UNITED STATES 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, 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 (I.R.S. Employer
incorporation or organization) Identification No.)
102 Founders Court, Orangeburg, SC 29118
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code (803) 535-1060
Securities registered pursuant to Section 12(b) of
the Act:
Title of each class Name of each exchange on which registered
Common Stock, No Par Value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
[ ] Yes [X] No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d)
of the Act.
[ ] Yes [X] No
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past
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 [ ] 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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated file. 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 a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of the last business day of the registrant's most recently
completed second fiscal quarter, June 30, 2006, was approximately $53,738,000.
As of March 14, 2007, there were 4,466,772 shares of the registrant's common
stock, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 2007 Annual Meeting of
Shareholders - Part III
10-K TABLE OF CONTENTS
Part I Page
Item 1 Business ............................................................................. 4
Item 1A Risk Factors ......................................................................... 13
Item 1B Unresolved Staff Comments ............................................................ 16
Item 2 Properties ........................................................................... 16
Item 3 Legal Proceedings .................................................................... 17
Item 4 Submission of Matters to a Vote of Security Holders .................................. 17
Part II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities ............................................. 18
Item 6 Selected Financial Data .............................................................. 21
Item 7 Management's Discussion and Analysis of Financial Condition and Results of
Operations ........................................................................ 22
Item 7A Quantitative and Qualitative Disclosures about Market Risk ........................... 49
Item 8 Financial Statements and Supplementary Data .......................................... 53
Report of Independent Registered Public Accounting Firm .............................. 54
Consolidated Balance Sheets, December 31, 2006 and 2005 .............................. 55
Consolidated Statements of Income,
Years Ended December 31, 2006, 2005 and 2004 ...................................... 56
Consolidated Statements of Changes in Shareholders' Equity,
Years Ended December 31, 2006, 2005 and 2004 ...................................... 57
Consolidated Statements of Cash Flows,
Years Ended December 31, 2006, 2005 and 2004 ...................................... 58
Notes to Consolidated Financial Statements ........................................... 59
Quarterly Data for 2006 and 2005 ..................................................... 93
Item 9 Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure ............................................ 94
Item 9A Controls and Procedures .............................................................. 94
Item 9A(T). Controls and Procedures .............................................................. 94
Item 9B Other Information .................................................................... 94
Part III
Item 10 Directors, Executive Officers and Corporate Governance ............................... 94
Item 11 Executive Compensation ............................................................... 95
Item 12 Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters ....................................................... 95
Item 13 Certain Relationships and Related Transactions
and Director Independence ......................................................... 96
Item 14 Principal Accountant Fees and Services ............................................... 96
Part IV
Item 15 Exhibits and Financial Statement Schedules ........................................... 97
2
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 Corporation's expectations, beliefs, estimates and projections are expressed
in good faith and are believed by the Corporation to have a reasonable basis,
including without limitation, management's examination of historical operating
trends, data contained in the Corporation'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 Corporation cautions readers that forward-looking statements,
including without limitation, those relating to the Corporation'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 not guarantees of future performance, and 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 Corporation's reports filed with the Securities and
Exchange Commission. The risks and uncertainties include, but are not limited
to:
o the Corporation's growth and ability to maintain growth;
o governmental monetary and fiscal policies, as well as legislative and
regulatory changes;
o the effect of interest rate changes on our level and composition of
deposits, loan demand and the value of our loan collateral and
securities;
o the effects of competition from other financial institutions operating
in the Corporation's market areas and elsewhere, including
institutions operating locally, regionally, nationally and
internationally;
o failure of assumptions underlying the establishment of the allowance
for loan losses, including the value of collateral securing loans; and
o loss of consumer confidence and economic disruptions resulting from
terrorist activities.
The Corporation undertakes no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.
References to our Website Address
References to our website address throughout this Annual Report on Form
10-K and in any documents incorporated into this Form 10-K 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-K or the accompanying
materials.
3
PART I
Item 1. Business
Form of organization
Community Bankshares, Inc. (CBI or the Corporation) is a South Carolina
corporation and a bank holding company. CBI commenced operations on July 1,
1993, upon effectiveness of the acquisition of the Orangeburg National Bank as a
wholly-owned subsidiary. In June 1996 CBI acquired all the stock of Sumter
National Bank. In July 1998 CBI acquired all the stock of Florence National
Bank. In July 2002 CBI acquired by merger Ridgeway Bancshares, Inc., the parent
company of the former Bank of Ridgeway.
Orangeburg National Bank was chartered in 1987 as a national bank, and
operated from two offices located in Orangeburg, South Carolina. Sumter National
Bank (the Sumter bank), a national bank, was chartered in 1996 and operated from
two offices located in Sumter, South Carolina. Florence National Bank (the
Florence bank), a national bank, was chartered in 1998 and operated from two
offices located in Florence, South Carolina. Bank of Ridgeway (the Ridgeway
bank), a South Carolina state-chartered bank organized in 1898, operated from
one office in Ridgeway, one office in Winnsboro, and one office in Blythewood,
South Carolina. In November 2001, CBI acquired all the common stock of Resource
Mortgage Inc., a Columbia, South Carolina based mortgage company, and
subsequently renamed it Community Resource Mortgage, Inc. (CRM).
In August 2006, Orangeburg National Bank's name was changed to
Community Resource Bank, N.A. ("CRB" or the "Bank"), and in October 2006, the
Sumter bank, the Florence bank and the Ridgeway bank were merged into CRB. As a
result, the Corporation now consists of the holding Company (CBI), the bank
subsidiary (CRB) and the mortgage company (CRM). Effective in January 2007 the
operations of the mortgage company became a division of the Bank. The Bank plans
to continue to conduct mortgage loan origination operations under the name
"Community Resource Mortgage, a division of Community Resource Bank" (the
"Mortgage Division"). CRM remains a separate corporate entity and wholly-owned
subsidiary of the Corporation, but with only limited assets and activities. The
Bank now operates in four geographical regions: Orangeburg, Sumter, Florence and
the Midlands (Fairfield and Richland counties). The Mortgage Division operates
in the Richland, Sumter and Charleston County areas of South Carolina, and in
the Mecklenburg County area of North Carolina. Customers now have access to
services and information through nine branches, and management expects to have a
tenth office open by the fourth quarter 2007.
Business of banking
Community Resource Bank, N.A. offers a full array of commercial bank
services. Deposit services include business and personal checking accounts, NOW
accounts, savings accounts, money market accounts, various term certificates of
deposit, IRA accounts, and other deposit services. The Federal Deposit Insurance
Corporation insures deposits up to applicable limits. Most of the Bank's
deposits are attracted from individuals and small to medium sized businesses.
The Bank offers secured and unsecured, short-to-intermediate term
loans, with floating and fixed interest rates for commercial and consumer
purposes. Consumer loans include car loans, home equity improvement loans
secured by first and second mortgages, personal expenditure loans, education
loans, and the like. Commercial loans include short-term unsecured loans, short
and intermediate term real estate mortgage loans, loans secured by listed
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stocks, loans secured by equipment, inventory, accounts receivable, and the
like. The Bank does not and will not discriminate against any applicant for
credit on the basis of race, color, creed, sex, age, marital status, familial
status, handicap, or derivation of income from public assistance programs.
Other services offered by the Bank include safe deposit boxes, night
depository service, VISA and Master Card brand credit cards (through a
correspondent), tax deposits, sale of U.S. Treasury bonds, notes and bills and
other U. S. government securities (through a correspondent), twenty-four hour
automated teller service, and consumer and commercial Internet banking services.
The Bank has ATMs that are part of the Star and Cirrus networks.
The Mortgage Division provides a wide variety of one to four family
residential mortgage products in the Columbia, Sumter, and Charleston, South
Carolina markets. During the first quarter of 2007, the Mortgage Division
announced its intention to enter the Charlotte, North Carolina market.
Competition
The market for financial institutions in our various markets is highly
competitive. Banks generally compete with other financial institutions through
the banking services and products offered, the pricing of services, the level of
service provided, the convenience and availability of services, and the degree
of expertise and personal concern with which services are offered. The Bank
encounters strong competition from most of the financial institutions in its
market areas.
The primary market area for the Bank comprises generally the middle of
the state and Pee Dee section of South Carolina and, with loan and mortgage
production offices, also includes Charleston and York Counties in South
Carolina, and Mecklenburg County in North Carolina. In the conduct of certain
banking business, the Bank also competes with credit unions, consumer finance
companies, insurance companies, money market mutual funds, and other financial
institutions, many of which are not subject to the same degree of regulation and
restrictions imposed upon the Bank. Many of these competitors have substantially
greater resources and lending limits than the Bank and offer certain services,
such as international banking and trust services, which the Bank does not
provide. The Bank believes, however, that its relatively small size and
community banking orientation permits it to offer more personalized services
than many of its competitors.
At June 30, 2006, the Bank was the 14th largest (of 101) FDIC insured
financial institutions in the state of South Carolina. At that date the Bank had
$464 million in deposits, which represented .79% of the state's total FDIC
insured deposits of $59 billion. In Orangeburg County the Bank competed with
eight other FDIC insured institutions, in Sumter County seven, in Florence
County 18, in Richland County 16, and in Fairfield County three. At June 30,
2006, the Bank's Orangeburg offices had the second largest deposit share in
Orangeburg; the Bank's Sumter offices had the third largest deposit base in
Sumter; the Bank's Florence offices had the ninth largest deposit share in
Florence; and the Bank's Midlands offices had the largest deposit share in
Fairfield County.
The Mortgage Division provides services from offices in Richland,
Sumter and Charleston Counties of South Carolina, and Mecklenburg County of
North Carolina, where it competes with hundreds of financial institutions and
mortgage originators.
5
Dependence on Major Customers
The Bank does not consider itself dependent on any single customer or
small group of customers, either in the deposit or lending areas.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under
federal and state law. To the extent that the following information describes
statutory and regulatory provisions, it is qualified in its entirety by
reference to such statutes and regulations. Any change in applicable law or
regulation may have a material effect on the business of CBI and the Bank.
As discussed below under the caption "Gramm-Leach-Bliley Act", Congress
has adopted extensive changes in the laws governing the financial services
industry. Among the changes adopted are creation of the financial holding
company, a new type of bank holding company with powers that greatly exceed
those of standard holding companies, and creation of the financial subsidiary, a
subsidiary that can be used by national banks to engage in many, though not all,
of the same activities in which a financial holding company may engage. The
legislation also establishes the concept of functional regulation whereby the
various financial activities in which financial institutions engage are overseen
by the regulator with the relevant regulatory experience. Accordingly, the
following discussion relates to the supervisory and regulatory provisions that
apply to CBI and the Bank as they currently operate.
Regulation of Bank Holding Companies
General
As a bank holding company registered under the Bank Holding Company Act
("BHCA"), CBI is subject to the regulations of the Board of Governors of the
Federal Reserve System (the "Federal Reserve"). Under the BHCA, CBI's activities
and those of its subsidiaries are limited to banking, managing or controlling
banks, furnishing services to or performing services for its subsidiaries or
engaging in any other activity which the Federal Reserve determines to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. The BHCA prohibits CBI from acquiring direct or indirect
control of more than 5% of the outstanding voting stock or substantially all of
the assets of any bank or from merging or consolidating with another bank
holding company without prior approval of the Federal Reserve. The BHCA also
prohibits CBI from acquiring control of any bank operating outside the State of
South Carolina unless such action is specifically authorized by the statutes of
the state where the bank to be acquired is located.
Additionally, the BHCA prohibits CBI from engaging in or from acquiring
ownership or control of more than 5% of the outstanding voting stock of any
company engaged in a non-banking business unless such business is determined by
the Federal Reserve to be so closely related to banking as to be properly
incident thereto. The BHCA generally does not place territorial restrictions on
the activities of such non-banking-related activities.
As discussed below under "Gramm-Leach-Bliley Act", a bank holding
company that meets certain requirements may now qualify as a financial holding
company and thereby significantly increase the variety of services it may
provide and the investments it may make.
CBI is also subject to limited regulation and supervision by the South
Carolina State Board of Financial Institutions (the "State Board"). A South
Carolina bank holding company may be required to provide the State Board with
6
information with respect to the financial condition, operations, management and
inter-company relationships of the holding company and its subsidiaries. The
State Board also may require such other information as is necessary to keep
itself informed about whether the provisions of South Carolina law and the
regulations and orders issued thereunder by the State Board have been complied
with, and the State Board may examine any bank holding company and its
subsidiaries. Furthermore, pursuant to applicable law and regulations, the
Company must receive approval of, or give notice to (as applicable) the State
Board prior to engaging in the acquisition of banking or non-banking
institutions or assets.
Obligations of Holding Company to its Subsidiary Banks
A number of obligations and restrictions are imposed on bank holding
companies and their depository institution subsidiaries by Federal law and
regulatory policies that are designed to reduce potential loss exposure to the
depositors of such depository institutions and to the FDIC insurance funds in
the event the depository institution is in danger of becoming insolvent or is
insolvent. For example, under the policy of the Federal Reserve, a bank holding
company is required to serve as a source of financial strength to its subsidiary
depository institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. In addition, the
"cross-guarantee" provisions of the Federal Deposit Insurance Act, as amended
("FDIA"), require insured depository institutions under common control to
reimburse the FDIC for any loss suffered or reasonably anticipated by the
Deposit Insurance Fund of the FDIC as a result of the default of a commonly
controlled insured depository institution or for any assistance provided by the
FDIC to a commonly controlled insured depository institution in danger of
default. The FDIC may decline to enforce the cross-guarantee provisions if it
determines that a waiver is in the best interest of the Deposit Insurance Fund.
The FDIC's claim for damages is superior to claims of stockholders of the
insured depository institution or its holding company but is subordinate to
claims of depositors, secured creditors and holders of subordinated debt (other
than affiliates) of the commonly controlled insured depository institutions.
The FDIA also provides that amounts received from the liquidation or
other resolution of any insured depository institution by any receiver must be
distributed (after payment of secured claims) to pay the deposit liabilities of
the institution prior to payment of any other general or unsecured senior
liability, subordinated liability, general creditor or stockholder. This
provision gives depositors a preference over general and subordinated creditors
and stockholders in the event a receiver is appointed to distribute the assets
of the bank.
Any capital loans by a bank holding company to any of its subsidiary
banks are subordinate in right of payment to deposits and to certain other
indebtedness of such subsidiary bank. In the event of a bank holding company's
bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of a subsidiary bank will be assumed
by the bankruptcy trustee and entitled to a priority of payment.
Under the National Bank Act, if the capital stock of a national bank is
impaired by losses or otherwise, the Office of the Comptroller of the Currency
("OCC") is authorized to require payment of the deficiency by assessment upon
the bank's shareholders', pro rata, and to the extent necessary, if any such
assessment is not paid by any shareholder after three months notice, to sell the
stock of such shareholder to make good the deficiency.
7
Capital Adequacy Guidelines for Bank Holding Companies and Banks
The various federal bank regulators, including the Federal Reserve and
the FDIC, have adopted risk-based and leverage capital adequacy guidelines
assessing bank holding company and bank capital adequacy. These standards define
what qualifies as capital and establish minimum capital standards in relation to
assets and off-balance-sheet exposures, as adjusted for credit risks. The
capital guidelines and CBI's capital position are summarized in Note 19 to the
Financial Statements, contained elsewhere in this report. The Bank is considered
well capitalized.
Failure to meet capital guidelines could subject the Bank to a variety
of enforcement remedies, including the termination of deposit insurance by the
FDIC and a prohibition on the taking of brokered deposits.
The risk-based capital standards of both the Federal Reserve Board and
the FDIC explicitly identify concentrations of credit risk and the risk arising
from non-traditional activities, as well as an institution's ability to manage
these risks, as important factors to be taken into account by the agencies in
assessing an institution's overall capital adequacy. The capital guidelines also
provide that an institution's exposure to a decline in the economic value of its
capital due to changes in interest rates be considered by the agencies as a
factor in evaluating a bank's capital adequacy. The Federal Reserve Board also
has recently issued additional capital guidelines for bank holding companies
that engage in certain trading activities.
Payment of Dividends
CBI is a legal entity separate and distinct from the Bank. Most of the
revenues of CBI result from dividends paid to CBI by the Bank. There are
statutory and regulatory requirements applicable to the payment of dividends by
subsidiary bank as well as by CBI to its shareholders.
Each national banking association is required by federal law to obtain
the prior approval of the OCC for the payment of dividends if the total of all
dividends declared by the board of directors of such bank in any year will
exceed the total of (i) such bank's net profits (as defined and interpreted by
regulation) for that year plus (ii) the retained net profits (as defined and
interpreted by regulation) for the preceding two years, less any required
transfers to surplus. In addition, national banks can pay dividends only to the
extent that retained net profits (including the portion transferred to surplus)
exceed bad debts (as defined by regulation).
The payment of dividends by CBI and the Bank may also be affected or
limited by other factors, such as the requirements to maintain adequate capital
above regulatory guidelines. In addition, if, in the opinion of the applicable
regulatory authority, a bank under its jurisdiction is engaged in or is about to
engage in an unsafe or unsound practice (which, depending on the financial
condition of the Banks, could include the payment of dividends), such authority
may require, after notice and hearing, that such bank cease and desist from such
practice. The OCC has indicated that paying dividends that deplete a national
bank's capital base to an inadequate level would be an unsafe and unsound
banking practice. The Federal Reserve, the OCC and the FDIC have issued policy
statements, which provide that bank holding companies and insured banks should
generally only pay dividends out of current operating earnings.
8
Certain Transactions by CBI with its Affiliates
Federal law regulates transactions among CBI and its affiliates,
including the amount of the Banks' loans to or investments in nonbank affiliates
and the amount of advances to third parties collateralized by securities of an
affiliate. Further, a bank holding company and its affiliates are prohibited
from engaging in certain tie-in arrangements in connection with any extension of
credit, lease or sale of property or furnishing of services.
FDIC Insurance Assessments
The FDIC merged the Bank Insurance Fund and the Savings Association
Insurance Fund to form the Deposit Insurance Fund ("DIF") on March 31, 2006 in
accordance with the Federal Deposit Insurance Reform Act of 2005. The FDIC
maintains the DIF by assessing depository institutions an insurance premium. The
amount each institution is assessed is based upon statutory factors that include
the balance of insured deposits as well as the degree of risk the institution
poses to the insurance fund. The FDIC uses a risk-based premium system that
assesses higher rates on those institutions that pose greater risks to the DIF.
Under the rule adopted by the FDIC in November 2006, beginning January 1, 2007,
the FDIC will place each institution in one of four risk categories using a
two-step process based first on capital ratios (the capital group assignment)
and then on other relevant information (the supervisory group assignment).
Beginning January 1, 2007, rates will range between 5 and 43 cents per $100 in
assessable deposits.
Regulation of the Bank
Community Resource Bank, N.A. is subject to regulation and examination
by OCC bank examiners. In addition, the Bank is subject to various other state
and federal laws and regulations, including state usury laws, laws relating to
fiduciaries, consumer credit laws and laws relating to branch banking. The
Bank's loan operations are subject to certain federal consumer credit laws and
regulations promulgated thereunder, including, but not limited to: the federal
Truth-In-Lending Act, governing disclosures of credit terms to consumer
borrowers; the Home Mortgage Disclosure Act, requiring financial institutions to
provide certain information concerning their mortgage lending; the Equal Credit
Opportunity Act and the Fair Housing Act, which prohibit discrimination on the
basis of certain prohibited factors in extending credit; and the Fair Debt
Collection Act, governing the manner in which consumer debts may be collected by
collection agencies. The deposit operations of the Bank are subject to the Truth
in Savings Act, requiring certain disclosures about rates paid on savings
accounts; the Expedited Funds Availability Act, which deals with disclosure of
the availability of funds deposited in accounts and the collection and return of
checks by banks; the Right to Financial Privacy Act, which imposes a duty to
maintain certain confidentiality of consumer financial records and the
Electronic Funds Transfer Act and regulations promulgated thereunder, which
govern automatic deposits to and withdrawals from deposit accounts and
customers' rights and liabilities arising from the use of automated teller
machines and other electronic banking services. The Bank is also subject to the
Fair Credit Reporting Act, governing the use and provision of information to
credit reporting agencies; the Bank Secrecy Act, dealing with, among other
things, the reporting of certain currency transactions; and the USA PATRIOT Act,
dealing with, among other things, requiring the establishment of anti-money
laundering programs including standards for verifying customer information at
account opening.
The Bank is subject to the requirements of the Community Reinvestment
Act (the "CRA"). The CRA imposes on financial institutions an affirmative and
ongoing obligation to meet the credit needs of their local communities,
9
including low- and moderate-income neighborhoods, consistent with the safe and
sound operation of those institutions. Each financial institution's actual
performance in meeting community credit needs is evaluated as part of the
examination process, and also is considered in evaluating mergers, acquisitions
and applications to open a branch or facility.
Other Safety and Soundness Regulations
Prompt Corrective Action. The federal banking agencies have broad
powers under current federal law to take prompt corrective action to resolve
problems of insured depository institutions. The extent of these powers depends
upon whether the institutions in question are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized."
A bank that is "undercapitalized" becomes subject to provisions of the
Federal Deposit Insurance Act ("FDIA") restricting payment of capital
distributions and management fees; requiring the bank's primary federal
regulator to monitor the condition of the bank; requiring submission by the bank
of a capital restoration plan; prohibiting the acceptance of employee benefit
plan deposits; restricting the growth of the bank's assets and requiring prior
approval of certain expansion proposals. A bank that is "significantly
undercapitalized" is also subject to restrictions on compensation paid to senior
management of the bank, and a bank that is "critically undercapitalized" is
further subject to restrictions on the activities of the bank and restrictions
on payments of subordinated debt of the bank. The purpose of these provisions is
to require banks with less than adequate capital to act quickly to restore their
capital and to have the bank's primary federal regulator move promptly to take
over banks that are unwilling or unable to take such steps.
Brokered Deposits. Under current FDIC regulations, "well capitalized"
banks may accept brokered deposits without restriction, "adequately capitalized"
banks may accept brokered deposits with a waiver from the FDIC (subject to
certain restrictions on interest rates that may be paid on such deposits), while
"undercapitalized" banks may not accept brokered deposits. The regulations
provide that the definitions of "well capitalized", "adequately capitalized" and
"undercapitalized" are the same as the definitions adopted by the agencies to
implement the prompt corrective action provisions described in the previous
paragraph.
Interstate Banking
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act
of 1994 ("Riegle-Neal"), CBI and any other adequately capitalized bank holding
company located in South Carolina can acquire a bank located in any other state,
and a bank holding company located outside South Carolina can acquire any South
Carolina-based bank, in either case subject to certain deposit percentage and
other restrictions. Riegle-Neal also provides that, in any state that has not
previously elected to prohibit out-of-state banks from operating interstate
branches within its territory, adequately capitalized and managed bank holding
companies can consolidate their multistate bank operations into a single bank
subsidiary and branch interstate through acquisitions. De novo branching by an
out-of-state bank is permitted only if it is expressly permitted by the laws of
the host state. The authority of a bank to establish and operate branches within
a state will continue to be subject to applicable state branching laws. South
Carolina law was amended, effective July 1, 1996, to permit such interstate
branching but not de novo branching by an out-of-state bank.
