------
(Dollars in thousands)
Dollar Percentage
For the Three Months Ended June 30, 2006 2005 Change Change
---- ---- ------ ------
Interest income ............................................. $ 9,103 $ 7,774 $ 1,329 17.1%
Interest expense ............................................ 3,736 2,503 1,233 49.3%
------- ------- -------
Net interest income ......................................... 5,367 5,271 96 1.8%
Provision for loan losses ................................... 675 585 90 15.4%
Noninterest income .......................................... 2,060 1,966 94 4.8%
Noninterest expenses ........................................ 4,632 4,225 407 9.6%
Income tax expense .......................................... 747 876 (129) -14.7%
------- ------- -------
Net income .................................................. $ 1,373 $ 1,551 $ (178) -11.5%
======= ======= =======
Six Months Ended June 30, 2006 and 2005
CBI's consolidated net income for the six months ended June 30, 2006
was positively affected by increased levels of net interest income, primarily
related to increased loan volumes and yields, and higher amounts of mortgage
11
loan brokerage income which reflect continued strength in the housing markets
within the Company's market areas. A significant proportion of the banking
subsidiaries' loan portfolios are made up of variable rate loans. Those loans
have been repriced favorably several times during 2006. The prime rate, which is
the index to which most of those variable rate loans are related, increased four
times totaling 100 basis points during 2006, and eight times totaling 200 basis
points since June 30, 2005.
Interest expense, noninterest expenses and the provision for loan
losses negatively affected results for the 2006 year-to-date period because of
the same factors discussed above for the second quarter.
Summary Income Statement
------------------------
(Dollars in thousands)
Dollar Percentage
For the Six Months Ended June 30, 2006 2005 Change Change
---- ---- ------ ------
Interest income ..................................... $17,716 $15,027 $ 2,689 17.9%
Interest expense .................................... 7,122 4,719 2,403 50.9%
------- ------- -------
Net interest income ................................. 10,594 10,308 286 2.8%
Provision for loan losses ........................... 1,290 1,035 255 24.6%
Noninterest income .................................. 3,994 3,631 363 10.0%
Noninterest expenses ................................ 9,259 8,344 915 11.0%
Income tax expense .................................. 1,465 1,649 (184) -11.2%
------- ------- -------
Net income .......................................... $ 2,574 $ 2,911 $ (337) -11.6%
======= ======= =======
Net Interest Income
Net interest income is the amount of interest income earned on interest
earning assets (primarily loans, securities, interest bearing deposits with
other banks, and federal funds sold), less the interest expense incurred on
interest bearing liabilities (interest bearing deposits and other borrowings),
and is the principal source of the Company's earnings. Net interest income is
affected by the level of interest rates, volume and mix of interest earning
assets and interest bearing liabilities and the relative funding of those
assets.
Three Months Ended June 30, 2006 and 2005
Net interest income for the three months ended June 30, 2006 was
$5,367,000, an increase of $96,000, or 1.8%, over the amount reported for the
second quarter of 2005. Interest income and interest expense for the 2006
quarter were both significantly higher than during the same period of 2005, due
to increases in the related balance sheet items and increases in interest rates
earned on, or paid for, those items.
The average rate earned on loans, including loans held for sale, was
7.54% and 6.80% for the second quarters of 2006 and 2005, respectively. The
average yield on earning assets was 6.99% for the second quarter of 2006,
compared with 6.30% for the second quarter of 2005. The average cost of time
deposits increased to 4.03% for the second quarter of 2006, compared with 2.91%
for the same period of 2005. The average cost of all interest-bearing
liabilities was 3.40% for the 2006 quarter and 2.47% for the same period of
2005. Accordingly, the interest rate spread (interest earning assets yield minus
the rate paid for interest-bearing liabilities) for the 2006 second quarter
narrowed to 3.59%, or 24 basis points lower than for the same period of 2005 and
12
net yield on earning assets (net interest income divided by average interest
earning assets) for the 2006 quarter was 4.12%, or 15 basis points lower than
for the same period of 2005.