The Riegle-Neal Act, together with legislation adopted in South
Carolina, resulted in a number of South Carolina banks being acquired by large
out-of-state bank holding companies. Size gives the larger banks certain
10
advantages in competing for business from larger customers. These advantages
include higher lending limits and the ability to offer services in other areas
of South Carolina and the region. As a result, the Bank does not generally
attempt to compete for the banking relationships of large corporations, but
concentrate their efforts on small to medium-sized businesses and on
individuals. CBI believes its Bank has competed effectively in this market
segment by offering quality, personal service.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act, which makes it easier for affiliations
between banks, securities firms and insurance companies to take place, became
effective in March 2000. The Act removes Depression-era barriers that had
separated banks and securities firms, and seeks to protect the privacy of
consumers' financial information.
Under provisions of the legislation and regulations adopted by the
appropriate regulators, banks, securities firms and insurance companies are able
to structure new affiliations through a holding company structure or through a
financial subsidiary. The legislation creates a new type of bank holding company
called a "financial holding company" which has powers much more extensive than
those of standard holding companies. These expanded powers include authority to
engage in "financial activities," which are activities that are (1) financial in
nature; (2) incidental to activities that are financial in nature; or (3)
complementary to a financial activity and that do not impose a safety and
soundness risk. Significantly, the permitted financial activities for financial
holding companies include authority to engage in merchant banking and insurance
activities, including insurance portfolio investing. A bank holding company can
qualify as a financial holding company and expand the services it offers only if
all of its subsidiary depository institutions are well-managed, well-capitalized
and have received a rating of "satisfactory" on their last Community
Reinvestment Act examination.
The legislation also creates another new type of entity called a
"financial subsidiary." A financial subsidiary may be used by a national bank or
a group of national banks to engage in many of the same activities permitted for
a financial holding company, though several of these activities, including real
estate development or investment, insurance or annuity underwriting, insurance
portfolio investing and merchant banking, are reserved for financial holding
companies. A bank's investment in a financial subsidiary affects the way in
which the bank calculates its regulatory capital, and the assets and liabilities
of financial subsidiaries may not be consolidated with those of the bank. The
bank must also be certain that its risk management procedures are adequate to
protect it from financial and operational risks created both by itself and by
any financial subsidiary. Further, the bank must establish policies to maintain
the separate corporate identities of the bank and its financial subsidiary and
to prevent each from becoming liable for the obligations of the other. The Bank
has a financial subsidiary for the sale of securities and insurance products.
The Act also establishes the concept of "functional supervision,"
meaning that similar activities should be regulated by the same regulator.
Accordingly, the Act spells out the regulatory authority of the bank regulatory
agencies, the Securities and Exchange Commission and state insurance regulators
so that each type of activity is supervised by a regulator with corresponding
expertise. The Federal Reserve Board is intended to be an umbrella supervisor
with the authority to require a bank holding company or financial holding
company or any subsidiary of either to file reports as to its financial
condition, risk management systems, transactions with depository institution
subsidiaries and affiliates, and compliance with any federal law that it has
authority to enforce.
Although the Act reaffirms that states are the regulators for insurance
activities of all persons, including federally-chartered banks, the Act
11
prohibits states from preventing depository institutions and their affiliates
from conducting insurance activities.
The Act also establishes a minimum federal standard of privacy to
protect the confidentiality of a consumer's personal financial information and
gives the consumer the power to choose how personal financial information may be
used by financial institutions.
The Act and the regulations adopted pursuant to the Act create new
opportunities for CBI to offer expanded services to customers in the future,
though, except as noted above, CBI has not yet determined what the nature of the
expanded services might be or when CBI might find it feasible to offer them. The
Act has increased competition from larger financial institutions that are
currently more capable than CBI of taking advantage of the opportunity to
provide a broader range of services. However, CBI continues to believe that its
commitment to providing high quality, personalized service to customers will
permit it to remain competitive in its market area.
Fiscal and Monetary Policy
Banking is a business which depends to a large extent on interest rate
differentials. In general, the difference between the interest paid by a bank on
its deposits and its other borrowings, and the interest received by a bank on
its loans and securities holdings, constitutes the major portion of a bank's
earnings. Thus, the earnings and growth of CBI are subject to the influence of
economic conditions generally, both domestic and foreign, and also to the
monetary and fiscal policies of the United States and its agencies, particularly
the Federal Reserve. The Federal Reserve regulates the supply of money through
various means, including open-market dealings in United States government
securities, the discount rate at which banks may borrow from the Federal
Reserve, and reserve requirements on deposits. The nature and timing of any
changes in such policies and their impact on CBI cannot be predicted.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act, which was enacted in 2002, mandated extensive
reforms and requirements for public companies. The SEC has adopted extensive new
regulations pursuant to the requirements of the Sarbanes-Oxley Act. The
Sarbanes-Oxley Act and the SEC's new regulations have increased the
Corporation's cost of doing business, particularly its fees for internal and
external audit services and legal services, and the law and regulations are
expected to continue to do so. However, the Corporation does not believe that it
will be affected by Sarbanes-Oxley and the new SEC regulations in ways that are
materially different or more onerous than those of other public companies of
similar size and in similar businesses.
Legislative Proposals
Legislation which could significantly affect the business of banking is
introduced in Congress from time to time. CBI cannot predict the future course
of such legislative proposals or their impact on CBI should they be adopted.
Employees
At December 31, 2006 the Corporation employed 195 full time equivalent
employees. Management believes that its employee relations are excellent.
12
Further Information
Further information about the business of the Corporation and the Banks
is set forth in this Form 10-K under Item 7 - "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Item 1A. Risk Factors
Risks Related to Our Industry
We are subject to governmental regulation which could change and
increase our cost of doing business or have an adverse effect on our business.
We operate in a highly regulated industry and are subject to
examination, supervision and comprehensive regulation by various federal and
state agencies. Most of this regulation is designed to protect our depositors
and other customers, not our shareholders. Our compliance with the requirements
of these agencies is costly and may limit our growth and restrict certain of our
activities, including, payment of dividends, mergers and acquisitions,
investments, loans and interest rates charged, and locations of offices. We are
also subject to capitalization guidelines established by federal authorities and
our failure to meet those guidelines could result in limitations being imposed
on our activities or, in an extreme case, in our bank's being placed in
receivership. We have also recently been subjected to the extensive and
expensive requirements imposed on public companies by the Sarbanes-Oxley Act of
2002 and related regulations.
The laws and regulations applicable to the banking industry could
change at any time, and we cannot predict the impact of these changes on our
business or profitability. Because government regulation greatly affects the
business and financial results of all commercial banks and bank holding
companies, our cost of compliance could adversely affect our ability to operate
profitably.
We are susceptible to changes in monetary policy and other economic
factors which may adversely affect our ability to operate profitably.
Changes in governmental, economic and monetary policies may affect the
ability of our bank to attract deposits and make loans. The rates of interest
payable on deposits and chargeable on loans are affected by governmental
regulation and fiscal policy as well as by national, state and local economic
conditions. All of these matters are outside of our control and affect our
ability to operate profitably.
Risks Related to Our Business
We depend on the services of a number of key personnel, and a loss of
any of those personnel could disrupt our operations and result in reduced
revenues.
The success of our business depends to a great extent on our customer
relationships. Our growth and development to date have depended in large part on
the efforts of our senior management team. A number of these senior officers
have primary contact with our customers and are extremely important in
maintaining personalized relationships with our customer base, a key aspect of
our business strategy, and in increasing our market presence. The unexpected
13
loss of services of one or more of these key employees could have a material
adverse effect on our operations and possibly result in reduced revenues if we
were unable to find suitable replacements promptly.
We may be unable to successfully manage our sustained growth.
Our future profitability will depend in part on our ability to manage
growth successfully. Our ability to manage growth successfully will depend on
our ability to maintain cost controls and asset quality while attracting
additional loans and deposits, as well as on factors beyond our control, such as
economic conditions and interest rate trends. If we grow too quickly and are not
able to control costs and maintain asset quality, growth could materially
adversely affect our financial performance.
Our continued pace of growth or regulatory requirements may require us
to raise additional capital in the future, but that capital may not be available
when it is needed or be available on favorable terms.
We anticipate that our current capital resources will satisfy our
capital requirements for the foreseeable future. Nevertheless, we may need to
raise additional capital to support additional growth or to meet regulatory
requirements. Our ability to raise additional capital, if needed, will depend,
among other things, on conditions in the capital markets at that time, which are
outside our control, and on our financial condition and performance. If we
cannot raise additional capital on acceptable terms when needed, our ability to
further expand our operations through internal growth and acquisitions could be
limited.
If our loan customers do not pay us as they have contracted to, we may
experience losses.
Our principal revenue producing business is making loans. If the loans
are not repaid, we will suffer losses. Even though we maintain an allowance for
loan losses, the amount of the allowance may not be adequate to cover the losses
we experience. We attempt to mitigate this risk by a thorough review of the
creditworthiness of loan customers. Nevertheless, there is risk that our credit
evaluations will prove to be inaccurate due to changed circumstances or
otherwise.
We face strong competition from larger, more established competitors
which may adversely affect our ability to operate profitably.
We encounter strong competition from financial institutions operating
in our market areas. In the conduct of our business, we also compete with credit
unions, insurance companies, money market mutual funds and other financial
institutions, some of which are not subject to the same degree of regulation as
we are. Many of these competitors have substantially greater resources and
lending abilities than we have and offer services, such as investment banking,
trust and international banking services that we do not provide. We believe that
we have competed, and will continue to be able to compete, effectively with
these institutions because of our experienced bankers and personalized service,
as well as through loan participations and other strategies and techniques.
However, we cannot promise that we are correct in our belief. If we are wrong,
our ability to operate profitably may be negatively affected.
Technological changes affect our business, and we may have fewer
resources than many of our competitors to invest in technological improvements.
The financial services industry continues to undergo rapid
technological changes with frequent introductions of new technology-driven
products and services. In addition to enabling financial institutions to serve
clients better, the effective use of technology may increase efficiency and may
14
enable financial institutions to reduce costs. Our future success may depend, in
part, upon our ability to use technology to provide products and services that
provide convenience to customers and to create additional efficiencies in our
operations. We may need to make significant additional capital investments in
technology in the future, and we may not be able to effectively implement new
technology-driven products and services. Many of our competitors have
substantially greater resources to invest in technological improvements.
Our profitability and liquidity may be affected by changes in interest
rates and economic conditions.
Our profitability depends upon our net interest income, which is the
difference between interest earned on our interest-earning assets, such as loans
and investment securities, and interest expense on interest-bearing liabilities,
such as deposits and borrowings. Our net interest income will be adversely
affected if market interest rates change such that the interest we pay on
deposits and borrowings increases faster than the interest earned on loans and
investments. Interest rates, and consequently our results of operations, are
affected by general economic conditions (domestic and foreign) and fiscal and
monetary policies. Monetary and fiscal policies may materially affect the level
and direction of interest rates. Beginning in June 2004 through June 2006, the
Federal Reserve raised rates 17 times for a total increase of 4.25%. Although
rates have not been increased since June 2006, the Federal Reserve may increase
them at any time. Increases in interest rates generally decrease the market
values of interest-bearing investments and loans held and therefore may
adversely affect our liquidity and earnings. Increased interest rates also
generally affect the volume of mortgage loan originations, the resale value of
mortgage loans originated for resale, and the ability of borrowers to perform
under existing loans of all types.
Risks Related to Our Common Stock
Our common stock has a limited trading market, which may limit your
ability to sell your stock.
Our common stock is traded on the American Stock Exchange under the
symbol "SCB." Since January 1, 2006, the average weekly trading volume has been
approximately 8,500 shares. Accordingly, a shareholder who wishes to sell a
large number of shares may experience a delay in selling the shares or have to
sell them at a lower price in order to sell them promptly.
We may issue additional securities, which could affect the market price
of our common stock and dilute your ownership.
We may issue additional securities to raise additional capital, to
support growth, or to make acquisitions. Sales of a substantial number of shares
of our common stock, or the perception by the market that those sales could
occur, could cause the market price of our common stock to decline or could make
it more difficult for us to raise capital through the sale of common stock or to
use our common stock in future acquisitions.
There is no guarantee we will continue to pay cash dividends in the
future at the same or any level.
Declaration and payment of dividends are within the discretion of our
board of directors. Our bank is currently our only source of funds with which to
pay cash dividends. Our bank's declaration and payment of future dividends to us
15
is within the discretion of the bank's boards of directors, and is dependent
upon its earnings, financial condition, its need to retain earnings for use in
the business and any other pertinent factors. The bank's payment of dividends is
also subject to various regulatory requirements and the ability of the bank's
regulators to forbid or limit payment(s) of dividends.
Provisions in our articles of incorporation and South Carolina law may
discourage or prevent takeover attempts, and these provisions may have the
effect of reducing the market price for our stock.
Our articles of incorporation include several provisions that may have
the effect of discouraging or preventing hostile takeover attempts, and
therefore of making the removal of incumbent management difficult. The
provisions include staggered terms for our board of directors and requirements
of supermajority votes to approve certain business transactions. In addition,
South Carolina law contains several provisions that may make it more difficult
for a third party to acquire control of us without the approval of our board of
directors, and may make it more difficult or expensive for a third party to
acquire a majority of our outstanding common stock. To the extent that these
provisions are effective in discouraging or preventing takeover attempts, they
may tend to reduce the market price for our stock.
Our common stock is not insured, so you could lose your total
investment.
Our common stock is not a deposit, savings account or obligation of our
bank and is not insured by the Federal Deposit Insurance Corporation or any
other government agency. Should our business fail, you could lose your total
investment.
Item 1B. Unresolved Staff Comments
Not applicable because the Registrant is not an accelerated filer, a
large accelerated filer, or a well-known seasoned issuer.
Item 2. Description of Property
The Corporation owns approximately three acres of land located at 102
Founders Court in the northeast area of the City of Orangeburg on which it built
a two story, 16,000 square foot corporate headquarters and operations center.
The new building was completed during the fourth quarter of 2005, and the
Corporation began operating from this facility in mid-January 2006.
The Corporation leases office space for its Chief Credit Officer and
Director of Human Resources at 508 Hampton Street, Suite 203, Columbia, SC under
the terms of a lease that expires in November, 2007. At the end of that period,
the lease will automatically renew on a month-to-month basis.
The Bank owns land located at 1820 Columbia Road NE, in Orangeburg,
South Carolina, where the Bank maintains an office in a one-story building of
approximately 7,000 square feet, and land located at the corner of Glover and
Broughton Streets, Orangeburg, SC where it operates a branch facility of
approximately 6,500 square feet.
The Bank also owns property at 683 Bultman Drive in Sumter on which is
located a one-story 6,500 square foot bank office building. The Bank leases
property at 1135 West Liberty Street where it operates a branch office in a
16
one-story building of approximately 3,600 square feet. The land, approximately
one acre, is leased under a non-cancellable operating lease for an initial term
of twenty years, with four five-year renewal options. The Bank is responsible
for property taxes and improvements.
The Bank leases approximately 1.7 acres of land located at 2009
Hoffmeyer Road in Florence, South Carolina for a banking office. The lease is
for an initial term of ten years and provides for two ten year renewals and a
final two year renewal. The Bank is responsible for property taxes and
improvements. The Bank built a 7,500 square foot, one-story building for the
office on the leased site. The Bank also leases approximately one quarter acre
of land and a 2,000 square foot building at 812 Second Loop Road, Florence, SC
for a branch office. The lease is for an initial term of five years and contains
both early termination and renewal options. The Bank purchased a 1.1 acre lot in
the 600 block of the Pamplico Highway in Florence which is intended for future
development as a banking office.
The Bank also maintains offices in a two story building on a quarter
acre site at 100 S. Palmer Street in Ridgeway, a 1,900 square foot one story
branch office on a one acre site at 610 West Moultrie Street in Winnsboro, SC.
and, as of August 2006, leases approximately 7,000 square feet of a two-story
14,000 square foot office building located at 312 Blythewood Road in Blythewood,
SC. The site previously used for the Blythewood branch operation is currently
vacant and the Bank intends to sell it. The Bank has purchased a one acre parcel
of land on Clemson Road in Columbia, SC on which it intends to build a 5,000
square foot branch office. This office is expected to be operational by the end
of 2007.
CRM operates from leased offices located at 508 Hampton Street, Suite
201, Columbia, SC, 1135 West Liberty Street, Sumter, SC, and 1156 Bowman Road,
Suite 103, Mount Pleasant, SC. The Hampton Street, Columbia office is leased
under the terms of a five year lease. At the end of that period, the lease will
automatically renew on a month-to-month basis. The Bank also leases space at
2109 South Boulevard, Suite 114, Charlotte, NC.
Information about future lease payments is included in Note 7 to the
consolidated financial statements contained elsewhere in this report.
Item 3. Legal Proceedings
The Company, the Bank and CRM are from time to time subject to legal
proceedings in the ordinary course of their business. No proceedings were
pending at December 31, 2006, that management believes are likely to have a
material adverse effect on the Company or its subsidiaries.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted for a vote of the security holders during the
fourth quarter of 2006.
17
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
The Corporation's shares of Common Stock are traded on the American
Stock Exchange (the AMEX) under the ticker symbol SCB.
The following table summarizes the range of high and low prices for the
Corporation's Common Stock as reported on the American Stock Exchange for each
quarterly period over the last two years.
Quarter Ended High Low
----------------- ---- ---
March 31, 2006 $ 17.20 $ 15.02
June 30, 2006 $ 16.40 $ 14.90
September 30, 2006 $ 17.69 $ 15.45
December 31, 2006 $ 17.00 $ 15.65
March 31, 2005 $ 18.59 $ 16.45
June 30, 2005 $ 18.50 $ 15.91
September 30, 2005 $ 17.95 $ 16.45
December 31, 2005 $ 18.24 $ 16.60
During 2006, the Corporation had stock sales volume of 443,500 shares
compared with 324,300 shares the prior year.
There were 2,085 holders of record of the Corporation's Common Stock
(no par value) as of March 15, 2007.
During 2006, the Corporation authorized and paid quarterly cash
dividends totaling $.44 per share. The total cost of these dividends was
$1,952,000 or 39.0% of net income. During 2005, the Corporation authorized and
paid quarterly cash dividends totaling 40 cents per share. The total cost of
these dividends was $1,761,000 or 174.2% of net income. The dividend policy of
the Corporation is subject to the discretion of the Board of Directors and
depends upon a number of factors, including earnings, financial condition, cash
needs and general business conditions, as well as applicable regulatory
considerations. Subject to ongoing review of these circumstances, the Board
expects to maintain a reasonable, safe and sound dividend payment policy.
The current source of dividends to be paid by the Corporation is the
dividends received from the Bank. Accordingly, the laws and regulations that
govern the payment of dividends by national banking associations may restrict
the Corporation's ability to pay dividends. National banks may pay dividends
only out of present and past earnings and are subject to numerous limitations
designed to ensure that banks have adequate capital to operate safely and
soundly (See Item 1. Description of Business - Supervision and Regulation -
Payment of Dividends, and Item 8 - Financial Statements and Supplementary Data -
Note 19 - Regulatory Matters). As of December 31, 2006, the Bank could have
declared additional dividends of up to $5,606,000 without the approval of
regulatory authorities. As of January 1, 2007, the dividend restrictions would
have allowed the Bank to pay no more than approximately $3,424,000 in dividends
without the prior approval of regulators.
The information required by Item 201(d) of Regulation S-K is set forth
in Item 12 of this Form 10-K. Except as previously reported in its Form 10-Q for
the quarter ended March 31, 2006, the Company did not sell any of its equity
18
securities during the year ended December 31, 2006 that were not registered
under the Securities Act of 1933.
Neither the Corporation nor any "affiliated purchaser" as defined by 17
C.F.R. 240.10b-18(a)(3) purchased any shares of the Corporation's common stock
during the fourth quarter of 2006.
Shareholder Return Performance Graph
The Company is required to provide its shareholders with a line graph
comparing the Company's total cumulative shareholder return with a performance
indicator of the overall stock market and either a published industry index or a
Company-determined peer comparison. Shareholder return (measured through
increases in stock prices and payment of dividends) is often a benchmark used in
assessing corporate performance and the reasonableness of compensation paid to
executive officers.
The performance graph presented below compares the Company's cumulative
total return over the most recent five year period with the Russell 2000 Index
(reflecting overall stock market performance for small cap stocks) and the SNL
Southeast Banks Index (reflecting changes in overall stock market performance
for a group of 142 banking companies headquartered in the Southeastern Region of
the United States) and the Community Bankshares Peer Group consisting of the 32
publicly traded banks and thrift institutions headquartered in South Carolina.
Returns are shown on a total return basis, assuming reinvestment of dividends
and a beginning stock price of $100 per share. Values presented for the
Company's stock are based on information compiled by SNL Financial, LC, which
prepared the performance graph.
19
Period Ending
-------------
Index 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06
-------- -------- -------- -------- -------- --------
Community Bankshares, Inc. ..................... 100.00 127.56 154.38 150.01 142.65 145.28
Russell 2000 ................................... 100.00 79.52 117.09 138.55 144.86 171.47
SNL Southeast Bank Index ....................... 100.00 110.46 138.72 164.50 168.39 197.45
Community Bankshares Peer Group* ............... 100.00 120.62 162.82 190.48 187.06 201.71
*Community Bankshares Peer Group consists of the 32 publicly traded banks and
thrifts headquatered in South Carolina.
This subsection "Shareholder Return Performance Graph" shall not be
deemed to be "soliciting material" or to be filed with the Securities and
Exchange Commission and shall not be deemed incorporated by reference into any
filing under the Securities Act of 1933 or the Securities Exchange Act of 1934
except to the extent the Corporation specifically incorporates it therein by
reference.
20
Item 6. Selected Financial Data
The following is a summary of the consolidated financial position and
results of operations of the Corporation for the years ended December 31, 2002
through 2006.
(Dollars in thousands, except per share data)
Years Ended December 31,
------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
INCOME STATEMENT DATA
Net interest income ........................... $ 21,553 $ 20,801 $ 17,843 $ 16,708 $ 14,625
Provision for loan losses ..................... 2,950 9,637 5,102 1,119 1,033
Noninterest income ............................ 8,306 8,003 7,278 9,125 7,194
Noninterest expense ........................... 19,227 17,391 15,039 15,932 12,465
Net income .................................... 5,009 1,011 3,209 5,635 5,401
PER COMMON SHARE
Net income - basic ............................ $ 1.13 $ 0.23 $ 0.74 $ 1.31 $ 1.42
Net income - diluted .......................... 1.11 0.22 0.72 1.27 1.38
Cash dividends ................................ 0.44 0.40 0.40 0.36 0.32
Book value .................................... 11.85 11.12 11.39 11.10 10.16
BALANCE SHEET DATA (YEAR END)
Total assets .................................. $578,517 $556,836 $512,377 $466,580 $437,320
Loans held for sale ........................... 9,235 12,447 15,090 8,411 24,664
Loans, net .................................... 405,058 402,343 389,302 327,900 302,911
Deposits ...................................... 483,621 464,209 423,458 378,704 337,062
Shareholders' equity .......................... 52,624 48,992 50,027 48,070 43,717
FINANCIAL RATIOS
Return on average assets ...................... 0.89% 0.19% 0.67% 1.25% 1.43%
Return on average equity ...................... 9.80% 1.94% 6.41% 12.17% 15.10%
Net interest margin ........................... 4.08% 4.12% 3.98% 3.95% 4.14%
OPERATIONS DATA
Bank's branch offices ......................... 9 9 9 8 8
Mortgage loan offices ......................... 4 4 4 3 3
Employees (full-time equivalent) .............. 195 194 182 190 175
21
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operation
INTRODUCTION
The discussion and data presented below analyze major factors and
trends regarding the financial condition and results of operations of Community
Bankshares Inc. and its subsidiaries for the three year period ended December
31, 2006. This information should be reviewed in conjunction with the
consolidated financial statements and related notes contained elsewhere in this
report.
Business of the Corporation
Community Bankshares Inc. is a bank holding company. In prior years,
CBI owned four banking subsidiaries: Orangeburg National Bank, Sumter National
Bank, Florence National Bank, and the Bank of Ridgeway; and a mortgage company
subsidiary, Community Resource Mortgage, Inc. ("CRM"). In the August 2006,
Orangeburg National Bank was renamed Community Resource Bank, N.A. ("CRB" or
"the Bank") and, in October 2006, the other bank subsidiaries were merged into
CRB. The executive management, item and data processing and other technical
services previously provided by CBI for its subsidiaries are now provided by the
same personnel, acting as a division of the Bank. While CRM continues to exist
as a separate wholly-owned subsidiary, most of its activities are being
conducted by the Bank as of January 2007. The accounting for the merger of these
related entities was done in manner similar to a pooling of interest, in
conformity with the requirements of FASB Statement 141. The consolidated
financial report for 2006 represents the operations of the holding company, the
bank and the mortgage company on a consolidated basis. Condensed parent-only
financial statements are presented in the notes to the consolidated financial
statements.
Community Resource Bank, N.A. is a national banking association that
commenced operations in November 1987, under the name Orangeburg National Bank.
It operates from two offices in Orangeburg, South Carolina, two offices in
Sumter, South Carolina, two offices in Florence, South Carolina, and one office
in each of Ridgeway, Winnsboro and Blythewood, SC. The Bank provides a variety
of commercial banking services in its community markets. Its primary customer
markets are consumers and small to medium size businesses.
The Bank continues to conduct mortgage brokerage activities under the
name "Community Resource Mortgage, a division of Community Resource Bank" (the
"Mortgage Division"), and offers a variety of one to four family residential
mortgage products, primarily for resale in the secondary market, from offices in
Columbia, Sumter, Charleston in South Carolina, and Charlotte, North Carolina.
The offices function as loan production offices for CRB. Community Resource
Mortgage, Inc. continues to exist as a wholly-owned subsidiary of the
Corporation, but its activities currently are limited to servicing a small
number and dollar amount of older real estate loans.
22
EARNINGS PERFORMANCE
2006 compared with 2005
For the year ended December 31, 2006, the Corporation recorded net
income of $5,009,000, an increase of $3,998,000, or 395.5%, from net income of
$1,011,000 for 2005. Net income per share for 2006 was $1.13 compared with $.23
for 2005. Diluted net income per share was $1.11 for 2006 compared with $.22 for
2005. Return on average assets was .89% for 2006 compared with .19% for 2005 and
return on average shareholders' equity was 9.80% for 2006 compared with 1.94%
for 2005.
The change in net income for 2006 was affected primarily by the
following factors:
o the 2006 loan loss provision expense decreased by $6,687,000 from the
2005 amount, primarily due to improvements in credit quality achieved
partially through improved underwriting, credit analysis and a
redesigned loan approval system;
o the sale of an $8,162,000 portfolio of loans, mostly including
potential problem loans, that resulted in the realization of a gain of
$514,000;
o higher interest income brought about primarily by higher rates charged
on loans and obtained from investments in taxable securities which was
largely offset by higher interest expense resulting largely from
higher rates paid for deposits and for long-term debt;
o increased noninterest expenses reflecting the costs of consolidation
of the Corporation's former banking subsidiaries under a single
charter, including direct and ancillary expenses associated with
changing the name of the banking subsidiary;
o increased premises and fixed asset expense associated with the
relocation of the Corporation's headquarters and Blythewood branch;
and
o increased other non-interest expense associated with the
implementation of a new management information system.
Net interest income for 2006 was $752,000 more than for 2005. Interest
rate spread, the difference between the average yield earned on earning assets
and the average rate paid for interest bearing liabilities was 13 basis points
lower in 2006 than in 2005 and net yield on earning assets for 2006 decreased by
4 basis points to 4.08% compared with 2005.
2005 compared with 2004
For the year ended December 31, 2005, the Corporation recorded net
income of $1,011,000, a decrease of $2,198,000, or 68.5%, from net income of
$3,209,000 for 2004. Net income per share for 2005 was $.23 compared with $.74
for 2004. Diluted net income per share was $.22 for 2005 compared with $.72 for
2004. Return on average assets was .19% for 2005 compared with .67% for 2004.
Return on average shareholders' equity was 1.94% for 2005 compared with 6.41%
for 2004.
The change in net income for 2005 was affected primarily by the
following factors:
o the 2005 loan loss provision expense increased by $4,535,000 over 2004
primarily due to credit quality issues centered mainly in one bank
subsidiary;
o mortgage loan brokerage income increased by $571,000 due to an
increase in residential mortgage loan production that resulted, in
23
part, from modifying the mortgage subsidiary's loan origination and
funding activities, and from a resurgence in demand for residential
mortgage loans;
o noninterest expenses increased by $2,352,000, primarily due to the
hiring of additional corporate executive and administrative officers,
and increased commission-based compensation paid by the mortgage
subsidiary;
o increased average holdings of loans and investments and higher yields
associated with those instruments resulted in a $6,732,000 increase in
interest and dividend income;
o interest expense increased by $3,774,000 principally due to higher
interest rates paid on time deposits; and
o income tax expense was reduced by $1,006,000 due to lower taxable
income resulting from the net effect of the factors enumerated above.
Net interest income for 2005 increased by $2,958,000 over the 2004
amount due to increases of $6,134,000 and $426,000 in interest income on loans
and federal funds sold, respectively, and increases of $3,438,000 and $343,000
in interest expenses related to interest-bearing deposits and long-term debt,
respectively. Interest expense for long-term debt increased in 2005 due to
increases in the average amount of such debt outstanding and increased variable
interest rates paid for $10,000,000 of junior subordinated debt issued by the
Corporation during 2004. The proceeds of this debt were used primarily to
increase the capitalization of some of the former bank subsidiaries, to fund
mortgage loan brokerage production and for other general corporate purposes.
Credit Quality Matters
The greatest single factor in the changing net income during the past
three years was the provisions for loan losses. In 2006 the provision was
$2,950,000, in 2005 the provision was $9,637,000 and in 2004 it was $5,102,000.
This compares to $1,119,000 in 2003, $1,033,000 in 2002 and $650,000 in 2001.
More than 80% of the provisions made in 2005 and 2004 were attributable
to credit quality issues at one of the Corporation's then subsidiary banks. The
Corporation became aware of credit quality issues at that bank in mid-2004 in
connection with the departure of a senior lending officer. Management initially
became aware of a number of loans with significant issues and began a program to
strengthen and collect those loans. That program was only partially successful
as some of the borrowers' financial conditions and value of collateral
deteriorated during collection efforts. In 2004, the Corporation also undertook
efforts to begin to strengthen its credit risk management system.
As part of the ongoing process of risk assessment and mitigation,
management hired a Chief Credit Officer for the Corporation early in the second
quarter of 2005. Also at that time management changed its outside independent
loan review firm to gain greater resources and expertise. The changes allowed
the Corporation to obtain the benefits of detailed, thorough reviews of a
greater portion of its loan portfolio in a shorter time period than had
previously been possible.
During 2005 the independent loan review firm reviewed all of the
Corporation's loan relationships greater than $400,000, approximately 40% of
loans outstanding. Their review resulted in the movement of a significant number
and dollar amount of loans into less favorable risk grades. In such cases,
management also undertook a review of the value of any collateral securing the
loans to estimate the net realizable value of the collateral in the event of a
default.
24
In some cases, management concluded that it was probable that the
Corporation would be unable to collect the amounts due according to the
contractual terms of the loan agreements and categorized those loans as
impaired. In other cases, the downgraded loans were designated as potential
problem loans. Although designation as a potential problem loan does not
represent management's estimate that the Corporation will suffer a loss with
respect to the loan, it does identify loans that merit close attention to reduce
the risk of loss.
During 2006 the Board of Directors approved a new credit approval
policy. The policy is designed to facilitate the efficient approval of
conforming loans (loans that are within standard underwriting criteria) at the
lowest organizational level possible, and it also provides for more rigorous
review of loans that are non-conforming, usually larger and more complex
requests. Larger requests, depending on their size, require approval from the
bank President, Chief Credit Officer or the Senior Management Loan Committee.
Loan requests greater than approximately 3.5% of capital, or insider related
loans, require approval at the Board Loan Committee or Board of Directors level.
Also during 2006 management introduced an automated underwriting and
decision making tool for consumer lending from Baker Hill, with credit scoring
models supplied by Fair Isaac Corporation, a leading consumer credit
underwriting authority. The system is designed to assure that all credit
decisions are based on current and complete credit information, complete
application data and thorough underwriting. This new process has improved the
timeliness and quality of our decision making on consumer lending.
During late 2006, the independent loan review firm reviewed a large
sample of the Corporation's loan relationships, aggregating over $100 million,
or approximately 24%, of loans outstanding. This review resulted in a minimal
movement of accounts and dollars into less favorable risk grades.
The Corporation is required to estimate the collectibility of its loan
portfolio as of each accounting period end and, as a result, provide an
allowance for loan losses. The allowance for loan losses is increased by the
provision for loan losses, which is charged to expense, and by any recoveries
received on loans previously charged off. The allowance is decreased by
deducting the amount of uncollectible loans charged off. The reviews referred to
above were factored into management's estimates of the probable losses inherent
in the Corporation's loan portfolio at December 31, 2005 and 2006 and
substantially impacted the amount of the allowance at each of those dates which,
in turn, substantially impacted the very large provisions for loan losses
recorded in 2005 and the large, but substantially reduced, provision in 2006.
At year end 2005, approximately 55% of the Corporation's impaired loans
and 58% of the potential problem loans were associated with the same then bank
subsidiary, although that bank accounted for only 29% of the Corporation's total
loans. Over the course of 2005, management of the Corporation took a number of
additional actions to improve credit risk management at that subsidiary. These
included more aggressive review of maturing loans to improve the bank's
collateral position and the borrowers' ability to service the debt; the hiring
of an experienced special assets officer on a contract basis, under the
supervision of the Chief Credit Officer, to work out problem loans; a more
frequent level of loan review conducted by the external loan review firm; and a
mandatory loan approval review of larger loan relationships conducted by the
Chief Credit Officer as well as the Loan Committee of the bank. Management
believes that this will result in a significant improvement in the early
identification of problem and potential problem loans and it will also improve
the quality of new loans.
25
At year end 2006, approximately 41% of the Corporation's impaired loans
and 30% of the potential problem loans were associated with the same region's
portfolio, although it accounted for only 22% of the Corporation's total loans
and unfunded commitments. During the year management continued with the
initiatives discussed above and also hired a new senior loan officer to bolster
the region's lending staff. Management expects to see continued improvement in
asset quality based on the impact of the initiatives begun in 2005 and 2006.
Additional information about the Corporation's provision for loan
losses, allowance for loan losses, impaired loans and potential problem loans is
discussed under the heading "Allowance for Loan Losses" below.
Net Interest Income
Net interest income, the difference between interest income earned and
interest expense incurred, is the principal source of the Corporation's
earnings. Net interest income is affected by changes in the levels of interest
rates and by changes in the volume and mix of interest earning assets and
interest bearing liabilities. Because longer-term rates were largely unaffected
by the Federal Reserve Board's actions with respect to interest rates,
especially those in the 15 to 30-year range which largely influences mortgage
rates, a resurgence in mortgage loan demand that began during 2005 continued
throughout much of 2006.
Beginning in 2000 and continuing until late in the second quarter of
2004, the Federal Reserve Board provided stimulus to the U.S. economy by first
setting, and then maintaining, interest rates at low levels. The effects of
these actions on the Corporation were varied. The Corporation's overall funding
costs decreased during the period, but there were similar decreases in the
yields realized on loans and investments. The mortgage subsidiary experienced
extremely large volumes of originations and refinancing activity, which strained
its ability both to fund and to process those transactions until the volume
diminished in the fourth quarter of 2003. Beginning in mid-2004 and continuing
through mid-2006, the Federal Reserve Board steadily increased certain
short-term interest rates under its control, as it perceived an increasing risk
from price inflation. These actions resulted in similar increases in other
market rates of interest, primarily in the short and intermediate terms up to
about seven years. Longer term rates remained at approximately the same levels
as previously. These actions affected CBI as follows: loan yields and interest
costs increased as interest rates on loans with variable interest rates were
reset and maturing time deposits and newly acquired time deposits were priced at
current market levels; savings, NOW and money market rates were adjusted upward
primarily in response to market competition for deposits; and borrowing costs
increased as rates associated with those instruments moved higher.
Net interest income was $21,553,000, $20,801,000, and $17,843,000 for
2006, 2005, and 2004, respectively. The amounts of interest income and interest
expense increased significantly in both 2006 and 2005. Average earning assets
and average interest bearing liabilities amounts also increased steadily over
those two years.
The following table presents the average balance sheets, the average
yield and the interest earned on earning assets, and the average rate and the
interest expense on interest bearing liabilities for the years ended December
31, 2006, 2005, and 2004.
26
Average Balances, Yields and Rates
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Interest Interest Interest
Average Income/ Yields/ Average Income/ Yields/ Average Income/ Yields/
Balances Expense Rates Balances Expense Rates Balances Expense Rates
-------- ------- ----- -------- ------- ----- -------- ------- -----
(Dollars in thousands)
Assets
Interest-bearing deposits with other banks .... $ 1,719 $ 118 6.86% $ 694 $ 49 7.06% $ 1,086 $ 20 1.84%
Investment securities - taxable ............... 59,416 2,470 4.16% 54,077 1,758 3.25% 49,546 1,518 3.06%
Investment securities - tax exempt (1) ........ 5,030 180 3.58% 6,259 215 3.44% 9,201 312 3.39%
Federal funds sold ............................ 33,583 1,501 4.47% 17,900 629 3.51% 16,950 203 1.20%
Loans, including held for sale (1) (2) (3) .... 429,131 32,785 7.64% 426,384 28,955 6.79% 371,061 22,821 6.15%
-------- ------- -------- ------- -------- -------
Total interest earning assets ..... 528,879 37,054 7.01% 505,314 31,606 6.25% 447,844 24,874 5.55%
Cash and due from banks ....................... 15,301 15,671 15,587
Allowance for loan losses ..................... (10,053) (5,402) (4,615)
Premises and equipment ........................ 10,079 8,257 7,327
Intangible assets ............................. 7,033 7,280 7,526
Other assets .................................. 9,022 4,573 4,041
-------- -------- --------
Total assets ...................... $560,261 $535,693 $477,710
======== ======== ========
Liabilities and shareholders' equity
Interest bearing deposits
Interest bearing transaction accounts .. $ 70,561 $ 793 1.12% $ 60,785 $ 452 0.74% $ 54,918 $ 225 0.41%
Savings ................................ 91,064 2,476 2.72% 89,407 1,393 1.56% 80,534 814 1.01%
Time deposits .......................... 242,093 9,969 4.12% 225,627 6,895 3.06% 190,290 4,263 2.24%
-------- ------- -------- ------- -------- -------
Total interest bearing deposits ... 403,718 13,238 3.28% 375,819 8,740 2.33% 325,742 5,302 1.63%
Short-term borrowings ......................... 13,680 400 2.92% 8,584 198 2.31% 10,309 205 1.99%
Long-term debt ................................ 28,342 1,863 6.57% 32,815 1,867 5.69% 28,601 1,524 5.33%
-------- ------- -------- ------- -------- -------
Total interest bearing liabilities 445,740 15,501 3.48% 417,218 10,805 2.59% 364,652 7,031 1.93%
Noninterest-bearing demand deposits ........... 60,099 64,339 61,220
Other liabilities ............................. 3,315 2,116 1,782
Shareholders' equity .......................... 51,107 52,020 50,056
-------- -------- --------
Total liabilities and
shareholders' equity ............ $560,261 $535,693 $477,710
======== ======== ========
Interest rate spread (4) ...................... 3.53% 3.66% 3.62%
Net interest income and net yield
on earning assets (5) .................. $21,553 4.08% $20,801 4.12% $17,843 3.98%
======= ======= =======
(1) Interest income on tax-exempt loans and investment securities has not been
calculated on a tax-equivalent basis.
(2) Nonaccruing loans are included in the average balances and income from such
loans is recognized on a cash basis.
(3) Interest income includes immateral amounts of loan fees.
(4) Total interest earning assets yield less total interest bearing liabilities
rate.
(5) Net yield equals net interest income divided by total interest earning
assets.
27
For 2006, average loans, including loans held for sale increased by
only $2,747,000, or .6%, over the average amount for 2005. However, the average
yield on loans increased by 85 basis points, resulting in an increase of
$3,830,000 in interest income on those assets. The average amounts invested in
taxable investment securities during 2006 increased by $5,339,000, or 9.9%, over
the average amount of such investments for 2005. In addition, the average yield
on those investments increased to 4.16% for 2006 from 3.25% for 2005.
Consequently, interest income on taxable investment securities for 2006
increased by $712,000. Similarly, the 2006 average amount of federal funds sold
increased by $15,683,000, or 87.6% over the 2005 average amount, and the yield
earned in 2006 was 96 basis points higher than in 2005. Interest income on
federal funds sold for 2006 increased by $872,000. Average interest-bearing
deposit accounts for 2006 were significantly higher than for 2005, with a growth
rate of 7.4%. The rates paid for those deposits increased, also, and the rate
differentials associated with savings and time deposits accounted for the
majority of the $4,498,000 increase in deposit interest expense for 2006.
During 2005, loans, including loans held for sale, grew $17,692,000
over the amount as of December 31, 2004. Average loans including loans held for
sale, however, were $55,323,000 more in 2005 than in 2004 and represented almost
all of the increase in average total interest earning assets during 2005.
Deposit growth was robust in 2005, as well, with the 2005 year-end amount
increasing by $40,751,000 over the 2004 year-end, and the average amount of
deposits increasing by $53,196,000 for 2005 over the comparable 2004 amount.
Deposits are generally obtained from within the Bank's market areas. The Bank
began accepting Health Savings Account deposits in 2005 as an additional product
offering, but the amounts of such deposits are not yet significant. Interest
costs associated with deposits increased primarily due to increased market
rates.
Time deposits are the largest category of the Corporation's deposit
liabilities. Interest rates paid for such liabilities increased during 2006.
Accordingly, interest expense associated with those deposits increased to
$9,969,000 in 2006 from $6,895,000 in 2004. The average rates paid for time
deposits increased to 4.12% in 2006 from 3.06% in 2005 and 2.24% in 2004.
Interest expenses for short-term borrowings more than doubled in 2006 from 2005
after being level compared with 2004, due to both increased rates and higher
volumes. Long-term debt is composed of fixed rate advances from the Federal Home
Loan Bank of Atlanta and $10,300,000 of variable-rate junior subordinated debt.
The subordinated debt reprices quarterly and is indexed to the three-month LIBOR
rate plus 280 basis points.
The table "Volume and Rate Variance Analysis" provides a summary of
changes in net interest income resulting from changes in volume and changes in
rate. The changes in volume are the difference between the current and prior
year's balances multiplied by the prior year's rate. The changes in rate are the
difference between the current and prior year's rate multiplied by the prior
year's balance.
As shown in the table, the increases in net interest income during 2006
and 2005 resulted primarily from higher volumes of earning assets. Increased
interest income for 2006 caused by rate increases was offset to a large extent
by rate increases on interest bearing liabilities.
28
Volume and Rate Variance Analysis
2006 compared with 2005 2005 compared with 2004
----------------------- -----------------------
Volume * Rate * Total Volume * Rate * Total
-------- ------ ----- -------- ------ -----
(Dollars in thousands)
Interest earning assets
Interest-bearing deposits with other banks ............. $ 70 $ (1) $ 69 $ (10) $ 39 $ 29
Investment securities - taxable ........................ 187 525 712 144 96 240
Investment securities - tax exempt ..................... (44) 9 (35) (101) 4 (97)
Federal funds sold ..................................... 665 207 872 12 414 426
Loans, including held for sale ......................... 188 3,642 3,830 3,611 2,523 6,134
------- ------- ------- ------- ------- -------
Interest income ................................ 1,066 4,382 5,448 3,656 3,076 6,732
------- ------- ------- ------- ------- -------
Interest bearing liabilities
Interest bearing deposits
Interest bearing transaction accounts .............. 82 259 341 26 201 227
Savings ............................................ 26 1,057 1,083 98 481 579
Time deposits ...................................... 534 2,540 3,074 889 1,743 2,632
------- ------- ------- ------- ------- -------
Total interest bearing deposits ................ 642 3,856 4,498 1,013 2,425 3,438
Short-term borrowings .................................. 139 63 202 (37) 30 (7)
Long-term debt ......................................... (273) 269 (4) 235 108 343
------- ------- ------- ------- ------- -------
Total interest expense ......................... 508 4,188 4,696 1,211 2,563 3,774
------- ------- ------- ------- ------- -------
Net interest income ............................ $ 558 $ 194 $ 752 $ 2,445 $ 513 $ 2,958
======= ======= ======= ======= ======= =======
----------------------
* The rate/volume variance for each category has been allocated on a
consistent basis between rate and volume variances based on the percentage
of rate or volume variance to the sum of the two absolute variances except
in categories having balances in only one period. In such cases, the entire
variance is attributed to volume variance.
Although management currently expects that interest rates are more
likely to decrease slightly in 2007, management has not presently identified any
factors that it believes might cause interest rates to move significantly,
either up or down, in a short period of time. At year-end 2006, management
estimates that a 100 basis point shift in interest rates, in either direction,
would have a minimal effect on the Bank's net interest income and net income.
However, changes in interest rates that can significantly affect the
Corporation, positively or negatively, are possible. In the absence of
significant changes in market interest rate levels, any significant changes in
net interest income during 2007 are expected to result from changes in the
volumes of interest earning assets and liabilities. Management expects to
continue using its marketing strategies to increase the Corporation's market
share of both deposits and quality loans within its market areas. These
strategies involve offering attractive interest rates and outstanding customer
service.