Average amounts of interest earning assets were significantly higher in
the 2006 period than in the 2005 period. However, that growth was overshadowed
by growth in the average amounts of interest-bearing liabilities. During the
second quarter of 2006, the Company was significantly more reliant on
interest-bearing liabilities to fund earning assets than it was during the 2005
second quarter.
Average Balances, Yields and Rates
Quarter Ended June 30,
----------------------
2006 2005
---- ----
Interest Interest
Average Income / Yields / Average Income / Yields /
Balances Expense Rates (1) Balances Expense Rates (1)
-------- ------- --------- -------- ------- ---------
(Dollars in thousands)
Assets
Interest earning deposits ............................... $ 1,791 $ 35 7.84% $ 537 $ 11 8.22%
Investment securities - taxable ......................... 56,700 553 3.91% 50,462 412 3.27%
Investment securities - tax exempt (2) .................. 4,966 44 3.55% 6,248 54 3.47%
Federal funds sold ...................................... 25,220 315 5.01% 12,921 95 2.95%
Loans, including loans held for sale (2) (3) ............ 433,767 8,156 7.54% 424,925 7,202 6.80%
--------- ------- --------- -------
Total interest earning assets .................. 522,444 9,103 6.99% 495,093 7,774 6.30%
Cash and due from banks ................................. 14,438 15,967
Allowance for loan losses ............................... (10,665) (4,963)
Premises and equipment, net ............................. 9,827 7,753
Intangible assets ....................................... 7,670 7,310
Other assets ............................................ 8,724 4,206
--------- ---------
Total assets ................................... $ 552,438 $ 525,366
========= =========
Liabilities and shareholders' equity
Interest bearing deposits
Savings ............................................ $ 89,000 $ 576 2.60% $ 87,738 $ 320 1.46%
Interest bearing transaction accounts .............. 73,212 179 0.98% 59,058 97 0.66%
Time deposits ...................................... 240,609 2,417 4.03% 217,270 1,574 2.91%
--------- ------- --------- -------
Total interest bearing deposits ................ 402,821 3,172 3.16% 364,066 1,991 2.19%
Short-term borrowings ................................... 7,718 89 4.63% 8,335 44 2.12%
Long-term debt .......................................... 30,145 475 6.32% 33,556 468 5.59%
--------- ------- --------- -------
Total interest bearing liabilities ............. 440,684 3,736 3.40% 405,957 2,503 2.47%
Noninterest bearing demand deposits ..................... 57,052 65,701
Other liabilities ....................................... 2,493 2,448
Shareholders' equity .................................... 52,209 51,260
--------- ---------
Total liabilities and shareholders' equity ..... $ 552,438 $ 525,366
========= =========
Interest rate spread .................................... 3.59% 3.83%
Net interest income and net yield on earning assets ..... $ 5,367 4.12% $ 5,271 4.27%
(1) Yields and rates are annualized.
(2) Yields on tax-exempt securities and loans have not been stated on a
tax-equivalent basis.
(3) Nonaccruing loans are included in the average balances and income from such
loans is recognized on a cash basis.
13
Six Months Ended June 30, 2006 and 2005
Net interest income for the six months ended June 30, 2006 increased by
$286,000, or 2.8% over the amount for the same period of 2005. Both interest
income and interest expense increased significantly in the 2006 period due to
continued increases in market interest rates and higher levels of interest
earning assets and interest-bearing liabilities.
For the 2006 year-to-date period, the interest rate spread and net
yield on earning assets both decreased as compared with the same period of 2005.
Interest rate spread decreased by 27 basis points and net yield on earning
assets decreased by 15 basis points. These decreases resulted primarily from
higher rates paid on interest-bearing liabilities, which increased slightly more
than rates earned on earning assets. Net interest income increased despite this
narrowing of interest margins, however, because of higher amounts of interest
earning assets, especially loans and federal funds sold.