Provision for Loan Losses
The provision for loan losses is charged to earnings based on
management's continuing review and evaluation of the loan portfolio and its
estimate of the adequacy of the related allowance for loan losses. Provisions
for loan losses totaled $2,950,000, $9,637,000, and $5,102,000 for the years
ended December 31, 2006, 2005 and 2004, respectively. Net charge-offs for 2006
were $9,929,000, compared with $2,038,000 and $4,961,000 for 2005 and 2004,
respectively.
As previously discussed, during the second half of 2004, management
became aware of credit quality concerns relative to the loan portfolio of one of
its then subsidiary banks and a $3,435,000 real estate secured loan at another
of its subsidiary banks. Consequently, during that period significant increases
29
were recorded in the Corporation's loan loss provision resulting in an overall
provision of $5,102,000 for the year.
In 2005, the Corporation's external loan review firm reviewed the
larger loan relationships at the former subsidiary bank at which there were
credit quality concerns about the loan portfolio. Based on those reviews, and
further analysis and review conducted by management, significant increases were
recorded in the Corporation's loan loss provision during the last two quarters
of 2005. This resulted in a provision of $9,637,000 for the year so that, in the
opinion of management, the allowance for loan losses would be adequate to absorb
the probable losses remaining in the loan portfolio.
In 2006, the loan loss provision was reduced significantly as a result
of the initiatives begun in 2004 and improvements in problem loan administration
during the year.
Management has made numerous improvements in the lending area,
including new loan personnel, improved risk management systems, more extensive
external loan review, redesigned loan approval processes, increased use of
technology and more active management of problem and potential problem loans. In
the opinion of management, absent unforeseen changes in the local or national
economies, these changes have significantly reduced the probability that loan
loss provisions comparable to the levels recorded in 2004 and 2005 will be
needed in the future.
See "Impaired Loans," "Potential Problem Loans," "Allowance for Loan
Losses," and "The Application of Critical Accounting Policies" for further
discussion of the loans and provisions for loan losses referenced above and a
discussion of the methodology used and the factors considered by management in
its estimate of the allowance for loan losses.
Noninterest Income
Noninterest income for 2006 increased by $303,000, or 3.8%, over the
2005 amount primarily as a result of a $514,000 gain realized on the sale of
approximately $8,162,000 of loans.
Noninterest income for 2005 increased by $725,000, or 10.0%, over the
2004 amount, primarily as a result of increased mortgage brokerage income.
Interest rates associated with mortgage loans did not change significantly in
2005, and the demand for housing in the Corporation's market areas remained
strong. Service charges on deposit accounts increased by $158,000 in 2005 due to
increased management oversight of fee waivers and changes in the fee structure.
Noninterest Expenses
Noninterest expenses for 2006 increased by $1,836,000, or 10.6%, over
the 2005 amount. An increase of $1,288,000 in salaries and employee benefits was
largely responsible for this increase. In addition, marketing and supplies
expenses increased significantly as a result of the former Orangeburg bank's
name change and the consolidation of the former banking subsidiaries into the
Bank.
Noninterest expense for 2005 increased by $2,352,000 or 15.6% over the
2004 amount. Higher salaries and employee benefits expenses were largely
responsible for this increase. These items increased by $1,304,000, primarily
due to the operation of an additional office of Florence National Bank in 2005,
higher commissions and bonuses paid by the mortgage subsidiary, and the hiring
of a new Chief Executive Officer, a Chief Credit Officer, and a Human Resources
Director. Expenses related to premises and equipment increased in 2005 by
$250,000 over the 2004 amount due to higher depreciation expenses that resulted
30
from the additional office of Florence National Bank and equipment purchased and
placed in service during the year. Construction of a new headquarters office and
operations building was completed during the fourth quarter of 2005 and the
building was placed in service in the first quarter of 2006.
Income Taxes
Income tax expense for 2006 was $2,673,000, an increase of $1,908,000
over the 2005 amount. Income tax expense for 2005 decreased to $765,000 from
$1,771,000 for 2004. The decrease and subsequent increase in income tax expense
amounts resulted directly from variations in the amounts of income before income
taxes each year. The effective income tax rate (income tax expense divided by
income before income taxes) was 34.8%, 43.1%, and 35.6% for 2006, 2005 and 2004,
respectively. The effective tax rate for 2005 was abnormally high because South
Carolina required that each of the four former subsidiary banks file a separate
income tax return. One of the subsidiary banks recorded a loss for 2005. South
Carolina bank tax is based on a bank's net income for financial reporting
purposes but does not provide any offsetting benefit for operating losses.
INVESTMENT PORTFOLIO
The Corporation's investment portfolio consists primarily of short- and
intermediate-term debt issues of government-sponsored enterprises such as the
Federal Home Loan Bank, the Federal Farm Credit Bank and the Federal National
Mortgage Association. Investment securities averaged $64,446,000 in 2006,
$60,336,000 in 2005, and $58,747,000 in 2004.
The table below summarizes the amortized cost and estimated fair value
of the Corporation's investment portfolio for the past three years.
Securities Portolio Composition
December 31,
------------
2006 2005 2004
---- ---- ----
Amortized Estimated Amortized Estimated Amortized Estimated
cost fair value cost fair value cost fair value
---- ---------- ---- ---------- ---- ----------
Securities available-for sale
Government-sponsored enterprises ............... $82,145 $81,739 $55,781 $54,917 $50,619 $50,361
States and political subdivisions .............. 3,032 3,044 3,754 3,784 4,985 5,110
------- ------- ------- ------- ------- -------
Total available for sale ...................... $85,177 $84,783 $59,535 $58,701 $55,604 $55,471
======= ======= ======= ======= ======= =======
Securities held-to-maturity
States and political subdivisions .............. $ 1,750 $ 1,750 $ 1,850 $ 1,820 $ 1,925 $ 1,907
======= ======= ======= ======= ======= =======
The following is a summary of maturities and weighted average yields of
securities as of December 31, 2006:
31
Securities Portfolio Maturities and Yields
December 31, 2006
-----------------
After After
One Year Five Years
Within Through Through After
One Year Five Years Ten Years Ten Years Total
-------- ---------- --------- --------- -----
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Government-sponsored enterprises ......... $11,159 3.46% $51,561 4.88% $18,203 4.96% $ - 0.00% $80,923 4.70%
States and political subdivisions (1) .... 302 3.80% 2,634 3.87% 1,858 3.55% - 0.00% 4,794 3.74%
Mortgage-backed securities (2) ........... - 0.00% 806 3.02% - 0.00% 10 8.03% 816 3.08%
------- ------- ------- ---- -------
Total ............................... $11,461 3.47% $55,001 4.80% $20,061 4.83% $ 10 8.03% $86,533 4.63%
======= ======= ======= ==== =======
------------------
(1) Yields on tax-exempt securities of states and political subdivisions have
not been calculated on a tax-equivalent basis.
(2) Maturity category based on final stated maturity dates. Average maturity is
expected to be substantially shorter because of the monthly return of
principal on certain securities.
On an ongoing basis, management assigns securities upon purchase into
one of two categories (available-for-sale or held-to-maturity) based on intent,
taking into consideration other factors including expectations for changes in
market rates of interest, liquidity needs, asset/liability management
strategies, and capital requirements. The Corporation has never held securities
for trading purposes. No transfers of available-for-sale or held-to-maturity
securities to other categories were made in any of the years 2004 through 2006.
During 2006, the composition of the securities portfolio changed
significantly. Most notably, the amount invested in securities at year-end 2006
was approximately $26,000,000 more than the amount at the end of 2005. This
increase resulted from growth in deposits which was not matched by loan growth.
Interest rates associated with investment securities, particularly for those
with maturities in the near- to mid-term, have become more attractive in recent
years. The Bank purchased approximately $43,449,000 of securities issued by
government-sponsored enterprises throughout 2006.
During 2005, the composition of the securities portfolio was little
changed. The amount of securities held at the end of 2005 was only $3,155,000
more than the amount held at the end of 2004. Purchases for the securities
accounts during 2005 were generally made to replace issues called or matured
during the year. Securities purchased had maturities ranging from approximately
two years to approximately eight years in the future.
During the years ended December 31, 2006, 2005 and 2004, the
Corporation sold investment securities for gross proceeds of $0, $4,412,000, and
$13,676,000, respectively. Realized (losses) and gains on those transactions
were $0, ($10,000), and $76,000 for the years ended December 31, 2006, 2005 and
2004, respectively. During 2006, a security that imposed an early redemption
penalty on its issuer was redeemed early, and the Bank realized a gain of $1,000
on that transaction. Securities may be sold to provide liquidity, to reduce
interest rate risk, or for other reasons. There were no sales of
held-to-maturity securities in any of the periods presented.
All mortgage-backed securities held by the Corporation were issued by
the Federal Home Loan Mortgage Corporation, the Federal National Mortgage
Association or the Government National Mortgage Association.
32
LOAN PORTFOLIO
Management believes the loan portfolio is adequately diversified.
Nevertheless, the Bank considers that credit concentrations exist if the
outstanding direct or indirect borrowings plus any unfunded commitments to the
same, or similarly situated, loan customers exceed 25% of the Bank's capital.
This concentration threshold as of December 31, 2006 was approximately
$13,400,000. While the Bank manages its loan portfolio generally to avoid loan
concentrations, as of December 31, 2006, the Bank had loans, or commitments to
fund loans, totaling $25,797,000, or 48% of the Bank's capital, outstanding to
builders for construction of speculative 1-4 family residences. The Bank
considers the risks associated with this concentration to be mitigated by a
geographic dispersion of the properties throughout central South Carolina, a
diversity of building contractors, relatively short maturities of the loans, and
personnel experienced in construction loan administration. The Bank is aware
that changes in the economy could have an adverse impact on the housing
construction industry and on its customers' ability to service their debts.
Accordingly, management intends to systematically reduce the overall levels of
these loans.
The Bank's internal loan policy and bank regulatory guidance outline
loan-to-value requirements for normal underwriting. On occasion, the Bank may
make loans that exceed those parameters. As of December 31, 2006, $24,835,000 of
the Bank's loans, or 46% of the Bank's capital, had loan-to-value ratios that
exceeded those guidelines. Generally, these loans were made to customers with
better than average risk profiles. Loans with high loan-to-value ratios may
increase the risk inherent in our loan portfolio. Management intends to reduce
the overall level of these loans as expeditiously as possible.
The Corporation has a geographic concentration of loans within the
Bank's market area because of the nature of its business. There are no other
significant concentrations of loans in any particular individual, industry or
groups of related individuals or industries and there are no foreign loans.
The following table shows the composition of the loan portfolio by
category:
Loan Portfolio Composition
December 31,
------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(Dollars in thousands)
Commercial, financial and agricultural ............. $ 86,080 $ 95,023 $ 96,275 $ 84,844 $ 78,210
Real estate - construction ......................... 40,541 37,923 29,968 23,590 23,345
Real estate - mortgage ............................. 253,423 243,837 230,986 188,530 168,499
Consumer installment ............................... 29,676 37,201 36,420 35,142 36,430
-------- -------- -------- -------- --------
Total loans - gross .......................... $409,720 $413,984 $393,649 $332,106 $306,484
======== ======== ======== ======== ========
Commercial, financial, and agricultural loans, primarily representing
loans made to small and medium size businesses, may be made on either a secured
or an unsecured basis. When taken, security usually consists of liens on
inventories, receivables, equipment, and furniture and fixtures. Unsecured
business loans are generally short-term with emphasis on repayment strengths and
low debt-to-worth ratios. Commercial lending involves significant risk because
repayment usually depends on the cash flows generated by a borrower's business,
and debt service capacity can deteriorate because of downturns in national and
33
local economic conditions. The Bank's Loan Committee is responsible for
overseeing the credit granting and monitoring processes. The Corporation's Chief
Credit Officer has specific authority over significantly large loan requests.
Real estate loans consist of construction loans and other loans secured
by mortgages. Because the Corporation's subsidiary is a community bank, real
estate loans comprise the bulk of the loan portfolio. As shown in the preceding
table, most of the growth in the loan portfolio since the end of 2002 has been
in real estate loans. The Bank's Loan Policy generally limits loan-to-value
ratios for real estate loans to approximately 80%.
The Bank generally does not compete with 15 and 30 year fixed rate
secondary market mortgage interest rates, so it has elected to pursue the
origination of mortgage loans that could easily be sold into the secondary
mortgage market through its mortgage division. These loans are generally
pre-qualified with various underwriters to facilitate the sales process. In
2006, 2005 and 2004, the Corporation sold $238,033,000, $213,195,000, and
$174,074,000, respectively, of such loans. The Bank may originate mortgage loans
for its own loan portfolio, but such loans are usually for a shorter term than
loans originated to sell and usually have a variable rate or the terms of the
loans require that the interest rate be adjusted to the current market rate
within a three to five year term.
Consumer installment loans to individuals are generally for personal,
automobile, or household purposes and may be secured or unsecured.
Unsecured Loans
The Corporation does not aggressively seek to make unsecured loans,
since these loans may be somewhat more risky than collateralized loans. There
are, however, occasions when it is in the business interests of the Corporation
to provide short-term, unsecured loans to its most credit-worthy customers.
Unsecured loans accommodate the credit needs of those customers and provide the
bank the opportunity to earn additional interest income through pricing
commensurate with the loans' increased risk. As of December 31, 2006, the
Corporation had approximately $23,000,000, or 5.6% of its loan portfolio in
unsecured loans, substantially unchanged from approximately $23,000,000, or 5.6%
of its loan portfolio, as of December 31, 2005. Such loans are made on the basis
of management's evaluation of the customer's ability to repay and net worth.
As of December 31, 2006, unsecured loans totaling $101,000 were
included in nonaccrual loans and $317,000 of such loans were included in
potential problem loans.
Maturity and Interest Sensitivity Distribution of Loans
The following table sets forth the maturity and interest sensitivity
distribution of the Corporation's loans, by type, as of December 31, 2006 as
well as the type of interest requirement on loans due after one year.
34
December 31, 2006
-----------------
After one
Within one year but within After five
year five years years Total
---- ---------- ----- -----
(Dollars in thousands)
Commercial, financial and agricultural ............................. $ 40,218 $ 39,309 $ 6,553 $ 86,080
Real estate ........................................................ 91,961 146,185 55,818 293,964
Consumer installment ............................................... 8,998 19,947 731 29,676
-------- -------- -------- --------
Total .............................................................. $141,177 $205,441 $ 63,102 $409,720
======== ======== ======== ========
Predetermined rate, maturity greater than one year ................. $ - $157,590 $ 35,578 $193,168
Variable rate or maturity within one year .......................... $141,177 $ 47,851 $ 27,524 $216,552
Loan Sale
During 2006, as part of its ongoing loan risk management and mitigation
strategy, management considered the possibility of selling a portion of the
Corporation's loan portfolio. Management determined that there was a secondary
market demand for certain select, real estate secured credits that it might
desire to sell. After some research, it was determined that there was
approximately $8.1 million in such loans, of which $1.3 million were problem
loans and the remaining $6.8 million were potential problem loans.
In December 2006, with Board approval, this $8,162,000 of loans was
sold in a non-recourse transaction. Net of the fee for this transaction and the
aggregate specific allocation for loan losses associated with the loans of $1.5
million, the Corporation realized a gain on sale of $514,000.
As discussed in the following section, the sale resulted in a
substantial decrease in the aggregate amounts of problem and potential problem
loans during the fourth quarter.
Impaired Loans, Other Nonperforming Loans and Potential Problem Loans
Impaired loans are those loans on which, based on current information
and events, it is probable that the Corporation will be unable to collect all
amounts due according to the contractual terms of the loan agreement. Loans
which management has identified as impaired generally are nonaccrual loans.
Loans that are 90 days or more past due and still accruing interest represent
loans with significant performance issues, but where management believes that
each loan's collateral position provides enough protection that the Bank expects
full recovery of principal and interest on the loan. Following is a summary of
the Corporation's nonaccrual and other nonperforming loans included in total
loans at December 31 of each year shown:
35
December 31,
------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(Dollars in thousands)
Nonaccrual loans ................................... $ 4,714 $11,651 $ 4,941 $ 2,595 $ 796
Accruing loans 90 days or more past due ............ 232 729 137 146 1,740
------- ------- ------- ------- -------
Total ......................................... $ 4,946 $12,380 $ 5,078 $ 2,741 $ 2,536
======= ======= ======= ======= =======
Total as a % of outstanding loans ............. 1.21% 2.99% 1.29% 0.83% 0.83%
Impaired loans (included in non accrual) ........... $ 4,714 $11,651 $ 4,941 $ 2,595 $ 796
Impaired loans a percentage of allowance ........... 101.12% 100.09% 113.66% 61.70% 22.28%
for loan losses
Gross income that would have been recorded for the years ended December
31, 2006, 2005 and 2004, if nonaccrual loans had been performing in accordance
with their original terms was approximately $429,000, $448,000, and $63,000,
respectively. No material amounts of cash basis interest income were recognized
in 2006, 2005 and 2004 on non-accrual loans.
The Corporation's accounting policies on nonaccrual and impaired loans
are discussed in Note 2 to the consolidated financial statements.
Potential problem loans, a lower level of concern than impaired and
nonperforming loans, are defined as loans where information about the borrowers'
possible credit problems causes management to have serious doubts about the
borrowers' ability to comply with the present repayment terms and which may
result in disclosure in the future as impaired or non-performing loans. The
amount of potential problem loans does not represent management's estimate of
potential losses since a significant portion of these loans are secured by real
estate and other forms of collateral.
The following table is a summary of nonperforming loans and potential
problem loans for each of the past eight quarters.
36
90 Days or
More Past Due Total Percentage Percentage
Nonaccrual and Still Nonperforming of Total Potential of Total
Loans Accuring 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%
Net change ....................... (2,483) 175 (2,308) (219)
-------- -------- -------- --------
September 30, 2006 ............... 8,668 377 9,045 2.19% 22,866 5.55%
Net change ....................... (3,954) (145) (4,099) (7,475)
-------- -------- -------- --------
December 31, 2006 ................ $ 4,714 $ 232 $ 4,946 1.21% $ 15,391 3.76%
======== ======== ======== ========
Nonaccrual loans decreased by a net of $6,937,000, or 59.5%, during
2006. Most of this decrease was accomplished through charge-off during 2006 of
amounts previously recognized as nonaccrual loans.
During 2006, management focused on reviewing and establishing workout
or collection plans or providing other credit enhancements for all significant
nonperforming and potential problem loans. For some loans, that was not possible
so management chose to charge-off the remaining balances.
During the second quarter of 2006, 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.
During the third quarter of 2006, approximately $829,000 of loans were
first recognized as nonaccrual loans. Of the $2,483,000 net decrease in
nonaccrual loans during the third quarter of 2006, approximately $1,357,000 was
attributable to write-downs or charge-offs. The remainder of the net decrease
represents payments received, amounts refinanced with significant credit
enhancements and returned to accruing status, and loans paid in full during the
period.
During the fourth quarter of 2006, approximately $1,455,000 of loans
were first recognized as nonaccrual loans. In that same period $651,000 was
removed from nonaccrual status due to sales and workouts, $1,293,000 was
associated with the loan sale, and the remainder of the decrease was due to
charge-offs.
37
Management will continue to monitor the levels of nonperforming 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
nonperforming assets and potential problem loans in determining how the
provision and allowance for loan losses is estimated and adjusted. In the
opinion of management, the Company's allowance for loan losses at December 31,
2006 is adequate to provide for probable losses inherent in the loan portfolio.
At December 31, 2006, the Corporation had identified $15,391,000, or
3.76%, of the loan portfolio, as potential problem loans. This is a decrease of
$13,922,000, or 47.5%, from the amount as of December 31, 2005. Approximately
$6,800,000 of this decrease in potential problem loans was associated with the
sale of approximately $8,100,000 of potential problem loans during the fourth
quarter of 2006. The amount of potential problem loans does not represent
management's estimate of potential losses since a significant portion of these
loans are secured by real estate and other forms of collateral. Approximately
$316,000 of potential problem loans were unsecured as of December 31, 2006.
Foreclosed Assets
Foreclosed assets were carried in the consolidated balance sheets at
$591,000, $185,000, and $252,000 as of December 31, 2006, 2005 and 2004,
respectively. Foreclosed assets are initially recorded at fair value, less
estimated costs to sell, at the date of foreclosure, establishing a new cost
basis. Loan losses arising from the acquisition of such property are charged
against the allowance for loan losses as of that date. Subsequent to
foreclosure, valuations are periodically performed by management and the assets
are carried at the lower of the new cost basis or fair value, less estimated
costs to sell. Revenues and expenses from operations and changes in any
subsequent valuation allowance are included in net foreclosed assets costs and
expenses.
Special Assets Management
In late 2005, management hired an experienced Special Assets Officer on
a contract basis. The initial term of his agreement with the Corporation has
ended; however, he continues to work on an as-needed basis with the Corporation,
under the direction and supervision of the Chief Credit Officer. His efforts
during 2005 and 2006 were very helpful in reducing the aggregate level of
problem loans through all appropriate banking and legal options.
In 2007, management plans to create and fill a new position in the
credit administration area that will be dedicated to problem loan administration
and collection. It is expected that this position will be helpful in continuing
to reduce the levels of problem and potential problem loans and the amount of
time required in this area from senior loan officers.
ALLOWANCE FOR LOAN LOSSES
The table, "Analysis of the Allowance for Loan Losses," summarizes loan
balances as of the end of each period indicated, averages for each period,
changes in the allowance arising from mergers, charge-offs and recoveries by
loan category, and additions to the allowance which have been charged to
expense.