14
Average Balances, Yields and Rates
Six Months Ended June 30,
-------------------------
2006 2005
---- ----
Interest Interest
Average Income / Yields / Average Income / Yields /
Balances Expense Rates (1) Balances Expense Rates (1)
-------- ------- --------- -------- ------- ---------
(Dollars in thousands)
Assets
Interest earning deposits ............................... $ 1,665 $ 55 6.66% $ 665 $ 19 5.76%
Investment securities - taxable ......................... 57,281 1,093 3.85% 51,264 817 3.21%
Investment securities - tax exempt (2) .................. 5,193 91 3.53% 6,535 110 3.39%
Federal funds sold ...................................... 27,394 638 4.70% 12,336 163 2.66%
Loans, including loans held for sale (2) (3) ............ 431,948 15,839 7.39% 420,422 13,918 6.68%
--------- -------- --------- --------
Total interest earning assets .................. 523,481 17,716 6.82% 491,222 15,027 6.17%
Cash and due from banks ................................. 15,332 15,897
Allowance for loan losses ............................... (11,002) (4,890)
Premises and equipment, net ............................. 10,135 7,820
Intangible assets ....................................... 7,096 7,341
Other assets ............................................ 8,353 4,185
--------- ---------
Total assets ................................... $ 553,395 $ 521,575
========= =========
Liabilities and shareholders' equity
Interest bearing deposits
Savings ............................................ $ 87,270 $ 1,027 2.37% $ 88,899 $ 627 1.42%
Interest bearing transaction accounts .............. 73,557 398 1.09% 61,724 192 0.63%
Time deposits ...................................... 238,367 4,550 3.85% 213,048 2,907 2.75%
--------- -------- --------- --------
Total interest bearing deposits ................ 399,194 5,975 3.02% 363,671 3,726 2.07%
Short-term borrowings ................................... 8,990 190 4.26% 8,390 87 2.09%
Long-term debt .......................................... 31,421 957 6.14% 32,329 906 5.65%
--------- -------- --------- --------
Total interest bearing liabilities ............. 439,605 7,122 3.27% 404,390 4,719 2.35%
Noninterest bearing demand deposits ..................... 60,102 64,266
Other liabilities ....................................... 2,731 1,955
Shareholders' equity .................................... 50,957 50,964
--------- ---------
Total liabilities and shareholders' equity ..... $ 553,395 $ 521,575
========= =========
Interest rate spread .................................... 3.55% 3.82%
Net interest income and net yield
on earning assets .................................. $ 10,594 4.08% $ 10,308 4.23%
(1) Yields and rates are annualized.
(2) Yields on tax-exempt securities and loans have not been stated on a
tax-equivalent basis.
(3) Nonaccruing loans are included in the average balances and income from such
loans is recognized on a cash basis.
Provision and Allowance for Loan Losses
The provision for loan losses for the 2006 three month period was
$675,000, an increase of $90,000, or 15.4%, from $585,000 for the same period of
2005. The provision for loan losses increased to $1,290,000 for the 2006 six
month period from $1,035,000 for the 2005 six month period, an increase of
$255,000 or 24.6%. High levels of non-performing and potential problem loans
15
continue to affect the Company's allowance and provision for loan losses
negatively. Management continues to use new information about these loans to
refine its estimates of the loans' ultimate collectibility and the adequacy of
its loan loss allowance.
Net charge-offs during the six months ended June 30, 2006 were
$3,060,000, compared with $570,000 for the same period of 2005. The coverage
ratio (allowance for loan losses divided by non-performing loans) was .87x as of
June 30, 2006 and .94x as of December 31, 2005.
The activity in the allowance for loan losses is summarized in the
following table:
Six Months Year Ended Six Months
Ended December 31, Ended
June 30, 2006 2005 June 30, 2005
------------- ---- -------------
(Dollars in thousands)
Allowance at beginning of period ................................. $ 11,641 $ 4,347 $ 4,347
Transfer of allowance for off-balance-sheet
contingencies to other liabilities ............................. - (305) -
Provision for loan losses ........................................ 1,290 9,637 1,035
Net charge-offs .................................................. (3,060) (2,038) (570)
--------- --------- ---------
Allowance at end of period ....................................... $ 9,871 $ 11,641 $ 4,812
========= ========= =========
Allowance as a percentage of loans outstanding ................... 2.35% 2.81% 1.16%
Loans at end of period ........................................... $ 419,170 $ 413,984 $ 413,875
========= ========= =========
Following is a summary of non-performing loans as of June 30, 2006 and
December 31, 2005:
June 30, 2006 December 31, 2005
------------- -----------------
(Dollars in thousands)
Non-performing loans
Nonaccrual loans ............................................................... $11,151 $11,651
Past due 90 days or more and still accruing .................................... 202 729
------- -------
Total ............................................................ $11,353 $12,380
======= =======
Nonperforming loans as a percentage of:
Loans outstanding .............................................................. 2.71% 2.99%
Allowance for loan losses ...................................................... 115.01% 106.35%
16
The following table shows quarterly changes in nonperforming and
potential problem loans since December 31, 2004.
90 Days or
More Past Due Total Percentage Percentage
Nonaccrual and Still Nonperforming of Total Potential of Total
Loans Accruing Loans Loans Problem Loans Loans
----- -------- ----- ----- ------------- -----
(Dollars in thousands)
December 31, 2004 ................ $ 4,941 $ 137 $ 5,078 1.29% $ 4,628 1.18%
Net change ....................... 118 215 333 2,972
-------- -------- -------- --------
March 31, 2005 ................... 5,059 352 5,411 1.33% 7,600 1.87%
Net change ....................... 200 (9) 191 10,400
-------- -------- -------- --------
June 30, 2005 .................... 5,259 343 5,602 1.35% 18,000 4.35%
Net change ....................... 4,954 74 5,028 (4,107)
-------- -------- -------- --------
September 30, 2005 ............... 10,213 417 10,630 2.57% 13,893 3.35%
Net change ....................... 1,438 312 1,750 15,420
-------- -------- -------- --------
December 31, 2005 ................ 11,651 729 12,380 2.99% 29,313 7.08%
Net change ....................... 3,128 949 4,077 (2,767)
-------- -------- -------- --------
March 31, 2006 ................... 14,779 1,678 16,457 3.94% 26,546 6.36%
Net change ....................... (3,628) (1,476) (5,104) (3,461)
-------- -------- -------- --------
June 30, 2006 .................... $ 11,151 $ 202 $ 11,353 2.71% $ 23,085 5.51%
======== ======== ======== ========
During the second quarter of 2006, nonperforming loans decreased by
$5,104,000 and potential problem loans decreased by $3,461,000. These
improvements were the results of net charge-offs of $3,060,000 coupled with
collections and improvements in the remaining loans. For example, management
settled a loan relationship of $1,450,000 that was included in nonaccrual loans
as of March 31, 2006, realizing a recovery of approximately $350,000 and a
charge-off of $1,100,000. Management also completed a project in the 2006 second
quarter that involved reviewing, and establishing workout or collection plans or
providing other credit enhancements for, all significant nonperforming and
potential problem loans.
Management will continue to monitor the levels of non-performing loans
and address the weaknesses in these credits to enhance the ultimate collection
or recovery of these assets. Management considers the levels and trends in
non-performing assets and potential problem loans in determining how the
provision and allowance for loan losses is estimated and adjusted. In the
opinion of management, the Corporation's allowance for loan losses at June 30,
2006 is adequate to provide for losses that may be inherent in the loan
portfolio.
Noninterest Income
Noninterest income for the 2006 second quarter increased $94,000, or
4.8%, over the $1,966,000 reported for the same 2005 period. Mortgage loan
brokerage income for the 2006 quarter increased by $128,000, or 14.9%, over the
$859,000 in the 2005 period.
For the six months ended June 30, 2006, noninterest income increased
$363,000, or 10.0%, over noninterest income for the first six months of 2005.
Mortgage loan brokerage income for the first six months of 2006 increased
$273,000, and service charge income increased by $79,000, as compared to the
same period of 2005.