38
Years Ended December 31,
------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(Dollars in thousands)
Total amount of loans outstanding at end of year ................. $ 409,720 $ 413,984 $ 393,649 $ 332,106 $ 306,484
========= ========= ========= ========= =========
Average amount of loans outstanding .............................. $ 429,131 $ 426,384 $ 371,061 $ 340,518 $ 281,907
========= ========= ========= ========= =========
Allowance for loan losses - January 1 ............................ $ 11,641 $ 4,347 $ 4,206 $ 3,573 $ 2,830
--------- --------- --------- --------- ---------
Changes incident to merger activities ............................ - - - - 444
Transfer of allowance for off-balance-sheet
--------- --------- --------- --------- ---------
contingencies to other liabilities ..... ...................... - (305) - - -
--------- --------- --------- --------- ---------
Loans charged-off
Real estate ...................................................... 4,129 99 1,293 250 175
Installment ...................................................... 520 432 387 247 223
Credit cards and related plans ................................... - - - - -
Commercial and other ............................................. 6,716 1,714 3,400 163 374
--------- --------- --------- --------- ---------
Total charge-offs ................................................ 11,365 2,245 5,080 660 772
--------- --------- --------- --------- ---------
Recoveries
Real estate ...................................................... 698 16 21 105 1
Installment ...................................................... 115 55 67 58 20
Credit cards and related plans ................................... - - - - -
Commercial and other ............................................. 623 136 31 11 17
--------- --------- --------- --------- ---------
Total recoveries ................................................. 1,436 207 119 174 38
--------- --------- --------- --------- ---------
Net charge-offs .................................................. 9,929 2,038 4,961 486 734
--------- --------- --------- --------- ---------
Provision for loan losses charged to expense ..................... 2,950 9,637 5,102 1,119 1,033
--------- --------- --------- --------- ---------
Allowance for loan losses - December 31 .......................... $ 4,662 $ 11,641 $ 4,347 $ 4,206 $ 3,573
========= ========= ========= ========= =========
Ratios
Net charge-offs to average loans outstanding ..................... 2.31% 0.48% 1.34% 0.14% 0.26%
Net charge-offs to loans outstanding at end of year .............. 2.42% 0.49% 1.26% 0.15% 0.24%
Allowance for loan losses to average loans ....................... 1.09% 2.73% 1.17% 1.24% 1.27%
Allowance for loan losses to total loans at end of year .......... 1.14% 2.81% 1.10% 1.27% 1.17%
Net charge-offs to allowance for losses .......................... 212.98% 17.51% 114.12% 11.55% 20.54%
Net charge-offs to provision for loan losses ..................... 336.58% 21.15% 97.24% 43.43% 71.06%
A discussion of the allocation of the allowance for loan losses is set
forth under the section "The Application of Critical Accounting Policies."
39
The Corporation operates a community bank in South Carolina under a
national bank charter. Under the provisions of law and regulations governing
banks, the bank's board of directors is responsible for determining the adequacy
of its loan loss allowance. In addition, the bank is supervised and regularly
examined by the Office of the Comptroller of the Currency (the "OCC"), the
primary regulator for national banks. As a normal part of a safety and soundness
examination, bank examiners assess and comment on the adequacy of a bank's
allowance for loan losses and may require that changes be made in the allowance.
It is the policy of the Corporation and its subsidiary bank to maintain
an allowance for loan losses which achieves the following objectives:
o Maintenance of the allowance at a level that is adequate to absorb all
estimated inherent losses in the loan and lease portfolio and all
unfunded and off balance sheet commitments;
o Evaluation and calculation of the adequacy of the allowance with a
sound and consistent analytical framework based on historical data
adjusted for current conditions in conformity with generally accepted
accounting practices and all applicable banking and regulatory
guidance; and
o Reflection in the allowance of all significant, existing conditions
affecting the ability of borrowers to repay their obligations.
Management reviews its allowance for loan losses utilizing three broad
loan categories: commercial, real estate and consumer installment loans. Within
these categories, the allowance for loan losses is composed of specific
allocations and general loan pool amounts. Specific allocation is done for
larger loans within each loan risk category. The commercial and real estate risk
pools are driven by credit risk grade classification. The consumer loan pools
are based on payment performance. The allowance assigned to these pools is based
on historical losses for each of the pools and industry standards. Other factors
considered are changes in policies and procedures, economic conditions,
portfolio changes, lending personnel experience, trend analysis, credit
concentrations, external factors, and the reports of the loan review system.
The loan risk grading system requires that lending officers assign a
risk grade, on a loan-by-loan basis, considering information about the
borrower's capacity to repay, collateral, payment history, and other known
factors. Assigned risk grades are updated monthly for any known changes in
circumstances affecting the borrower or the loan. The risk grading system is
monitored on a continuing basis by management and the external credit review
firm, which is independent of the lending function. During their 2006 review,
the external credit review firm recommended relatively few loan risk grade
changes to higher risk categories.
The following table presents the allocation of the Corporation's
allowance for loan losses, as of December 31, 2002 through 2006, compared with
the percentage of loans in the applicable categories to total loans.
40
December 31,
------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(Dollars in thousands)
Amount allocated to loan category
Commercial, financial and agricultural .................. $ 1,050 $ 6,333 $ 1,960 $ 1,796 $ 1,479
Real estate ............................................. 3,076 4,831 1,907 1,800 1,548
Consumer installment .................................... 536 477 480 610 546
------- ------- ------- ------- -------
Total .............................................. $ 4,662 $11,641 $ 4,347 $ 4,206 $ 3,573
======= ======= ======= ======= =======
December 31,
------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Percentage of loans in category
Commercial, financial and agricultural .................. 21.0% 23.0% 24.5% 25.5% 25.5%
Real estate ............................................. 71.8% 68.0% 66.3% 63.9% 62.6%
Consumer installment .................................... 7.2% 9.0% 9.2% 10.6% 11.9%
----- ----- ----- ----- -----
Total .............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
===== ===== ===== ===== =====
The following discussion presents specific factors that influenced
management's judgment of the amounts of additions to the allowance through
provisions charged to operating expenses for each of the years presented in the
table.
In 2002, $1,033,000 was provided for loan losses due to growth in the
loan portfolio totaling $76,579,000, of which approximately $44,078,000 was
obtained in the merger with Ridgeway Bankshares, Inc. Furthermore, net
charge-offs almost tripled compared with the prior year and an increase of
$5,827,000 was noted in the combined amounts of nonaccrual loans, accruing loans
90 or more days past due, and potential problem loans.
In 2003, $1,119,000 was provided for loan losses, primarily due to
growth in the loan portfolio and a significant increase in the amount of
nonaccrual loans.
The $5,102,000 and $9,637,000 provisions for loan losses recorded for
2004 and 2005, respectively, resulted from the circumstances detailed above.
In 2006, $2,950,000 was provided for loan losses, primarily due to
identified weaknesses in the loan portfolio and recognized shortfalls in
collateral values.
DEPOSITS
The average deposits for the Corporation for the years ended December
31, 2006, 2005 and 2004 are summarized below:
41
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Average Average Average Average Average Average
balance cost balance cost balance cost
------- ---- ------- ---- ------- ----
(Dollars in thousands)
Noninterest-bearing demand ..................... $ 60,099 - $ 64,339 - $ 61,220 -
Interest bearing transaction accounts .......... 70,561 1.12% 60,785 0.74% 54,918 0.41%
Savings - regular .............................. 20,327 0.77% 24,617 0.46% 20,106 0.54%
Savings - money market ......................... 70,737 3.28% 64,790 1.98% 60,428 1.17%
Time deposits less than $100 ................... 147,227 4.11% 136,087 2.97% 122,125 2.26%
Time deposits greater than $100 ................ 94,866 4.12% 89,540 3.19% 68,165 2.20%
-------- -------- --------
Total average deposits ......................... $463,817 $440,158 $386,962
======== ======== ========
Deposits are the primary source of funds for the Bank's lending and
investing activities. Deposits are attracted principally from customers within
the Bank's local market areas through the offering of a variety of products with
varying features and by offering competitive interest rates.
At December 31, 2006 the Corporation had $97,986,000 in certificates of
deposit of $100,000 or more. Approximately $34,821,000 mature within three
months, $28,307,000 mature over three through six months, $29,668,000 mature
over six months through twelve months and $5,190,000 mature after one year. This
level of large time deposits, as well as the growth in other deposits, can be
attributed to planned growth by management. The majority of time deposits
$100,000 and over is acquired within the Company's market areas in the ordinary
course of business from customers with standing banking relationships. However,
as of December 31, 2006, the Bank had $1,015,000 in brokered certificates of
deposit, all of which were issued in denominations of $100,000 or over. The
brokered certificates of deposit mature in the first quarter of 2007 and have an
interest rate of 4.50%. It is a common industry practice not to consider time
deposits of $100,000 or more as core deposits since their retention can be
influenced heavily by rates offered. Therefore, such deposits have the
characteristics of shorter-term purchased funds. Certificates of deposit
$100,000 and over require that the Corporation achieve and maintain an
appropriate matching of maturity distributions and a diversification of sources
to achieve an appropriate level of liquidity.
SHORT-TERM BORROWINGS
The Corporation's short-term borrowings may consist of federal funds
purchased and securities sold under agreements to repurchase, which generally
have maturities ranging from daily to no more than four days, and general
purpose lines of credit payable. As of December 31, 2006, short-term borrowings
consisted solely of securities sold under agreements to repurchase totaling
$12,948,000. These amounts are collateralized by investment securities and the
interest rate is subject to change daily.
Summary information about total short-term borrowings is provided in
the following table.
42
December 31,
------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Balance outstanding at end of year ........................................ $12,948 $ 8,975 $ 6,662
Weighted average interest rate at end of the period ....................... 4.00% 4.26% 1.54%
Interest expense .......................................................... $ 400 $ 198 $ 205
Maximum outstanding at any month-end during the period .................... $14,058 $ 8,975 $17,940
Average outstanding during the period ..................................... $13,680 $ 8,584 $10,309
Weighted average interest rate during the period .......................... 2.92% 2.31% 1.99%
LONG-TERM DEBT
The Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLB").
As such, it has access to long-term borrowing from the FHLB. As of December 31,
2006, the Bank had borrowed a total of $15,878,000 from the FHLB. The borrowings
are secured by blanket liens on all qualifying first lien residential mortgage
loans held by the Bank, specifically excluding such loans originated for resale
on the secondary market.
During the second quarter of 2004, the Corporation sponsored the
creation of SCB Capital Trust I (the "Trust"). The Trust issued securities
totaling $10,310,000. The Trust invested the proceeds of its debt issuance by
purchasing a like amount of junior subordinated debt issued by the Corporation.
The amount of the Corporation's debt is includible in Tier 1 capital for
purposes of computing the Corporation's regulatory required capital ratios.
RETURN ON EQUITY AND ASSETS
The following table shows the return on assets (net income divided by
average total assets), return on equity (net income divided by average equity),
dividend payout ratio (dividends declared per share divided by net income per
share), and equity to assets ratio (average equity divided by average total
assets) for the years ended December 31, 2006, 2005 and 2004.
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Return on assets (ROA) .................... 0.89% 0.19% 0.67%
Return on equity (ROE) .................... 9.80% 1.94% 6.41%
Dividend payout ratio ..................... 38.94% 173.91% 54.05%
Equity as a percent of assets ............. 9.12% 9.71% 10.48%
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 on the ability to attract deposits
within the Bank's market area. Core deposits (total deposits less certificates
43
of deposit of $100,000 or more) provide a relatively stable funding base.
Certificates of deposit of $100,000 or more are generally more sensitive to
changes in rates, so they must be monitored carefully. Asset liquidity is
provided by several sources, including amounts due from banks, federal funds
sold, and investments available-for-sale.
The Corporation maintains an available-for-sale investment securities
portfolio. While investment securities purchased for this portfolio are
generally purchased with the intent to be held to maturity, such securities are
marketable and occasional sales may occur prior to maturity as part of the
process of asset/liability and liquidity management. The Corporation also
occasionally designates securities as held-to-maturity. Securities in that
portion of the portfolio are generally not considered a primary source of
liquidity. Management deliberately maintains a relatively short-term maturity
schedule for its investments so that there is a continuing stream of maturing
investments that enables the Corporation to supply liquidity to its loan
portfolio and for customer withdrawals. In addition, to the extent that the
Corporation must maintain continuing positions in investment securities due to
pledging or other requirements, regular periodic maturities of investments helps
to ensure that the Corporation invests funds throughout periods of changing
rates which tends to mitigate the effects such changes have on the fair values
of investment securities.
The Corporation has substantially more liabilities maturing in the next
12 months than it has assets maturing in the same period. The Corporation also
has legal obligations to extend credit pursuant to loan commitments, lines of
credit and standby letters of credit which totaled $21,833,000, $49,104,000, and
$2,545,000, respectively, at December 31, 2006 (see Note 15 to the consolidated
financial statements). However, based on its historical experience, and that of
similar companies, the Corporation believes that it is unlikely that so many
deposits would be withdrawn, without being replaced by other deposits, and
extensions of credit would be required, that the Corporation would be unable to
meet its liquidity needs with the proceeds of maturing assets, in the ordinary
course of business.
The Corporation also maintains various federal funds lines of credit
with correspondent banks and is able to borrow from the Federal Home Loan Bank
of Atlanta and the Federal Reserve's discount window.
The Corporation, through the Bank, has a demonstrated ability to
attract deposits from its market area. Deposits grew from $255,433,000 as of
December 31, 2001 to $483,621,000 as of December 31, 2006, a five year compound
growth rate of 13.6%. This consistently growing base of deposits is the major
source of operating liquidity.
CAPITAL
Dividends
The Corporation exists as a legal entity distinct from its
subsidiaries. Its main sources of revenues consist of service fees and dividends
paid to it by the Bank. The Bank is subject to various laws and regulations that
limit the amounts of dividends that it may pay. In addition, the Corporation and
the Bank are each subject to regulatory minimum capital adequacy guidelines.
These regulatory restrictions have not historically hindered the Corporation's
or the Bank's ability to pay reasonable dividends and no such restrictions are
anticipated in 2007.
44
During 2006, the Corporation received dividends from the Bank totaling
$2,480,000. Subject to restrictions imposed by federal regulations, the Board of
Directors of the Bank could have declared additional dividends from retained
earnings of up to approximately $5,606,000 as of December 31, 2006. As of
January 1, 2007, the effect of those restrictions was to further restrict the
amount of dividends that the Bank could declare to $3,424,000. The Corporation
made dividend payments to shareholders of $1,952,000, $1,761,000 and $1,744,000
during 2006, 2005 and 2004, respectively.
Capital Adequacy
The Federal Reserve and federal bank regulatory agencies have adopted
risk-based capital standards for assessing the capital adequacy of bank holding
companies and financial institutions. Under the risk-based capital requirements,
the Corporation and the Bank are required to maintain a minimum ratio of total
capital to risk-weighted assets (including certain off-balance-sheet activities,
such as letters of credit) of 8%. At least half of total capital must be
composed of common equity, retained earnings and qualifying perpetual preferred
stock and certain hybrid instruments, less certain intangibles ("Tier 1
Capital"). The remainder may consist of certain subordinated debt or hybrid
capital instruments, qualified preferred stock and a limited amount of the
allowance for loan losses ("Tier 2 Capital," which, along with Tier 1 Capital,
composes "Total Capital"). Unrealized gains and losses on available-for-sale
securities generally are excluded from the calculation of the risk-based capital
ratios. To be considered well-capitalized under the risk-based capital
guidelines, a bank must maintain a total risk-weighted capital ratio of at least
10% and a Tier 1 risk-weighted ratio of at least 5%.
Each of the Federal bank regulatory agencies also has established
minimum leverage capital requirements for banking organizations. Pursuant to
these requirements, banking organizations generally must maintain a minimum
ratio of Tier 1 Capital to adjusted average quarterly assets equal to from 4% to
5%, subject to federal bank regulatory evaluation of the institution's overall
safety and soundness.
Federal regulators may categorize an institution as less than
well-capitalized based on subjective criteria. Management believes that there
are no conditions or events that would cause the Corporation's or the Bank's
capital category to be other than resulting from meeting the minimum ratio
requirements.
Under the risk-based capital standards and pursuant to the provisions
of the Federal Deposit Insurance Corporation Improvement Act of 1991, federal
bank regulatory agencies are required to implement prescribed "prompt corrective
actions" if an institution's capital position deteriorates to specified levels.
The corrective actions become increasingly stringent as the capital position
continues to deteriorate.
The Bank is considered to be "well capitalized" for regulatory
purposes. Detailed information on the Corporation's and the Bank's capital
positions can be found in Note 19 to the consolidated financial statements.
During the first quarter of 2004, the Corporation acquired $10,310,000
in proceeds from the issuance of junior subordinated debt. Of this amount,
$3,000,000 was used to provide additional capital to two of the former bank
subsidiaries, approximately $1,400,000 was used to repay a short-term line of
45
credit of the mortgage subsidiary and approximately $635,000 was used to repay
the Corporation's short-term borrowings. The remainder is being used for the
Corporation's general corporate purposes. Under current Federal Reserve policy,
the Corporation is allowed to treat the junior subordinated debt, subject to
certain limitations, as Tier 1 Capital for capital adequacy purposes.
INFLATION
The assets and liabilities of the Corporation are mostly monetary in
nature. Accordingly, the financial results and operations of the Corporation are
much more affected by changes in interest rates than changes in inflation. There
is, however, a strong correlation between increasing inflation and increasing
interest rates. The rate of inflation, as measured by the average change in the
Consumer Price Index for All Urban Consumers, has been moderate over the past
several years, about 3.2% in 2006, 3.4% in 2005 and 3.3% in 2004. Prospects
appear reasonable for continued moderate inflation, despite risks related to
energy prices and the political and military situation in the Middle East.
Although inflation does not normally affect a financial institution as
dramatically as it does businesses with large investments in plants and
inventories, it does have an effect. During periods of high inflation there are
usually corresponding increases in the money supply and banks experience
above-average growth in assets, loans, and deposits. General increases in the
prices of goods and services also result in increased operating expenses.
Further, inflation may adversely affect the Corporation's customers and
indirectly affect the business of the Corporation.
OFF-BALANCE-SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
The Corporation presently only engages in limited off-balance sheet
arrangements. Such arrangements are defined as potentially material
transactions, agreements, or other contractual arrangements which the
Corporation has entered into to which an entity unconsolidated with the
registrant is a party and, under which the Corporation, whether or not it is a
party to the arrangement, has, or in the future may have:
o any obligation under a direct or indirect guarantee or similar
arrangement;
o a retained or contingent interest in assets transferred to an
unconsolidated entity or similar arrangement that serves as credit,
liquidity or market risk support to such entity for such assets;
o derivatives, to the extent that the fair value thereof is not fully
reflected as a liability or asset in the financial statements; or
o any obligation, including a contingent obligation, arising out of a
variable interest (as referenced in FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (January 2003), as may be
modified or supplemented), in an unconsolidated entity that is held
by, and material to, the registrant, where such entity provides
financing, liquidity, market risk or credit support to, or engages in
leasing, hedging or research and development services with, the
Corporation.
The Corporation's off-balance sheet arrangements presently include only
commitments to extend credit and standby letters of credit. Such instruments
have elements of credit risk in excess of the amount recognized in the balance
sheet. The exposure to credit loss in the event of nonperformance by the other
parties to these instruments is represented by the contractual, or notional,
amount of those instruments. Generally, the same credit policies used for
on-balance sheet instruments, such as loans, are used in extending loan
46
commitments and letters of credit. The following table sets out the contractual
or notional amounts of those arrangements:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Loan commitments ................................... $21,833 $13,386
Unfunded commitments under lines of credit ......... 49,104 42,974
Standby letters of credit .......................... 2,545 2,024
Loan commitments involve 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 some
involve payment of a fee. Many of the commitments are expected to expire without
being fully drawn; therefore, the total amount of loan commitments does not
necessarily represent future cash requirements. Each customer's creditworthiness
is evaluated on a case-by-case basis. The amount of collateral obtained, if any,
upon extension of credit is based on management's credit evaluation of the
borrower. Collateral held varies but may include commercial and residential real
properties, accounts receivable, inventory and equipment.
Standby letters of credit are conditional commitments to guarantee the
performance of a customer to a third party. The credit risk involved in issuing
standby letters of credit is the same as that involved in making loan
commitments to customers.
As described under "Liquidity," management believes that its various
sources of liquidity provide the resources necessary for the Bank to fund the
loan commitments and to perform under standby letters of credit, if the need
arises.
The Corporation's contractual obligations are summarized in the
following table.
December 31, 2006
-----------------
Less than 1 Over 1 to 3 Over 3 to 5 After 5
Total Year Years Years Year
----- ---- ----- ----- ----
(Dollarsin thousands)
Contractual Obligations
Time deposits ................................. $243,708 $226,471 $ 15,111 $ 2,107 $ 19
Long-term debt ................................ 26,188 1,000 4,500 7,200 13,488
Operating lease obligations ................... 6,179 483 653 472 4,571
-------- -------- -------- -------- --------
Total ......................................... $276,075 $227,954 $ 20,264 $ 9,779 $ 18,078
======== ======== ======== ======== ========
In March 2007, the Bank entered into an agreement to construct a new
branch banking office on Clemson Road in northeast Richland County for a cost of
approximately $800,000. Completion of the project is expected by the fourth
quarter of 2007.
47
THE APPLICATION OF CRITICAL ACCOUNTING POLICIES
The consolidated financial statements are based on the selection and
application of accounting principles generally accepted in the United States of
America, which require management to make estimates and assumptions about future
events that affect the amounts reported in the financial statements and
accompanying notes. Future events and their effects cannot be determined with
absolute certainty. Therefore, the determination of estimates requires the
exercise of judgment. Actual results could differ from those estimates, and any
such differences may be material to the financial statements. Management
believes that the policy relating to the allowance for loan losses discussed in
the section entitled "Allowance for Loan Losses" may involve a higher degree of
judgment and complexity in its application and represents a critical accounting
policy used in the preparation of the Corporation's financial statements. In
addition, the valuation of deferred tax assets represents a similar critical
accounting policy. If different assumptions or conditions were to prevail, the
results could be materially different from the reported results.
IMPACT OF RECENT ACCOUNTING CHANGES
Hybrid Financial Instruments - The provisions of Statement of Financial
Accounting Standards No. 155 ("SFAS No. 155"), "Accounting for Certain Hybrid
Financial Instruments, an amendment of FASB Statements No. 133 and 140," are
effective January 1, 2007. SFAS No. 155 simplifies the accounting for certain
financial instruments containing embedded derivatives. SFAS No. 155 allows fair
value measurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." In addition, it
amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" to allow a qualifying special-purpose entity
to hold a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. The adoption of the
Statement is not expected to have a material effect on the Company's
consolidated financial statements.
Servicing of Financial Assets - The provisions of Statement of
Financial Accounting Standards No. 156 ("SFAS No. 156"), "Accounting for
Servicing of Financial Assets, an amendment of FASB Statement No. 140" are
effective January 1, 2007. This Statement potentially simplifies the accounting
for separately recognized loan servicing assets and liabilities and any
financial instruments used to hedge risks associated with those assets and
liabilities. Under SFAS 156, separately recognized servicing assets and
liabilities are accounted for initially at fair value, if practicable, and
subsequently are accounted for either at fair value or amortized over the
economic lives of the related loans. If the fair value method of subsequent
valuation is elected, SFAS No. 156 permits income statement recognition of the
potential offsetting changes in the fair values of the financial servicing
rights and liabilities and the derivative instruments used to hedge them in the
same accounting period. The Company currently has no separately recognized loan
servicing rights or liabilities and adoption in 2007 is not expected to have any
effect on the Company's consolidated financial statements.
Fair Value Measurements - The provisions of Statement of Financial
Accounting Standards No. 157 ("SFAS No. 157"), "Fair Value Measurements," are
effective for fiscal years beginning after November 15, 2007 (January 1, 2008
for the Company). SFAS No. 157 defines fair value and establishes a framework
for measuring fair value in GAAP. The Statement describes fair value as being
based on a hypothetical transaction to sell an asset or transfer a liability at
48
a specific measurement date, as considered from the perspective of a market
participant who holds the asset or owes the liability (an exit price
perspective). In addition, fair value should be viewed as a market-based
measurement, rather than an entity-specific measurement. Therefore, fair value
should be determined based on the assumptions that market participants would use
in pricing an asset or liability, including all risks and restrictions that may
be associated with that asset or liability. SFAS No. 157 does not amend the
definition of fair value used in conjunction with Share-Based Payments accounted
for under SFAS No. 123(R). The adoption of SFAS No. 157 in 2008 is not expected
to have a material effect on the Company's consolidated financial statements.