17
Noninterest Expenses
Noninterest expenses for the second quarter of 2006 were $407,000, or
9.6%, higher than the amounts reported for the same period of 2005. Salaries and
employee benefits expenses were $419,000, or 18.0%, higher in the 2006 period,
due to higher commission-based compensation expenses resulting from increased
activity in mortgage lending as well as additions made to the Company's
executive managment. Expenses related to premises and equipment increased by
$63,000 in the 2006 period, primarily due to the Company's occupancy of its new
headquarters and operations center building during the first quarter of 2006.
Noninterest expense for the first six months of 2006 was $915,000, or
11.0%, more than for the same period of 2005. Salaries and employee benefits for
the 2006 six month period were $720,000, or 15.6%, more than for the same period
of 2005. This expense increased due to higher levels of mortgage loan brokerage
commission-based compensation incurred in the 2006 period, additions made to the
Company's executive management, increased employee participation in the
Company's 401(k) plan, and normal periodic wage and salary adjustments. Expenses
associated with premises and equipment were $152,000, or 14.0%, higher in the
2006 period, primarily due to the Company's occupancy of its new headquarters
and operations center building during the first quarter of 2006.
Income Taxes
Income tax expense was $129,000 less in the 2006 second quarter than
for the 2005 period, as a result of lower net income before taxes. Income tax
expense for the 2006 six month period was $184,000 less than for the same period
of 2005.
LIQUIDITY
Liquidity is the ability to meet current and future obligations through
liquidation or maturity of existing assets or the acquisition of additional
liabilities. Adequate liquidity is necessary to meet the requirements of
customers for loans and deposit withdrawals in a timely and economical manner.
The most manageable sources of liquidity are composed of liabilities, with the
primary focus of liquidity management being the ability to attract deposits
within CBI's service areas. Individual and commercial deposits are the primary
source of funds for credit activities, along with long-term borrowings from the
Federal Home Loan Bank of Atlanta and the proceeds of issuing $10,000,000 of
subordinated debentures. Cash and amounts due from banks and federal funds sold
18
are CBI's primary sources of asset liquidity. These funds provide a cushion
against short-term fluctuation in cash flow from both loans and deposits.
Securities available-for-sale are CBI's principal source of secondary asset
liquidity. However, the availability of this source is limited by pledging
commitments for public deposits and securities sold under agreements to
repurchase, and is influenced by market conditions.
CBI's banking subsidiaries maintain various federal funds lines of
credit with correspondent banks. The banks are also able to borrow from the
Federal Home Loan Bank of Atlanta ("FHLB") and the Federal Reserve Bank's
discount window using their loan portfolios as security. During the second
quarter of 2006, the FHLB suspended the ability of one of the Company's
subsidiary banks to obtain additional financing from the FHLB because of the
increase in nonperforming and potential problem loans at that bank. This action
reduced by approximately $10,078,000 the amount previously reported as of
December 31, 2005 as available to the Company from the FHLB. The suspension does
not, however, accelerate repayment of any of that subsidiary bank's outstanding
obligations. The bank has not obtained any advances under that line for several
years, had no immediate or short-term plans to do so and, accordingly, does not
anticipate that this will materially impair the bank's liquidity planning.
Total deposits as of June 30, 2006 were $459,243,000, a decrease of
$4,966,000, or 1.1%, from the amount as of December 31, 2005. During the first
six months of 2006, there was a notable movement of funds from noninterest
bearing demand deposit accounts and interest-bearing transaction accounts into
savings and certificate of deposit accounts. Such transfers of funds are the
expected result of higher rates of interest, and larger differentials from rates
paid for highly liquid interest-bearing deposit accounts, that are currently
paid for longer-term, fixed rate deposits. As of June 30, 2006 the loan to
deposit ratio, excluding loans held for sale, was 91.3%, compared with 89.2% at
December 31, 2005 and 95.5% at June 30, 2005.
Management believes CBI's and its subsidiaries' liquidity sources are
adequate to meet their current and projected operating needs.
CAPITAL RESOURCES
CBI and its banking subsidiaries are subject to regulatory risk-based
capital adequacy standards. Under these standards, bank holding companies and
banks are required to maintain certain minimum ratios of capital to
risk-weighted assets and average total assets. Under the provisions of the
Federal Deposit Insurance Corporation Improvement Act of 1991, federal bank
regulatory authorities are required to implement prescribed "prompt corrective
actions" upon the deterioration of the capital position of a bank. If the
capital position of an affected institution were to fall below a certain level,
increasingly stringent regulatory corrective actions would be mandated.
During the first quarter of 2004, CBI sponsored the creation of a Trust
that issued $10,000,000 in trust preferred securities. The Trust invested the
proceeds of this issuance and $310,000 of capital provided by CBI into
$10,310,000 of junior subordinated debentures due in 2034 ("Debentures") issued
by CBI. Interest payments on the Debentures are due quarterly at a variable
interest rate. CBI used the proceeds of the Debentures to repay certain
pre-existing debt obligations, to enhance the capital position of two of the
subsidiary banks, to provide an additional funding mechanism for its mortgage
loan brokerage activities, and for other general corporate purposes. Under
current regulatory guidelines, the trust preferred securities issued by the
Trust are includible in CBI's Tier 1 capital for risk-based capital purposes.
The June 30, 2006 risk-based capital ratios for CBI and its banking
subsidiaries are presented in the following table, compared with the "well
capitalized" and minimum ratios under the regulatory definitions and guidelines:
19
June 30, 2006
-------------
Tier 1 Total Capital Leverage
------ ------------- --------
Community Bankshares, Inc. .......................................... 13.28% 14.46% 10.13%
Orangeburg National Bank ............................................ 11.35% 12.40% 8.71%
Sumter National Bank ................................................ 10.69% 12.00% 7.60%
Florence National Bank .............................................. 10.11% 11.36% 8.62%
Bank of Ridgeway .................................................... 11.13% 12.33% 8.11%
Minimum "well capitalized" requirement .............................. 6.00% 10.00% 6.00%
Minimum requirement ................................................. 4.00% 8.00% 5.00%
As shown in the table above, each of the capital ratios exceeds the
regulatory requirement to be considered "well capitalized." In the opinion of
management, the current and projected capital positions of CBI and its banking
subsidiaries are adequate.
OFF-BALANCE-SHEET ARRANGEMENTS
In the normal course of business, CBI engages in transactions that, in
accordance with generally accepted accounting principles, are not recorded in
the financial statements (generally commitments to extend credit) or are
recorded in amounts that differ from their notional amounts (generally
derivatives). These transactions involve elements of credit, interest rate and
liquidity risk of varying degrees.
Variable Interest Entity
As discussed under "Capital Resources" and in the notes to unaudited
consolidated financial statements under "Variable Interest Entity," as of June
30, 2006, CBI held an equity interest in, and guarantees the liabilities of, a
non-consolidated variable interest entity, SCB Capital Trust I.
Commitments
CBI's banking and mortgage brokerage subsidiaries are parties to credit
related financial instruments with off-balance-sheet risk in the normal course
of business to meet the financing needs of their customers. These financial
instruments include commitments to extend credit and standby letters of credit.
Such commitments involve varying degrees of credit and interest rate risk in
excess of the amount recognized in the consolidated balance sheets. Exposure to
credit loss is represented by the contractual, or notional, amounts of these
commitments. The same credit policies are used in making commitments as for
on-balance-sheet instruments.