Accounting for Uncertainty in Income Taxes - The provisions of
Financial Accounting Standards Board Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109," clarify the accounting for uncertainty in income tax positions. FIN 48
prescribes a two-step evaluation process that includes both a recognition
threshold and a measurement attribute for tax positions taken or expected to be
taken in a tax return. The provisions of FIN 48 are effective for the Company as
of January 1, 2007. The adoption of FIN 48 is not expected to have a material
effect on the Company's consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices
and rates. The Corporation'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 the
Corporation 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 the Corporation'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.
Achieving consistent growth in net interest income is the primary goal
of the Corporation's asset/liability function. The Corporation attempts to
control the mix and maturities of assets and liabilities to achieve consistent
growth in net interest income despite changes in market interest rates. The
Corporation seeks to accomplish this goal while maintaining adequate liquidity
and capital. The Corporation's asset/liability mix is sufficiently balanced so
that the effect of interest rates moving in either direction is not expected to
be material over time.
The Corporation's Asset/Liability Committee uses a simulation model to
assist in achieving consistent growth in net interest income while managing
interest rate risk. The model takes into account interest rate changes as well
as changes in the mix and volume of assets and liabilities. The model simulates
the Corporation's balance sheet and income statement under several different
rate scenarios. The model's inputs (such as interest rates and levels of loans
and deposits) are updated on a quarterly basis in order to obtain the most
accurate forecast possible. The forecast presents information over a
twelve-month period. It reports a base case in which interest rates remain flat
and variations that occur when rates increase and decrease 100, 200 and 300
basis points. According to the model, as of December 31, 2006 the Corporation is
positioned so that net interest income would decrease $15,000 and net income
would decrease $11,000 if interest rates were to rise 100 basis points in the
next twelve months. Conversely, net interest income would increase $15,000 and
net income would increase $11,000 if interest rates were to decline 100 basis
points. Computation of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
49
rates and loan prepayment, and should not be relied upon as indicative of actual
results. Further, the computations do not contemplate any actions the
Corporation could undertake in response to changes in interest rates or the
effects of responses by others, including borrowers and depositors.
The following table summarizes the Corporation's interest sensitivity
position as of December 31, 2006.
Interest Sensitivity Analysis
Within 3 Within 4-12 Within 1-5
months months years Over 5 years Total
------ ------ ----- ------------ -----
(Dollars in thousands)
Interest earning assets
Interest-bearing deposits ...................... $ 1,926 $ - $ - $ - $ 1,926
Taxable investment securities .................. 3,988 7,977 51,561 18,213 81,739
Tax exempt investment securities ............... 100 202 2,634 1,858 4,794
Other investments .............................. 3,246 - - - 3,246
Federal funds sold ............................. 29,102 - - - 29,102
Loans held for sale (1) ........................ 9,235 - - - 9,235
Loans (2) ...................................... 172,166 42,009 156,044 34,787 405,006
--------- --------- --------- --------- ---------
Total interest earning assets .................. 219,763 50,188 210,239 54,858 535,048
--------- --------- --------- --------- ---------
Interest bearing liabilities
Savings ........................................ $ 97,168 $ - $ - $ - $ 97,168
Interest bearing transaction accounts .......... 81,052 - - - 81,052
Time deposits < $100 ........................... 41,197 92,479 12,027 19 145,722
Time deposits > $100 ........................... 34,821 57,975 5,190 - 97,986
Short-term borrowings .......................... 12,948 - - - 12,948
Long-term debt ................................. 11,310 - 11,700 3,178 26,188
--------- --------- --------- --------- ---------
Total interest bearing liabilities ............. 278,496 150,454 28,917 3,197 461,064
--------- --------- --------- --------- ---------
Interest sensitivity gap ....................... $ (58,733) $(100,266) $ 181,322 $ 51,661 $ 73,984
Cumulative gap ................................. $ (58,733) $(158,999) $ 22,323 $ 73,984
RSA/RSL (3) .................................... 79% 33%
Cumulative RSA/RSL (3) ......................... 79% 63%
---------
(1) Loans held for sale are reflected in the period of expected sale.
(2) Excludes nonaccrual loans totaling $4,714,000.
(3) RSA- rate sensitive assets; RSL- rate sensitive liabilities
The above table reflects the balances of interest earning assets and
interest bearing liabilities at the earlier of their repricing or maturity
dates. Amortizing fixed rate loans are reflected at the scheduled maturity date.
Variable rate amortizing loans are reflected at the earliest date at which they
may be repriced contractually. Deposits in other banks and debt securities are
reflected at each instrument's ultimate maturity date. Overnight federal funds
sold are reflected as instantly repriceable. Interest bearing liabilities with
no contractual maturity, such as savings deposits and interest bearing
transaction accounts, are reflected in the earliest repricing period. Fixed rate
time deposits are reflected at their maturity dates.
The static interest rate sensitivity gap position, while not a complete
measure of interest sensitivity, is also reviewed periodically to provide
insights related to the static repricing structure of the Bank's assets and
liabilities. At December 31, 2006 on a cumulative basis through twelve months,
50
rate sensitive liabilities exceeded rate sensitive assets by $158,999,000. This
liability sensitive position is largely due to the assumption that the Bank's
$178,220,000 in interest bearing transaction accounts, savings accounts, and
money market accounts will reprice within a year. This assumption may or may not
be valid, since these accounts vary greatly in their sensitivity to interest
rate changes in the market. Rising interest rates would be likely to diminish
net interest income of banks in a liability sensitive position if the assumption
is valid and in the absence of other factors which would be likely to occur.
The Market Risk table, which follows this discussion, shows the
Corporation's financial instruments that are sensitive to changes in interest
rates. The Corporation uses certain assumptions to estimate fair values and
expected maturities. For assets, expected maturities are based upon contractual
maturity, projected repayments, and prepayment of principal and potential calls.
For core deposits without contractual maturity (i.e., interest checking, savings
and money market accounts), the table presents principal cash flows based on
management's judgment concerning their most likely runoff. The actual maturities
and runoff could vary substantially if future prepayments, runoff and calls
differ from the Corporation's historical experience.
51
December 31, 2006
-----------------
2006 Year-
End
Average Estimated
Rate 2007 2008 2009 2010 2011 Thereafter Balance Fair Value
---- ---- ---- ---- ---- ---- ---------- ------- ----------
(Dollars in thousands)
Interest earning assets
Interest-bearing deposits
with other banks ..................... 5.15% $ 1,926 $ - $ - $ - $ - $ - $ 1,926 $ 1,926
Investment securities .................. 4.63% 11,461 15,834 9,681 10,295 19,191 20,071 86,533 86,533
Federal funds sold ..................... 5.13% 29,102 - - - - - 29,102 29,102
Loans held for sale .................... 7.52% 9,235 - - - - - 9,235 9,235
Loans .................................. 7.69% 138,875 39,116 61,096 55,900 48,081 66,652 409,720 404,383
Interest bearing liabilities
Savings ................................ 2.85% $ 97,168 $ - $ - $ - $ - $ - $ 97,168 $ 97,168
Interest bearing
transaction accounts .... ............ 1.03% 81,052 - - - - - 81,052 81,052
Time deposits .......................... 4.52% 226,471 12,610 2,501 1,356 751 19 243,708 244,259
-------- ------- ------ ------ -------- ------- -------- --------
Total interest bearing deposits ........ 3.46% 404,691 12,610 2,501 1,356 751 19 421,928 422,479
Short-term borrowings .................. 4.00% 12,948 - - - - - 12,948 12,948
Long-term debt ......................... 6.45% 1,000 2,500 2,000 7,200 - 13,488 26,188 27,236
52
Item 8. Financial Statements and Supplementary Data
COMMUNITY BANKSHARES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Registered Public Accounting Firm ............... 54
Consolidated Balance Sheets, December 31, 2006 and 2005 ............... 55
Consolidated Statements of Income, Years Ended December 31,
2006, 2005, and 2004 ............................................. 56
Consolidated Statements of Changes in Shareholders' Equity,
Years Ended December 31, 2006, 2005, and 2004 .................... 57
Consolidated Statements of Cash Flows, Years Ended December 31,
2006, 2005, and 2004 ............................................. 58
Notes to Consolidated Financial Statements ............................ 59 - 93
53
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and
Board of Directors of
Community Bankshares, Inc.
We have audited the accompanying consolidated balance sheets of Community
Bankshares, Inc. and subsidiaries as of December 31, 2006 and 2005, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
2006. These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Community
Bankshares, Inc. and subsidiaries at December 31, 2006 and 2005, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles.
Columbia, South Carolina s/ J. W. Hunt and Company LLP
March 29, 2007
54
COMMUNITY BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Assets
Cash and due from banks ............................................................. $ 17,622 $ 19,508
Federal funds sold .................................................................. 29,102 32,483
--------- ---------
Total cash and cash equivalents ............................................... 46,724 51,991
Interest-bearing deposits with other banks .......................................... 1,926 1,038
Securities available-for-sale ....................................................... 84,783 58,701
Securities held-to-maturity (estimated fair value
$1,750 for 2006 and $1,820 for 2005) ................................................ 1,750 1,850
Other investments ................................................................... 3,246 2,980
Loans held for sale ................................................................. 9,235 12,447
Loans, net of allowance for loan
losses of $4,662 for 2006 and $11,641 for 2005 ...................................... 405,058 402,343
Premises and equipment - net ........................................................ 10,307 9,412
Accrued interest receivable ......................................................... 3,821 3,134
Net deferred income tax assets ...................................................... 1,231 3,655
Goodwill ............................................................................ 4,321 4,321
Core deposit intangible assets ...................................................... 2,591 2,837
Prepaid expenses and other assets ................................................... 3,524 2,127
--------- ---------
Total assets .................................................................. $ 578,517 $ 556,836
========= =========
Liabilities
Deposits
Demand, noninterest-bearing ...................................................... $ 61,693 $ 67,146
Interest-bearing transaction accounts ............................................ 81,052 77,858
Savings .......................................................................... 97,168 83,717
Certificates of deposit of $100 and over ......................................... 97,986 98,428
Other time deposits .............................................................. 145,722 137,060
--------- ---------
Total deposits ................................................................ 483,621 464,209
Short-term borrowings ............................................................... 12,948 8,975
Long-term debt ...................................................................... 26,188 32,196
Accrued interest payable ............................................................ 1,578 1,212
Accrued expenses and other liabilities .............................................. 1,558 1,252
--------- ---------
Total liabilities ............................................................. 525,893 507,844
--------- ---------
Commitments and contingent liabilities
Shareholders' equity
Common stock - no par value, 12,000,000 authorized shares;
issued and outstanding - 4,441,220 shares for 2006
and 4,404,303 shares for 2005 ..................................................... 30,603 30,202
Retained earnings ................................................................... 22,382 19,325
Accumulated other comprehensive income (loss) ....................................... (361) (535)
--------- ---------
Total shareholders' equity .................................................... 52,624 48,992
--------- ---------
Total liabilities and shareholders' equity .................................... $ 578,517 $ 556,836
========= =========
See accompanying notes to consolidated financial statements.
55
COMMUNITY BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands, except per share)
Interest and dividend income
Loans, including fees ............................................ $ 32,785 $ 28,955 $ 22,821
Interest-bearing deposits with other banks ....................... 118 49 20
Debt securities
Taxable ...................................................... 2,316 1,643 1,441
Tax exempt ................................................... 180 215 312
Dividends ........................................................ 154 115 77
Federal funds sold ............................................... 1,501 629 203
-------- -------- --------
Total interest and dividend income ........................ 37,054 31,606 24,874
-------- -------- --------
Interest expense
Deposits
Interest-bearing transaction accounts ........................ 793 452 225
Savings ...................................................... 2,476 1,393 814
Certificates of deposit of $100 and over ..................... 3,911 2,852 1,498
Other time deposits .......................................... 6,058 4,043 2,765
-------- -------- --------
Total interest on deposits ................................ 13,238 8,740 5,302
Short-term borrowings ............................................ 400 198 205
Long-term debt ................................................... 1,863 1,867 1,524
-------- -------- --------
Total interest expense .................................... 15,501 10,805 7,031
-------- -------- --------
Net interest income ................................................... 21,553 20,801 17,843
Provision for loan losses ............................................. 2,950 9,637 5,102
-------- -------- --------
Net interest income after provision ................................... 18,603 11,164 12,741
-------- -------- --------
Noninterest income
Service charges on deposit accounts .............................. 3,539 3,395 3,237
Mortgage brokerage income ........................................ 3,518 3,699 3,128
Gains (losses) on sales of securities ............................ 1 (10) 76
Gains on sales of loans .......................................... 514 - -
Deposit box rent ................................................. 55 52 51
Bank card fees ................................................... 22 35 30
Loan related insurance commissions ............................... 51 78 83
Other ............................................................ 606 754 673
-------- -------- --------
Total noninterest income .................................. 8,306 8,003 7,278
-------- -------- --------
Noninterest expenses
Salaries and employee benefits ................................... 10,820 9,532 8,228
Premises and equipment ........................................... 2,233 2,271 2,021
Marketing ........................................................ 537 421 445
Regulatory fees .................................................. 313 275 247
Supplies ......................................................... 640 261 288
Director fees .................................................... 287 312 298
FDIC insurance ................................................... 57 57 54
Other ............................................................ 4,340 4,262 3,458
-------- -------- --------
Total noninterest expenses ................................ 19,227 17,391 15,039
-------- -------- --------
Income before income taxes ............................................ 7,682 1,776 4,980
Income tax expense .................................................... 2,673 765 1,771
-------- -------- --------
Net income ............................................................ $ 5,009 $ 1,011 $ 3,209
======== ======== ========
Earnings per share
Basic ............................................................ $ 1.13 $ 0.23 $ 0.74
Diluted .......................................................... 1.11 0.22 0.72
See accompanying notes to consolidated financial statements
56
COMMUNITY BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Common Stock
------------ Accumulated
Number of Retained Other Comprehensive
Shares Amount Earnings Income (Loss) Total
------ ------ -------- ------------- -----
(Dollars in thousands, except per share)
Balance, January 1, 2004 ............................. 4,331,460 $ 29,402 $ 18,610 $ 58 $ 48,070
Comprehensive income
Net income ....................................... - - 3,209 - 3,209
---------
Unrealized net holding losses arising
during the period, net of
income tax effects of $56 ........................ - - - (100) (100)
Reclassification adjustment,
net of income tax effects of $28 ................. - - - (48) (48)
---------
Total other comprehensive income (loss) .......... - - - - (148)
---------
Total comprehensive income ....................... - - - - 3,061
---------
Exercise of stock options ............................ 59,324 640 - - 640
Cash dividends ($.40 per share) ...................... - - (1,744) - (1,744)
--------- --------- --------- --------- ---------
Balance, December 31, 2004 ........................... 4,390,784 30,042 20,075 (90) 50,027
Comprehensive income
Net income ....................................... - - 1,011 - 1,011
---------
Unrealized net holding losses arising
during the period, net of
income tax effects of $253 ....................... - - - (451) (451)
Reclassification adjustment,
net of income tax effects of $4 .................. - - - 6 6
---------
Total other comprehensive income (loss) .......... - - - - (445)
---------
Total comprehensive income ....................... - - - - 566
---------
Sale of common stock ................................. 775 14 - - 14
Exercise of stock options ............................ 12,744 146 - - 146
Cash dividends ($.40 per share) ...................... - - (1,761) - (1,761)
--------- --------- --------- --------- ---------
Balance, December 31, 2005 ........................... 4,404,303 30,202 19,325 (535) 48,992
Comprehensive income
Net income ....................................... - - 5,009 - 5,009
---------
Unrealized net holding gains arising
during the period, net of
income tax effects of $169 ....................... - - - 271 271
Reclassification adjustment,
net of income tax effects of $0 .................. - - - (1) (1)
Adjustment to initially apply SFAS
No. 158, net of income taxes of $47 .............. - - - (96) (96)
---------
Total other comprehensive income ................. - - - - 174
---------
Total comprehensive income ....................... - - - - 5,183
---------
Sale of common stock ................................. 1,000 16 - - 16
Exercise of stock options ............................ 35,917 385 - - 385
Cash dividends ($.44 per share) ...................... - - (1,952) - (1,952)
--------- --------- --------- --------- ---------
Balance, December 31, 2006 ........................... 4,441,220 $ 30,603 $ 22,382 $ (361) $ 52,624
========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements.
57
COMMUNITY BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Operating activities
Net income .................................................................... $ 5,009 $ 1,011 $ 3,209
Adjustments to reconcile net income to net cash provided
by operating activities
Provision for loan losses ............................................. 2,950 9,637 5,102
Depreciation .......................................................... 1,018 937 926
Writedowns of other real estate ....................................... 18 - 50
Amortization of definite-lived purchased intangibles .................. 246 246 246
Deferred income taxes ................................................. 2,158 (2,807) 288
Securities accretion and premium amortization ......................... 15 67 162
(Gain) loss on disposition of available-for-sale securities ........... (1) 10 (76)
Gain on sale of loans other than loans held for sale .................. (514) - -
Increase in accrued interest receivable ............................... (687) (715) (233)
Increase in accrued interest payable .................................. 366 521 106
Losses (gains) on sale of foreclosed assets ........................... 19 (24) (9)
Increase in prepaid expenses and other assets ......................... (991) (290) (1,243)
Increase (decrease) in accrued expenses and other liabilities ......... 306 286 (155)
Originations of loans held for sale ................................... (234,821) (210,552) (180,753)
Proceeds of sales of loans held for sale .............................. 238,033 213,195 174,074
--------- --------- ---------
Net cash provided by operating activities .......................... 13,124 11,522 1,694
--------- --------- ---------
Investing activities
Net (increase) decrease in interest-bearing deposits with other banks ......... (888) (186) 272
Purchases of available-for-sale securities .................................... (43,449) (16,243) (35,749)
Maturities of held-to-maturity securities ..................................... 100 75 75
Maturities and calls of available-for-sale securities ......................... 17,793 7,829 31,150
Proceeds from sale of available-for-sale securities ........................... - 4,412 13,676
Proceeds from sales of other investments ...................................... 642 - -
Purchases of other investments ................................................ (908) (338) (604)
Proceeds from sales of loans other than loans held for sale ................... 7,140 - -
Net increase in loans made to customers ....................................... (13,522) (22,748) (66,592)
Purchases of premises and equipment ........................................... (1,913) (2,610) (1,750)
Proceeds from sales of foreclosed assets ...................................... 788 224 136
--------- --------- ---------
Net cash used by investing activities .............................. (34,217) (29,585) (59,386)
--------- --------- ---------
Financing activities
Net increase in deposits ...................................................... 19,412 40,751 44,754
Net increase (decrease) in short-term borrowings .............................. 3,973 2,313 (11,298)
Proceeds from issuance of long-term debt ...................................... - 3,000 10,503
Repayments of long-term debt .................................................. (6,008) (1,377) (70)
Sale of common stock .......................................................... 16 14 -
Exercise of stock options ..................................................... 385 146 640
Cash dividends paid ........................................................... (1,952) (1,761) (1,744)
--------- --------- ---------
Net cash provided by financing activities .......................... 15,826 43,086 42,785
--------- --------- ---------
(Decrease) increase in cash and cash equivalents ................................... (5,267) 25,023 (14,907)
Cash and cash equivalents, beginning ............................................... 51,991 26,968 41,875
--------- --------- ---------
Cash and cash equivalents, ending .................................................. $ 46,724 $ 51,991 $ 26,968
========= ========= =========
Supplemental disclosures of cash flow information
Cash payments for interest expense, including $21 and $12 capitalized .............. $ 15,135 $ 10,296 $ 6,925
during construction in 2006 and 2005, respectively
Cash payments for income taxes ..................................................... 781 3,869 2,498
Supplemental disclosures of non-cash investing activities
Transfers of loans receivable to foreclosed assets ................................. $ 1,231 $ 70 $ 88
Other comprehensive income (loss) .................................................. 174 (445) (148)
See accompanying notes to consolidated financial statements.
58
COMMUNITY BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION
Community Bankshares, Inc. (the "Corporation"), was organized under the laws of
the State of South Carolina and was chartered as a business corporation on
November 30, 1992. Pursuant to the provisions of the Federal Bank Holding
Company Act, an application was filed with and approved by the Board of
Governors of the Federal Reserve System for the Corporation to become a bank
holding company by the acquisition of Orangeburg National Bank (ONB).
In June 1996, Sumter National Bank (SNB), and in July 1998, Florence National
Bank (FNB), commenced operations in Sumter and Florence, South Carolina,
respectively, following approval by the Comptroller of the Currency and other
regulators. Upon completion of their organization, the common stock of SNB and
FNB was acquired by the Corporation.
In November 2001, the Corporation acquired all the common stock of Resource
Mortgage, Inc., a Columbia, South Carolina based mortgage brokerage company. The
Corporation issued 95,454 shares of its common stock in exchange for 100% of the
common stock of Resource Mortgage, Inc. The subsidiary was renamed Community
Resource Mortgage, Inc. (CRM).
In July 2002, Ridgeway Bancshares, Inc., the holding company for the Bank of
Ridgeway (BOR), merged into the Corporation. The Corporation issued 1,000,000
shares of its common stock and paid $4,000,000 cash in exchange for 100% of the
common stock of Ridgeway Bancshares, Inc. The transaction was consummated on
July 1, 2002.
In June, 2006, ONB's name was changed to Community Resource Bank, N.A. (CRB),
and in October 2006, SNB, FNB and BOR were merged into CRB. In addition, most of
the activities previously conducted by the holding company as a service center
for the bank were moved into the bank as a division. As a result, the
Corporation now consists of the holding Company (CBI), the bank subsidiary (CRB)
and the mortgage company (CRM). In January 2007, most of the operations of the
mortgage company were incorporated into the Bank, though CRM remains a separate
subsidiary of the holding company with limited assets and activities.
CRB operates as a wholly-owned subsidiary of the Corporation with a separate
Board of Directors and operating policies and it provides a variety of financial
services to individuals and businesses throughout South Carolina. The primary
deposit products are checking, savings and term certificate accounts. The
primary lending products are consumer, commercial and mortgage loans.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the Corporation and its subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
59
USE OF ESTIMATES - The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the balance sheet and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of deferred tax
assets.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK - Most of the Corporation's
activities are with customers located within South Carolina. Note 4 discusses
the types of securities the Corporation purchases. Note 6 discusses the types of
lending in which the Corporation engages. The Bank grants commercial, consumer
and mortgage loans to customers throughout South Carolina. Although the Bank has
a diversified loan portfolio, a substantial portion of its debtors' ability to
honor their contracts is dependent upon the economies of various South Carolina
communities and, as of December 31, 2006, there was a concentration in loans for
the construction of speculative residential housing units and in high
loan-to-value real estate loans.