The following table sets forth the contractual amounts of commitments
which represent credit risk:
June 30, 2006
-------------
(Dollars in
thousands)
Loan commitments ................................... $ 54,598
Standby letters of credit .......................... 2,533
20
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being fully drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The amount of collateral
obtained, if deemed necessary by management upon extension of credit, is based
on management's credit evaluation of the counter-party. Collateral held varies
but may include personal residences, accounts receivable, inventory, property,
plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued to
guarantee the performance of a customer to a third party. Those letters of
credit are primarily issued to support private borrowing arrangements. All
letters of credit are short-term guarantees. The credit risk involved in issuing
letters of credit is essentially the same as that involved in extending loan
facilities to customers. Generally, collateral supporting those commitments is
held if deemed necessary. Since many of the standby letters of credit are
expected to expire without being drawn upon, the total letter of credit amounts
do not necessarily represent future cash requirements.
In mid-2005, CBI reached an agreement with Jack Henry & Associates,
Inc. to obtain licensing rights for a new core management information software
system, known as Silverlake, which will be used by each of its subsidiaries. The
cost of this core system conversion will be approximately $1,000,000. The
agreement also requires CBI to pay various support and maintenance costs
throughout the licensing period. CBI estimates that during the next five years
these costs will range from approximately $200,000 to $300,000 per year.
However, the exact amounts will be determined by future events, such as asset
growth, and cannot be exactly determined at this time. The Orangeburg National
Bank subsidiary was converted to the new system in June 2006 and the three
remaining banks are expected to be converted early in the fourth quarter of
2006.
Derivative Financial Instruments
In April, 2003, the Financial Accounting Standards Board issued
Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities." Among other requirements, this Statement provides that loan
commitment contracts entered into or modified after June 30, 2003 that relate to
the origination of mortgage loans that will be held for sale shall be accounted
for as derivative instruments by the issuer of the loan commitment. In March,
2004, the SEC issued its Staff Accounting Bulletin No 105 "Application of
Accounting Principles to Loan Commitments," which resulted in no changes in
CBI's accounting for such commitments. CBI issues mortgage loan rate lock
commitments to potential borrowers to facilitate its origination of home
mortgage loans that are intended to be sold. Between the time that CBI issues
its commitments and the time that the loans close and are sold, CBI is subject
to variability in the selling prices related to those commitments due to changes
in market rates of interest. However, CBI offsets this variability through the
use of so-called "forward sales contracts" to investors in the secondary market.
Under these arrangements, an investor agrees to purchase the closed loans at a
predetermined price. CBI generally enters into such forward sales contracts at
the same time that rate lock commitments are issued. These arrangements
effectively insulate CBI from the effects of changes in interest rates during
the time the commitments are outstanding, but the arrangements do not qualify as
fair value hedges. These derivative financial instruments are carried in the
balance sheet at estimated fair value and changes in the estimated fair values
of these derivatives are recorded in the statement of income in net gains or
losses on loans held for sale.
21
Derivative financial instruments are written in amounts referred to as
notional amounts. Notional amounts only provide the basis for calculating
payments between counterparties and do not represent amounts to be exchanged
between parties or a measure of financial risk. The following table includes the
notional principal amounts of rate lock commitments and forward sales contracts
as of June 30, 2006, and the estimated fair values of those financial
instruments included in other assets and liabilities in the balance sheet as of
that date.
June 30, 2006
-------------
Estimated
Fair Value
Notional Asset
Amount (Liability)
------ -----------
(Dollars in thousands)
Rate lock commitments to potential borrowers
to originate mortgage loans to be
held for sale ................................ $ 33,426 $ (359)
Forward sales contracts with investors
of mortgage loans to be held for sale ........ 33,426 359
22
Status of Plans for Transition to a Single Bank Charter
During the first and second quarters of 2006, CBI's Board of Directors
and the boards of the subsidiary banks approved a plan for a transition to a
single bank charter under the name of Community Resource Bank, NA. Contingent
upon receiving required legal and regulatory approvals, implementation of this
change is expected early in the fourth quarter of 2006. CBI expects that this
change ultimately will result in significant financial savings, improved
operational efficiency and effectiveness, improved customer service through
unified banking products and services, accelerated approval of loan requests,
and better availability of ATM and in-bank services for all customers.