CASH AND CASH EQUIVALENTS - For purposes of the consolidated statements of cash
flows, the Corporation has defined cash and cash equivalents as those amounts
included in the balance sheets under the caption, "Cash and due from banks" and
"Federal funds sold," all of which mature within ninety days.
INTEREST-BEARING DEPOSITS WITH OTHER BANKS - Interest-bearing deposits with
other banks generally mature within one year and are carried at cost.
SECURITIES - Securities that management has both the ability and positive intent
to hold to maturity are classified as held-to-maturity and carried at cost,
adjusted for amortization of premium and accretion of discounts using methods
approximating the interest method. The Corporation has decided generally to
avoid acquiring further held-to-maturity securities. Securities that may be sold
prior to maturity for asset/liability management purposes, or that may be sold
in response to changes in interest rates, changes in prepayment risk, increase
in regulatory capital, or other similar factors, are classified as
available-for-sale and are carried at estimated fair value. Unrealized gains and
losses on securities available-for-sale are excluded from earnings and reported
in other comprehensive income. Gains and losses on the sale of securities
available-for-sale are recorded on the trade date and are determined using the
specific identification method. Declines in the fair value of held-to-maturity
and available-for-sale securities below their cost that are deemed to be
other-than-temporary are reflected in earnings as realized losses.
Interest and dividends on securities, including the amortization of premiums and
the accretion of discounts, are reported in interest and dividends on
securities.
No securities are being held for short-term resale; therefore, the Corporation
does not currently use a trading account classification.
LOANS HELD FOR SALE - The Corporation originates loans held for sale to other
financial institutions under commitments or other arrangements in place prior to
loan origination. These loans are sold on a non-recourse basis. However,
standard contract warranties and representations apply to these sales and the
Corporation may from time to time be required to indemnify investors under those
provisions. Loans originated and intended for sale are residential mortgage
loans and are carried at the lower of cost or estimated fair value in the
aggregate. Gains and losses, if any, on the sale of such loans are determined
60
using the specific identification method. All fees and other income from these
activities are recognized in income when loan sales are completed.
LOANS - The Corporation grants mortgage, commercial and consumer loans to
customers. The ability of the Corporation's debtors to honor their contracts is
dependent upon the general economic conditions in its market areas. Loans
receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off generally are carried at
principal amounts outstanding, increased or reduced by deferred net loan costs
or fees and any unamortized purchase premiums or discounts. Interest income on
loans is recognized using the interest method based upon the principal amounts
outstanding. Loan origination and commitment fees and certain direct loan
origination costs (principally salaries and employee benefits) are deferred and
amortized as an adjustment of the related loan's yield. Generally, these amounts
are amortized over the contractual life of the related loans or commitments.
The accrual of interest on mortgage and commercial loans is discontinued at the
time the loan is 90 days delinquent unless the credit is well collateralized and
in process of collection. Unsecured personal credit lines and certain consumer
finance loans are typically charged off no later than the time the loan is 180
days delinquent.
Other consumer loans are typically charged off at the time the loan is 90 days
delinquent. Generally, loans are placed on nonaccrual or charged off at an
earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual
or charged off is reversed against interest income. The interest on these loans
is accounted for on the cash basis or cost recovery method, until the loans
qualify for return to accrual status. Loans are returned to accrual status only
when all the principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is established through
a provision for loan losses charged against earnings as losses are estimated to
have occurred. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.
It is the policy of Corporation and its subsidiary bank to maintain an allowance
for loan and lease losses which achieves the following objectives:
o Maintenance of the allowance at a level that is adequate to absorb all
estimated inherent losses in the loan portfolio and all unfunded and
off balance sheet commitments;
o Evaluation and calculation of the allowance with a sound and
consistent analytical framework based on historical data adjusted for
current conditions in conformity with generally accepted accounting
principles and all applicable banking and regulatory guidance; and
o Reflection in the allowance of all significant, existing conditions
affecting the ability of borrowers to repay.
Management reviews its allowance for loan losses utilizing three broad loan
categories: commercial, real estate and consumer installment loans. Within these
categories, the allowance for loan losses is composed of specific allocations
61
and general loan pool amounts. Specific allocation is done for larger loans of
each loan risk category. The commercial and real estate risk pools are driven by
credit risk grade classification. The consumer loan pools are based on payment
performance. The allowance assigned to these pools is based on historical losses
for each of the pools and industry standards. Other factors considered are
changes in policies and procedures, economic conditions, portfolio changes,
lending personnel experience, trend analysis, credit concentrations, external
factors, and the reports of the loan review system.
A loan is considered impaired when, based on current information and events, it
is probable that the Corporation will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
known circumstances surrounding the loan and the borrower, including the length
of the delay, the reasons for the delay, the borrower's prior payment record,
and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis for commercial and construction
loans by either the present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's obtainable market price, or the
fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify individual
consumer and residential loans for impairment disclosures.
DERIVATIVE FINANCIAL INSTRUMENTS - Statement of Financial Accounting Standards
("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities,
as amended, requires that all derivatives be recognized as assets or liabilities
in the balance sheet and measured at fair value. 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. The Corporation 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 the
Corporation issues its commitments and the time that the loans close and are
sold, the Corporation is subject to variability in the selling prices related to
those commitments due to changes in market rates of interest. However, the
Corporation 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. The
Corporation generally enters into such forward sales contracts at the same time
that rate lock commitments are issued. The forward sales contracts provide both
specific underwriting guidelines and definitive price quotes. These arrangements
effectively insulate the Corporation from the effects of changes in interest
rates during the time that the commitments are outstanding, but the arrangements
do not qualify, and are not designated, as fair value hedges. In keeping with
SEC Staff Accounting Bulletin 105, no income is recognized as of the original
commitment date on either the interest rate lock commitments or the forward
sales contracts. Subsequently, changes in the fair values of the instruments are
measured as of the end of each reporting period and the changes in the fair
values represent the amounts of the derivative assets and liabilities. In
addition, the changes in fair values of derivatives are recorded in the
statement of income in net gains or losses on loans held for sale. Because the
Corporation has effectively matched its forward sales contracts to investors and
62
rate lock commitments to potential borrowers, no net gains or losses due to
changes in market interest rates have been recorded in the statement of income
for 2006, 2005 or 2004.
Derivative financial instruments are written in amounts referred to as notional
amounts. Notional amounts provide only the basis for calculating payments
between counterparties and do not represent amounts to be exchanged between
parties or a measure of financial risk. The table below presents the notional
principal amounts of rate lock commitments and forward sales contracts as of
December 31, 2006 and 2005, and the estimated fair values of those financial
instruments included in other assets and liabilities in the balance sheets as of
those dates.
December 31,
------------
2006 2005
---- ----
Notional Estimated Notional Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
(Dollars in thousands)
Commitments to originate loans to be held for sale ................. $(12,868) $ (94) $(12,585) $ 1
Forward sales commitments .......................................... 12,868 94 12,585 (1)
-------- -------- -------- --------
Total .............................................. $ - $ - $ - $ -
======== ======== ======== ========
STOCK-BASED COMPENSATION - Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation, as amended, encouraged all
entities to adopt a fair value based method of accounting for employee stock
compensation plans, whereby compensation cost was measured at the grant date
based on the fair value of the award and recognized over the service period,
which was usually the vesting period. However, it also allowed an entity to
continue to measure compensation cost for those plans using the intrinsic value
based method of accounting prescribed by Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees," whereby compensation
cost was the excess, if any, of the quoted market price of the stock at the
grant date (or other measurement date) over the amount an employee was required
to pay to acquire the stock. Stock options issued under the Corporation's stock
option plans had no intrinsic value at the grant date, and under APB Opinion No.
25 no compensation cost was recognized for them. For 2005, the Corporation
elected to continue with the accounting methodology in APB Opinion No. 25 and,
as a result, provided pro forma disclosures of net income and earnings per share
and other disclosures, as if the fair value based method of accounting had been
applied. However, as required by revisions to SFAS No. 123 and Securities and
Exchange Commission rules, the Corporation adopted the accounting methodology of
SFAS No. 123(R) effective January 1, 2006. See "Accounting Changes - Share-Based
Payment." No awards of stock options were made in 2006 and all pre-existing
options awards were fully vested prior to the effective date of SFAS No. 123(R).
Therefore, no compensation costs are included in any period.
Had compensation cost for the Corporation's stock option plans been determined
based on the fair value at the grant dates for awards under the plans consistent
with the method prescribed by SFAS No. 123, the Corporation's net income and
earnings per share would have been adjusted to the pro forma amounts indicated
below:
63
Years Ended December 31,
------------------------
2005 2004
---- ----
(Dollars in thousands, except per share)
Net income, as reported ........................................................ $ 1,011 $ 3,209
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of any related tax effects ........................................... (185) (626)
--------- ---------
Pro forma net income ........................................................... $ 826 $ 2,583
========= =========
Net income per share, basic
As reported .............................................................. $ 0.23 $ 0.74
Pro forma ................................................................ 0.19 0.59
Net income per share, assuming dilution
As reported .............................................................. $ 0.22 $ 0.72
Pro forma ................................................................ 0.18 0.58
FORECLOSED ASSETS - Assets (primarily real estate and vehicles) acquired
through, or in lieu of, loan foreclosure are held for sale and are initially
recorded at fair value, less estimated costs to sell, at the date of
foreclosure, establishing a new cost basis. Loan losses arising from the
acquisition of such property are charged against the allowance for loan losses
as of that date. Subsequent to foreclosure, valuations are periodically
performed by management and the assets are carried at the lower of the new cost
basis or fair value, less estimated costs to sell. Revenues and expenses from
operations and changes in any subsequent valuation allowance are included in net
foreclosed assets costs and expenses. The carrying value of foreclosed assets
included in the balance sheets was $591,000 and $185,000 as of December 31, 2006
and 2005, respectively.
PREMISES AND EQUIPMENT - Premises and equipment are stated at cost, less
accumulated depreciation computed principally on the straight-line method over
the estimated useful lives of the assets. Useful lives of assets are outlined
below:
Buildings ............................................... 32 - 40 years
Building components ..................................... 5 - 30 years
Vault doors, safe deposit boxes, night depository, etc. . 32 - 40 years
Furniture, fixtures and equipment ....................... 5 - 25 years
Useful lives for leasehold improvements held under operating lease agreements
are estimated at the lesser of the assets' estimated useful lives as set forth
in the table above or the lease term, including certain renewals which are
deemed probable at lease inception.
INCOME TAXES - Deferred income tax assets and liabilities are reflected at
currently enacted income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or settled. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
OFF-BALANCE-SHEET CREDIT RELATED FINANCIAL INSTRUMENTS - In the ordinary course
of business the Bank enters into commitments to extend credit and grant standby
64
letters of credit. Such off-balance-sheet financial instruments are recorded in
the consolidated financial statements when they are funded.
SEGMENTS - Community Bankshares, Inc. through its bank subsidiary provides a
broad range of financial services to individuals and businesses in South
Carolina. These services include demand, time, and savings deposits; lending
services; ATM processing; and similar financial services. While the
Corporation's decision makers monitor the revenue streams of the various
financial products and services, operations are managed and financial
performance is evaluated on a corporate-wide basis. Accordingly, the subsidiary
operations are not considered by management to comprise more than one reportable
operating segment.
COMPREHENSIVE INCOME - Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Certain changes
in assets and liabilities, such as unrealized gains and losses on securities
available-for-sale, are reported as a separate component of the equity section
of the balance sheet. Such items, along with net income, are components of
comprehensive income. Currently, the Corporation's only components of other
comprehensive income (loss) are unrealized gains (losses) on securities
available-for-sale and unrecognized net losses on pension funds resulting from
the initial application of SFAS No. 158.
TRANSFERS OF FINANCIAL ASSETS - Transfers of financial assets are accounted for
as sales when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Corporation, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Corporation does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
ACCOUNTING CHANGES
Hybrid Financial Instruments - The provisions of Statement of Financial
Accounting Standards No. 155 ("SFAS No. 155"), "Accounting for Certain Hybrid
Financial Instruments, an amendment of FASB Statements No. 133 and 140," are
effective January 1, 2007. SFAS No. 155 simplifies the accounting for certain
financial instruments containing embedded derivatives. SFAS No. 155 allows fair
value measurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." In addition, it
amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities" to allow a qualifying special-purpose entity
to hold a derivative financial instrument that pertains to a beneficial interest
other than another derivative financial instrument. The adoption of the
Statement is not expected to have a material effect on the Company's
consolidated financial statements.
Servicing of Financial Assets - The provisions of Statement of
Financial Accounting Standards No. 156 ("SFAS No. 156"), "Accounting for
Servicing of Financial Assets, an amendment of FASB Statement No. 140" are
effective January 1, 2007. This Statement potentially simplifies the accounting
for separately recognized loan servicing assets and liabilities and any
financial instruments used to hedge risks associated with those assets and
liabilities. Under SFAS 156, separately recognized servicing assets and
65
liabilities are accounted for initially at fair value, if practicable, and
subsequently are accounted for either at fair value or amortized over the
economic lives of the related loans. If the fair value method of subsequent
valuation is elected, SFAS No. 156 permits income statement recognition of the
potential offsetting changes in the fair values of the financial servicing
rights and liabilities and the derivative instruments used to hedge them in the
same accounting period. The Company currently has no separately recognized loan
servicing rights or liabilities and adoption in 2007 is not expected to have any
effect on the Company's consolidated financial statements.
Fair Value Measurements - The provisions of Statement of Financial
Accounting Standards No. 157 ("SFAS No. 157"), "Fair Value Measurements," are
effective for fiscal years beginning after November 15, 2007 (January 1, 2008
for the Company). SFAS No. 157 defines fair value and establishes a framework
for measuring fair value in GAAP. The Statement describes fair value as being
based on a hypothetical transaction to sell an asset or transfer a liability at
a specific measurement date, as considered from the perspective of a market
participant who holds the asset or owes the liability (an exit price
perspective). In addition, fair value should be viewed as a market-based
measurement, rather than an entity-specific measurement. Therefore, fair value
should be determined based on the assumptions that market participants would use
in pricing an asset or liability, including all risks and restrictions that may
be associated with that asset or liability. SFAS No. 157 does not amend the
definition of fair value used in conjunction with Share-Based Payments accounted
for under SFAS No. 123(R). The adoption of SFAS No. 157 in 2008 is not expected
to have a material effect on the Company's consolidated financial statements.
Accounting for Uncertainty in Income Taxes - The provisions of
Financial Accounting Standards Board Interpretation No. 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109," clarify the accounting for uncertainty in income tax positions. FIN 48
prescribes a two-step evaluation process that includes both a recognition
threshold and a measurement attribute for tax positions taken or expected to be
taken in a tax return. The provisions of FIN 48 are effective for the Company as
of January 1, 2007. The adoption of FIN 48 is not expected to have a material
effect on the Company's consolidated financial statements.
ADVERTISING COSTS - The cost of advertising is expensed as incurred.
OTHER - Certain amounts previously reported in the consolidated financial
statements have been reclassified to conform to the current year's presentation
and disclosure requirements. These reclassifications had no effect on previously
reported net income or retained earnings.
NOTE 3 - CASH AND DUE FROM BANKS
The Bank is required to maintain average reserve balances with the Federal
Reserve or in available cash. The average daily reserve balance requirements at
December 31, 2006 and 2005 were approximately $1,300,000 and $3,942,000,
respectively. At December 31, 2006 the Corporation had cash balances with
unrelated correspondent banks, including bankers' banks, totaling approximately
$11,723,000, of which $429,000 was fully insured by the FDIC.
66
NOTE 4 - SECURITIES
Securities consist of the following:
December 31,
------------
2006 2005
---- ----
Gross Gross Gross Gross
Unrealized Unrealized Estimated Unrealized Unrealized Estimated
Amortized Holding Holding Fair Amortized Holding Holding Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
(Dollars in thousands)
Securities available-for-sale
Government-sponsored enterprises* ........ $82,145 $ 81 $ 487 $81,739 $55,781 $ 1 $ 865 $54,917
States and political
subdivisions ......................... 3,032 13 1 3,044 3,754 31 1 3,784
------- ------ ------- ------- ------- ------- ------- -------
Total securities available-for-sale .. $85,177 $ 94 $ 488 $84,783 $59,535 $ 32 $ 866 $58,701
======= ====== ======= ======= ======= ======= ======= =======
Securities held-to-maturity
States and political
subdivisions ......................... $ 1,750 $ - $ - $ 1,750 $ 1,850 $ - $ 30 $ 1,820
======= ====== ======= ======= ======= ======= ======= =======
------------------
* Government-sponsored enterprises consist of entities such as the Federal Home
Loan Bank, Federal Farm Credit Bank and Federal National Mortgage Association.
The amortized cost and fair value of debt securities at December 31, 2006 by
contractual maturity are detailed below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
December 31, 2006
-----------------
Available-for-sale Held-to-maturity
------------------ ----------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
(Dollars in thousands)
Securities
Due within one year ................................... $11,550 $11,461 $ - $ -
Due after one through five years ...................... 55,237 55,001 - -
Due after five through ten years ...................... 18,380 18,311 1,750 1,750
Due after ten years ................................... 10 10 - -
------- ------- ------- -------
Total ............................................. $85,177 $84,783 $ 1,750 $ 1,750
======= ======= ======= =======
67
The following tables provide information about the Corporation's securities
holdings which were maintained in an unrealized loss position as of December 31,
2006 and 2005:
December 31, 2006
-----------------
Continuously in Unrealized Loss Position for a Period of
--------------------------------------------------------
Less than 12 Months 12 Months or more Total
Estimated Unrealized Estimated Unrealized Estimated Unrealized
Fair Value Loss Fair Value Loss Fair Value Loss
---------- ---- ---------- ---- ---------- ----
(Dollars in thousands)
Description of Securities
Government-sponsored enterprises ............... $33,901 $ 164 $25,374 $ 323 $59,275 $ 487
States and political subdivisions .............. - - 1,279 1 1,279 1
------- ------- ------- ------- ------- -------
Total securities ............................... $33,901 $ 164 $26,653 $ 324 $60,554 $ 488
======= ======= ======= ======= ======= =======
December 31, 2005
-----------------
Continuously in Unrealized Loss Position for a Period of
--------------------------------------------------------
Less than 12 Months 12 Months or more Total
Estimated Unrealized Estimated Unrealized Estimated Unrealized
Fair Value Loss Fair Value Loss Fair Value Loss
---------- ---- ---------- ---- ---------- ----
(Dollars in thousands)
Description of Securities
Government-sponsored enterprises ............... $15,433 $ 118 $37,788 $ 747 $53,221 $ 865
States and political subdivisions .............. - - 801 1 801 1
------- ------- ------- ------- ------- -------
Total securities ............................... $15,433 $ 118 $38,589 $ 748 $54,022 $ 866
======= ======= ======= ======= ======= =======
At December 31, 2006, the Corporation held 36 securities that had been in an
unrealized loss position for less than 12 months and 35 securities that had been
in an unrealized loss position for 12 months or more. At December 31, 2005, the
Corporation held 20 securities that had been in an unrealized loss position for
less than 12 months and 46 securities that had been in an unrealized loss
position for 12 months or more. In assessing whether securities that had been in
an unrealized loss position for 12 months or more were other-than-temporarily
impaired, the Corporation considered numerous factors about these securities,
including the length of time of the impairment, near-term prospects for
recovery, and the expectations for changes in interest rates. Unrealized losses
reflected in this table generally are the result of interest rate changes that
have occurred since the securities were purchased. The Corporation has the
intent and ability to hold these securities until maturity and no loss is
expected on any of these securities if they are held until their maturities.
Accordingly, these losses are not considered other-than-temporary.
At December 31, 2006 and 2005, investment securities with a carrying value of
$38,921,000 and $27,509,000, respectively, were pledged to secure public
deposits, repurchase agreements and for other purposes required and permitted by
law.
For the years ended December 31, 2006, 2005 and 2004, proceeds from sales of
securities available-for-sale amounted to $0, $4,412,000, and $13,676,000,
respectively. In 2006, the company realized a $1,000 gain on the call of a
security at an amount in excess of par value. Gross realized gains from sales
totaled $0, $0 and $107,000, respectively. Gross realized losses were $0,
68
$10,000 and $31,000, respectively. The tax benefit (provision) applicable to the
net realized gains and losses amounted to $0, $4,000 and $(26,000),
respectively.
NOTE 5 - OTHER INVESTMENTS
Other investments consist of restricted stocks of the Federal Reserve Bank of
Richmond, the Federal Home Loan Bank of Atlanta, and correspondent bankers'
banks which are carried at cost. Management periodically evaluates these
investments for impairment, with any appropriate downward adjustments being made
when necessary.
NOTE 6 - LOANS
The following is a summary of loans by category:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Commercial, financial and agricultural ......... $ 86,080 $ 95,023
Real estate- construction ...................... 40,541 37,923
Real estate - mortgage ......................... 253,423 243,837
Consumer installment ........................... 29,676 37,201
--------- ---------
Total ..................................... 409,720 413,984
Allowance for loan losses ...................... (4,662) (11,641)
--------- ---------
Loans - net ............................... $ 405,058 $ 402,343
========= =========
Net deferred loan (fees) and costs of $(104,000) and $(25,000) were allocated to
the various loan categories as of December 31, 2006 and 2005, respectively.
Overdrawn deposits totaling $665,000 and $382,000 have been reclassified as loan
balances at December 31, 2006 and 2005, respectively.
Gross proceeds from sales of mortgage loans originated for resale were
approximately $238,033,000, $213,195,000, and $174,074,000 for the years ended
December 31, 2006, 2005, and 2004, respectively. Income from this activity is
recognized as mortgage brokerage income.
Loans outstanding to directors, executive officers, principal holders of equity
securities, or to any of their associates totaled $4,051,000 at December 31,
2006 and $7,071,000 at December 31, 2005. A total of $3,069,000 in loans were
made or added, while a total of $6,089,000 were repaid or deducted during 2006.
Related party loans are made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with unrelated persons and do not involve more than normal risk of
collectibility. Changes in the composition of the board of directors or the
group comprising executive officers also result in additions to or deductions
from loans outstanding to directors, executive officers or principal holders of
equity securities.
The Company generally does not engage in originating, holding, guaranteeing,
servicing or investing in loans where the terms of the loan product may give
69
rise to a concentration of credit risk as that term is used in Statement of
Financial Accounting Standards No. 107, "Disclosures about Fair Values of
Financial Instruments." However, at December 31, 2006, the Company had a
concentration involving loans for the construction of speculative residential
housing units totaling $25,797,000 or 48% of capital, and in real estate loans
with high loan-to-value ratios of $24,835,000, or 46% of capital.