Significant planning activities are ongoing for the transition phase of the
project.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. CBI's market risk arises principally from interest rate risk inherent
in its lending, deposit and borrowing activities. Management actively monitors
and manages its interest rate risk exposure. Although CBI manages other risks,
such as credit quality and liquidity risk in the normal course of business,
management considers interest rate risk to be its most significant market risk
and this risk could potentially have the largest material effect on CBI's
financial condition and results of operations. Other types of market risks such
as foreign currency exchange risk and commodity price risk do not arise in the
normal course of community banking activities.
CBI's Asset/Liability Committee uses a simulation model to assist in
achieving consistent growth in net interest income while managing interest rate
risk. According to the model, as of June 30, 2006, CBI is positioned so that net
interest income would increase $120,000 and net income would increase $72,000 in
the next twelve months if interest rates rose 100 basis points. Conversely, net
interest income would decline $120,000 and net income would decline $72,000 in
23
the next twelve months if interest rates declined 100 basis points. Computation
of prospective effects of hypothetical interest rate changes are based on
numerous assumptions, including relative levels of market interest rates and
loan prepayment, and should not be relied upon as indicative of actual results.
Further, the computations do not contemplate any actions CBI and its customers
could undertake in response to changes in interest rates.
As of June 30, 2006 there was no significant change from the interest
rate sensitivity analysis for the various changes in interest rates calculated
as of December 31, 2005. The foregoing disclosures related to the market risk of
CBI should be read in connection with Management's Discussion and Analysis of
Financial Position and Results of Operations included in the 2005 Annual Report
on Form 10-K.
Item 4. Controls and Procedures
Based on the evaluation required by 17 C.F.R. Section 240.13a-15(b) or
240.15d-15(b) of the Company's disclosure controls and procedures (as defined in
17 C.F.R. Sections 240.13a-15(e) or 240.15d-15(e)), the Company's chief
executive officer and chief financial officer concluded that such controls and
procedures, as of the end of the period covered by this quarterly report, were
effective.
There has been no change in the Company's internal control over
financial reporting during the most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
24
PART II--OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On Monday, May 16, 2006, the shareholders of Community Bankshares, Inc.
held their regular annual meeting. At the meeting, one matter was submitted to a
vote with results as follows:
1. Election of four directors to hold office for three-year terms:
SHARES VOTED
------------------------------------------
AGAINST OR BROKER
DIRECTORS FOR AUTHORITY WITHHELD NON-VOTES
--- ------------------ ---------
Three-Year Terms
E. J. Ayers, Jr. 3,124,186 18,717 0
Alvis J. Bynum 3,137,169 5,734 0
J. V. Nicholson, Jr. 3,080,013 62,890 0
J. Otto Warren, Jr. 3,137,169 5,734 0
The following directors continue to serve until the expiration of their
terms at the annual meetings to be held in the years indicated and were not
voted on at the 2006 annual meeting: Samuel L. Erwin - 2007; Anna O. Dantzler -
2007; Richard L Havekost - 2007 and Samuel F. Reid, Jr. - 2007; Thomas B.
Edmunds - 2008; Martha Rose C. Carson - 2008; J. M. Guthrie - 2008; Wm. Reynolds
Williams - 2008; and Charles E. Fienning - 2008.
Item 6. Exhibits
Exhibits 31-1 Rule 13a-14(a)/15d-14(a) Certification of principal
executive officer
31-2 Rule 13a-14(a)/15d-14(a) Certification of principal
financial officer
32 Certifications Pursuant to 18 U.S.C. Section 1350
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DATED: August 10, 2006
COMMUNITY BANKSHARES, INC.
By: s/ Samuel L. Erwin
-------------------------------------------
Samuel L. Erwin
Chief Executive Officer
By: s/ William W. Traynham
-------------------------------------------
William W. Traynham
President and Chief Financial Officer
(Principal Accounting Officer)
26
EXHIBIT INDEX
31-1 Rule 13a-14(a)/15d-14(a) Certification of principal executive officer
31-2 Rule 13a-14(a)/15d-14(a) Certification of principal financial officer
32 Certifications Pursuant to 18 U.S.C. Section 1350
27