Changes in the allowance for loan losses were as follows:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Balance at January 1 ................................................ $ 11,641 $ 4,347 $ 4,206
Transfer of allowance for off-balance-sheet ......................... - (305) -
contingencies to other liabilities
Provision charged to expense ........................................ 2,950 9,637 5,102
Recoveries .......................................................... 1,436 207 119
Charge-offs ......................................................... (11,365) (2,245) (5,080)
-------- -------- --------
Balance at December 31 .............................................. $ 4,662 $ 11,641 $ 4,347
======== ======== ========
The following is summary information pertaining to impaired loans:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Impaired loans without a valuation allowance ............... $ - $ 2,283
Impaired loans with a valuation allowance .................. 4,714 9,368
------- -------
Total impaired loans .................................. $ 4,714 $11,651
======= =======
Allowance for loan losses on impaired loans at year end .... $ 1,381 $ 3,767
======= =======
Average total investment in impaired loans during the year . $ 9,828 $ 7,725
No additional funds are irrevocably committed to be advanced in connection with
impaired loans.
Nonaccrual and past due loans at December 31, 2006 and 2005 were as follows:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Nonaccrual loans ............................... $ 4,714 $11,651
Accruing 90 days or more past due .............. 232 729
------- -------
Total .................................. $ 4,946 $12,380
======= =======
Gross interest income that would have been recorded for the years ended December
31, 2006, 2005, and 2004 if nonaccrual loans had been performing in accordance
with their original terms was approximately $429,000, $448,000, and $63,000,
respectively. No material amounts of cash basis income were recognized on such
loans during 2006, 2005 and 2004.
70
From time to time in the normal course of business, the Mortgage Division may be
required to repurchase loans sold into the secondary market because of investor
recourse rights. These recourse rights relate to early payment default, fraud in
the origination of loan or defect in the documentation for the loan. Management
has identified certain real estate-secured loans, with aggregate principal
amounts outstanding of $532,000 on which the investors have requested
indemnification pursuant to their recourse rights. This amount does not
represent management's estimate of anticipated loss and, at this time,
management is in the process of determining a probable loss amount associated
with these loans. During 2006, the Company recognized $144,000 in recourse loan
provision. Management will continue to regularly evaluate the estimated fair
value of these loans, and other such loans that may come to the attention of
management, and will make any appropriate accounting adjustment that may become
necessary.
NOTE 7 - PREMISES AND EQUIPMENT; OPERATING LEASES
Premises and equipment at December 31, 2006 and 2005 consist of the following:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Land ........................................... $ 2,808 $ 1,952
Buildings and components ....................... 5,209 3,884
Furniture, fixtures and equipment .............. 7,729 6,633
Construction in process - gross ................ 7 2,432
------- -------
Total ..................................... 15,753 14,901
Less, accumulated depreciation ................. 5,446 5,489
------- -------
Premises and equipment - net .............. $10,307 $ 9,412
======= =======
Depreciation expense was approximately $1,018,000, $937,000, and $926,000, for
the years ended December 31, 2006, 2005, and 2004, respectively. During 2006 and
2005, the Corporation capitalized interest of $21,000 and $12,000, respectively,
to construction in progress.
71
As of December 31, 2006 future minimum rent commitments under various
non-cancelable operating leases are as follows:
Year Amount
---- ------
(Dollars in thousands)
2007 ................................ $ 483
2008 ................................ 335
2009 ................................ 277
2010 ................................ 233
2011 ................................ 236
Thereafter ................................ 4,571
-------
Total .......................... $ 6,135
=======
Total rent expense for the years ended December 31, 2006, 2005, and 2004 was
$512,000, $413,000, and $308,000, respectively. Some leases provide for the
payment of executory costs and contain options to renew; lease payments for such
renewal periods are generally higher than during the original lease term.
NOTE 8 - INTANGIBLE ASSETS
Changes in the carrying amounts of goodwill for the years ended December 31,
2006 and 2005 are as follows:
Years Ended December 31,
------------------------
2006 2005
---- ----
(Dollars in thousands)
Balance, beginning of year ....................... $4,321 $4,321
Goodwill acquired during the year ................ - -
Impairment losses ................................ - -
------ ------
Balance, end of year ............................. $4,321 $4,321
====== ======
Goodwill is tested for impairment annually. As of December 31, 2006 no
impairment has been determined.
As part of the valuation of Ridgeway Bancshares, Inc. that was conducted by a
third party firm in conjunction with its acquisition by the Company, a core
deposit intangible was computed. Such amortizable intangible assets are
evaluated annually to determine whether any revisions of their estimated useful
lives are warranted. For the years ended December 31, 2006 and 2005, and 2004,
no such revisions have resulted.
The following tables present the gross carrying amounts and accumulated
amortization for the Corporation's amortizable intangible assets as of December
31, 2006 and 2005, and the estimated amounts of amortization expense to be
recognized for each of the five succeeding fiscal years, as of December 31, 2006
and 2005. Such assets are being amortized on a straight-line basis over fifteen
years, a period which represents the expected runoff period of the deposits
acquired.
72
December 31,
------------
2006 2005
---- ----
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
------ ------------ ------ ------------
(Dollars in thousands)
Amortizable intangible asset class
Core deposit intangible .................................... $3,698 $1,107 $3,698 $ 861
====== ====== ====== ======
Estimated amounts of amortization expense to be recognized in each of the next
five succeeding years are:
December 31,
------------
2006 2005
---- ----
Year (Dollars in thousands)
----
2006 $ - $ 246
2007 246 246
2008 246 246
2009 246 246
2010 246 246
2011 246 NA
NOTE 9 - DEPOSITS
At December 31, 2006, the scheduled maturities of certificates of deposit and
other time deposits are as follows:
Year Amount
---- ------
(Dollars in thousands)
2007 ............................ $ 226,471
2008 ............................ 12,610
2009 ............................ 2,501
2010 ............................ 1,356
2011 ............................ 751
Thereafter ............................ 19
---------
Total ...................... $ 243,708
=========
Deposits of directors and officers and their related business interests totaled
approximately $4,033,000 and $8,629,000 at December 31, 2006 and 2005,
respectively.
NOTE 10 - SHORT-TERM BORROWINGS
The Corporation's short-term borrowings generally consist of federal funds
purchased and securities sold under agreements to repurchase. Federal funds
73
purchased and securities sold under agreements with customers to repurchase
generally mature within one to four days from the transaction date. Securities
sold under agreements to repurchase are reflected at the amount of cash received
in connection with the transaction. The Corporation monitors the fair value of
the underlying securities on a daily basis and it is the Bank's policy to
maintain a collateral value greater than the principal and accrued interest of
the transaction. All securities underlying these agreements are
institution-owned securities.
Short-term borrowings are summarized as follows:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Securities sold under agreements to repurchase ......... $12,948 $ 5,372
Federal funds purchased ................................ - 421
Warehouse lines of credit .............................. - 1,182
Other short-term debt .................................. - 2,000
------- -------
Total .................................................. $12,948 $ 8,975
======= =======
The following table summarizes information about short-term borrowings during
each of the periods presented:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Balance outstanding at end of year ....................... $12,948 $ 8,975
Weighted average interest rate at end of the period ...... 4.00% 4.26%
Interest expense ......................................... $ 400 $ 198
Maximum outstanding at any month end during the period ... $14,058 $ 8,975
Average outstanding during the period .................... $13,680 $ 8,584
Weighted average interest rate during the period ......... 2.92% 2.31%
As of December 31, 2006, the Bank had unused credit availabilities under federal
funds lines established with unrelated correspondent banks totaling $38,300,000.
74
NOTE 11 - LONG-TERM DEBT
Long-term debt is summarized as follows:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Advances from Federal Home Loan Bank of Atlanta to
subsidiary banks, varying maturities to 2023
with interest rates from 2.00% to 6.14% ............... $15,878 $21,886
Junior Subordinated Debt to Unconsolidated Trusts (1), .. 10,310 10,310
------- -------
dated April 7, 2004, maturing April 7, 2034,
with variable interest rate based on 3-month LIBOR
Total long-term debt ................. $26,188 $32,196
======= =======
---------------------------------------------
(1) Securities qualify as Tier 1 capital under the regulatory risk-based capital
guidelines, subject to certain limitations.
Collateral for the Advances from Federal Home Loan Bank of Atlanta consists of
blanket liens on the Bank's one-to-four family first lien residential mortgage
loans and the Bank's stock in the FHLB. Such collateral was carried in the
consolidated balance sheet at approximately $76,694,000 and $66,500,000 at
December 31, 2006 and 2005, respectively.
Under the blanket lien agreements, the Bank had the ability to borrow additional
funds approximating $42,109,000 from the FHLB as of December 31, 2006. Any such
borrowings would be subject to the FHLB's normal approval process and would be
subject to interest rates established by the FHLB at the time of each such
transaction. The FHLB may terminate the availability at any time.
On March 8, 2004, the Corporation sponsored the creation of a Delaware trust,
SCB Capital Trust I (the "Trust"), and is the sole owner of the common
securities issued by the Trust. The Trust is a variable interest entity under
FIN 46R, but is not subject to consolidation by the Corporation since
substantially all risk of loss has been transferred to other entities through
the Trust's March 10, 2004 issuance of $10,000,000 in floating rate capital
securities. The proceeds of this issuance, and the amount of CBI's capital
investment, were used to acquire $10,310,000 principal amount of CBI's floating
rate junior subordinated deferrable interest debt securities ("Debentures") due
April 7, 2034, which securities, and the accrued interest thereon, now
constitute the Trust's sole assets. The interest rate associated with the debt
securities, and the distribution rate on the common securities of the Trust, was
established initially at 3.91% and is adjustable quarterly at the three month
LIBOR rate plus 280 basis points. The index rate (LIBOR) may not be lower than
1.11%. As of December 31, 2006, the interest rate associated with the debt was
8.17%. 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 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
75
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.
Required future principal reductions of the Corporation's long-term debt are
summarized as follows:
Year Amount
---- ------
(Dollars in thousands)
2007 $ 1,000
2008 2,500
2009 2,000
2010 7,200
2011 -
Thereafter 13,488
--------
Total $ 26,188
========
NOTE 12 - STOCK OPTIONS AND DIVIDEND REINVESTMENT SHARES
Under the Corporation's Dividend Reinvestment Plan, shareholders may reinvest
all or part of their cash dividends in shares of common stock and also purchase
additional shares of common stock. During the three-year period ended December
31, 2006 all shares purchased under this plan were purchased in the market by
Registrar and Transfer Company, the plan administrator, not issued by the
Corporation. At December 31, 2006, 624,665 common shares were reserved for
issuance pursuant to the dividend reinvestment and additional stock purchase
plan.
During 2001, the Corporation amended its 1997 Stock Option Plan (the "Plan") to
increase by 200,000 shares the number of shares reserved for issuance upon
exercise of options and to permit participation in the plan by non-employee
directors. During 2003, the Corporation amended the Plan to increase by 300,000
shares the number of shares reserved for issuance upon exercise of employee
incentive stock options. Under the Plan, as amended, up to 785,600 shares of
common stock were authorized to be granted to selected officers, other
employees, and non-employee directors of the Corporation and/or its subsidiaries
pursuant to exercise of incentive and nonqualified stock options. Of such
shares, 590,050 were reserved for issuance pursuant to exercise of incentive
stock options and 195,550 were reserved for issuance pursuant to exercise of
nonqualified stock options. At December 31, 2006, 347,619 of the Corporation's
authorized common shares remained reserved for future grant pursuant to the
Plan.
The exercise price of any incentive option granted is equal to the fair value of
the common stock on the date the option is granted. Nonqualified options can be
issued for less than fair value; however, the Corporation has not elected to
issue these options for less than fair value at the date of the grant.
76
A summary of the status of options issued pursuant to the Plan is presented
below:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Weighted Weighted Weighted
Average Intrinsic Average Average
Number of Exercise Value Number of Exercise Number of Exercise
Shares Price (000s) Shares Price Shares Price
------ ----- ------ ------ ----- ------ -----
Outstanding at beginning of year .............. 512,073 $14.46 482,817 $ 14.14 543,991 $ 13.85
Granted ....................................... - $ - 45,500 $ 17.34 27,000 $ 17.74
Exercised ..................................... (35,917) $10.72 (12,744) $ 11.44 (59,324) $ 10.80
Forfeited or expired .......................... (38,175) $18.60 (3,500) $ 18.50 (28,850) $ 18.85
Outstanding at end of year ................... 437,981 $14.41 $ 1,069 512,073 $ 14.46 482,817 $ 14.14
-------- ------- -------
Options exercisable at year end ............... 437,981 $14.41 $ 1,069 512,073 $ 14.46 455,817 $ 13.93
======== ======= =======
The weighted average fair values of options granted each year are computed using
the Black-Scholes option pricing model using the assumptions detailed below:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Weighted average fair value of options
granted during the year ............... $ - $ 2.33 $ 4.74
Risk-free interest rate ..................... NA 3.80% 3.74%
Expected life (years) ....................... NA 3.00 7.00
Expected volatility ......................... NA 18.75% 26.15%
Yield ....................................... NA 2.60% 2.18%
The following table summarizes information about the options outstanding:
December 31, 2006
-----------------
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Average Weighted
Remaining Average Average
Number Contractual Life Exercise Number Exercise
Range of Exercise Prices Outstanding (Years) Price Outstanding Price
------------------------ ----------- ------- ----- ----------- -----
$ 7.62 to $ 11.00 147,960 3.5 $ 10.44 147,960 $ 10.44
$12.83 $ 18.85 290,021 4.7 $ 16.43 290,021 $ 16.43
------- -------
437,981 4.3 $ 14.41 437,981 $ 14.41
======= =======
Until January 1, 2006, the Corporation applied APB Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans.
77
Accordingly, no compensation cost has previously been recognized. Effective
January 1, 2006, the Corporation adopted the provisions of SFAS No. 123(R) using
the modified prospective method. All option grants had fully vested prior to the
implementation of SFAS 123(R). Consequently, because adoption of SFAS No. 123(R)
under the modified prospective method requires the recognition of compensation
costs related only to the future vesting of stock option awards, no compensation
costs were included in the determination of income from operations, net income,
or any earnings per share amounts for 2006.
NOTE 13 - INCOME TAXES
The Corporation files consolidated federal income tax returns on a calendar-year
basis.
The provision for income taxes consists of the following:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Current
Federal ................................. $ 161 $ 3,396 $ 1,367
State ................................... 231 202 117
------- ------- -------
Total current ................. 392 3,598 1,484
Deferred
Federal ................................. 2,281 (2,833) 287
------- ------- -------
Total income tax expense ...... $ 2,673 $ 765 $ 1,771
======= ======= =======
The provision for income taxes differs from that computed by applying federal
statutory rates at 34% to income before income tax expense as indicated in the
following summary:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Tax expense at statutory rate .............. $ 2,611 $ 603 $ 1,693
State income tax, net of federal
income tax benefit .................... 153 134 184
Tax-exempt interest income ................. (78) (87) (133)
Amortization of organization costs and
core deposit intangibles .............. 84 84 84
Other, net ................................. (97) 31 (57)
------- ------- -------
Total ....................... $ 2,673 $ 765 $ 1,771
======= ======= =======
78
Temporary differences, which give rise to deferred tax assets and liabilities,
are as follows:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Deferred tax assets
Allowance for loan losses ....................... $ 1,273 $ 3,624
Unrealized net holding losses on
available-for-sale securities ................. 130 299
State net operating loss ........................ 162 109
Other ........................................... 210 155
------- -------
Gross deferred tax assets ............. 1,775 4,187
Valuation allowance ............................. (162) (109)
------- -------
Total ................................. 1,613 4,078
------- -------
Deferred tax liabilities
Accelerated depreciation ........................ 348 363
Accretion ....................................... 12 12
Purchase adjustments - securities ............... 14 24
Purchase adjustments - loans .................... 8 24
------- -------
Gross deferred tax liabilities ........ 382 423
------- -------
Net deferred income tax assets ....................... $ 1,231 $ 3,655
======= =======
The state of South Carolina has different tax rates and rules governing banks
and regular corporations. The Corporation (holding company only) and the
mortgage company (CRM) are regular corporations and file a consolidated state
tax return separate from the state bank tax return filed by CRB. Accordingly, at
December 31, 2006 and December 31, 2005, valuation allowances of $162,000 and
$109,000 were established to offset deferred tax assets, which management does
not consider likely to be realizable, arising from state net operating loss
carryforwards of the Corporation (parent company only) and CRM. The Corporation
had no available carrybacks, and realization of the remainder of the net
operating loss deductions is dependent upon the Corporation (parent company
only) and CRM having aggregate future taxable income. Management expects that
the holding company and CRM have limited prospects to generate future taxable
income. The state net operating loss carryforwards at December 31, 2006 total
$3,251,000 and expire as follows: 2024 - $1,407,000; 2025 - $763,000 and 2026 -
$1,081,000.
NOTE 14 - EMPLOYEE BENEFIT PLANS
The Corporation provides a defined contribution plan qualified under Internal
Revenue Code Section 401(k). All employees who are eligible employees and who
are age 21 or older may participate in the plan. Eligible employees are defined
as employees not represented by a bargaining unit which has bargained with the
Corporation in good faith on the subject of retirement benefits.
A participant may elect to make tax deferred contributions up to a maximum of
$15,000 (plus $5,000 catch-up contributions if they were at least 50 years old)
in the 2006 plan year. The Corporation will make matching contributions on
behalf of each participant for 100% of the elective deferral up to 3% of the
participant's eligible compensation, which excludes incentive awards and
bonuses, plus 50% of the incremental elective deferral up to 5% of the
participant's eligible compensation, for a maximum matching contribution of 4%.
The Corporation may also make additional contributions determined at the
discretion of the Board of Directors.
79
The Corporation's contributions for 401(k) related profit sharing for the years
ended December 31, 2006, 2005, and 2004 totaled approximately $291,000,
$174,000, and $285,000, respectively. Since 2001, the senior officers of the
Corporation have not participated in the profit sharing program.
A defined benefit pension plan covers the majority of the employees of the
former Bank of Ridgeway. This plan was in place prior to the Corporation's
acquisition of Ridgeway Bancshares, Inc. in 2002. Because there were no such
plans for the Corporation's other subsidiaries, and there are no intentions to
establish any other such plans, the Corporation froze benefit accruals and
discontinued additional participation and voluntary contributions in the plan
during 2003. Management has no immediate plans to formally terminate the plan
and distribute its assets. The changes in the pension plan have been accounted
for as curtailments in accordance with the provisions of SFAS No. 88. The
following table shows the activity and status of that plan:
As of December 31,
------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Change in Benefit Obligation
Benefit obligation as of January 1 .............. $ 831 $ 752 $ 710
Service cost .................................... - - -
Interest cost ................................... 38 46 46
Curtailments .................................... - - -
Actuarial (gain) loss ........................... 20 42 106
Acquisition ..................................... - - -
Benefits paid ................................... (220) (9) (110)
----- ----- -----
Benefit obligation as of December 31 ............ 669 831 752
----- ----- -----
Change in Plan Assets
Fair value of plan assets as of January 1 ....... 795 694 656
Actual return (loss) on plan assets ............. 57 50 88
Acquisition ..................................... - - -
Employer contributions .......................... 60 60 60
Benefits paid ................................... (220) (9) (110)
----- ----- -----
Fair value of plan assets as of December 31 ..... 692 795 694
----- ----- -----
Funded Status of the Plan ........................ 23 (36) (58)
Unrecognized transition obligation ............. - - -
Unrecognized net loss .......................... 143 142 101
----- ----- -----
Prepaid (accrued) benefit liability ............ $ 166 $ 106 $ 43
===== ===== =====
Amount Recognized in the Consolidated
Balance Sheets consists of:
Prepaid (accrued) benefit cost ............. $ 23 $ 106 $ 43
===== ===== =====
80
The actuarial assumptions used to determine the benefit obligation as of
December 31, 2006, 2005 and 2004 were as follows:
December 31,
------------
2006 2005 2004
---- ---- ----
Pension Benefits Weighted Average Assumptions
Discount rate ..................................... 6.00% 6.00% 6.25%
Rate of compensation increase ..................... 3.00% 3.00% 3.00%
The components of net periodic pension cost were as follows:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Components of Net Periodic Benefit Cost
Service cost ................................. $ - $ - $ -
Interest cost ................................ 38 46 46
Expected return on plan assets ............... (43) (51) (47)
Recognized net actuarial loss (gain) ......... - - -
Amortization of transition obligation ........ - - -
Amortization of unrecognized net loss ........ 5 2 2
Curtailment (gain) loss ...................... - - -
---- ---- ----
Net periodic benefit cost ................. $ - $ (3) $ 1
==== ==== ====
For the years ended December 31, 2006, 2005 and 2004, the assumptions used to
determine net periodic pension cost were as follows:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
Pension Cost Weighted Average Assumptions
Discount rate ........................................ 6.00% 6.25% 6.25%
Expected long-term rate of return on plan assets ..... 7.25% 7.25% 7.25%
Rate of compensation increase ........................ 3.00% 3.00% 3.00%
81
The following table shows the incremental effects of initially adopting the
provisions of SFAS No. 158 as of December 31, 2006:
Incremental Effect of Applying SFAS No. 158
on Individual Line Items in the
Consolidated Balance Sheet
December 31, 2006
-----------------
Before After
Application of Application of
SFAS No. 158 Adjustments SFAS No. 158
------------ ----------- ------------
(Dollars in thousands)
Prepaid pension assets/(Liability for pension benefits) ................... $ 166 $ (143) $ 23
Deferred income taxes ..................................................... 1,184 47 1,231
Total assets .............................................................. 578,613 (96) 578,517
Accumulated other comprehensive income .................................... (265) (96) (361)
Total shareholders' equity ................................................ 52,720 (96) 52,624
The following table provides information about pension-related amounts flowing
through or included in accumulated other comprehensive income during, or as of
the end of, each of the years indicated.
As of or for the Year Ended
December 31,
------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Amounts recognized in other comprehensive income during the period
Net (gain) or loss arising during the period ................................................. $143 $ - $ -
Net gain or (loss) reclassified as a component of periodic benefit cost ...................... - - -
Amounts recognized in other comprehensive income at the end of the period
Net (gain) or loss ........................................................................... 143 - NA
Net prior service cost or (credit) ........................................................... - - NA
Net transition asset or obligation ........................................................... - - NA
Amounts included in other comprehensive income at period end that are expected
to be recognized as components of net periodic benefit cost in the next
succeeding year
Net (gain) or loss .......................................................................... 141 NA NA
Net prior service cost or (credit) .......................................................... - NA NA
Net transition asset or obligation .......................................................... - NA NA
Amount of any plan assets expected to be returned to the Corporation
during the next 12-month period .............................................................. - NA NA
82
As of December 31, 2006 and 2005, pension plan assets consisted primarily of the
following:
Percentage of Plan Assets
at December 31,
---------------
Asset Category 2006 2005
---- ----
Equities ....................................... 50% 51%
Bonds .......................................... 26% 24%
Cash ........................................... 2% 0%
Stable value instruments ....................... 22% 25%
--- ---
Total ........................... 100% 100%
=== ===
The plan did not hold any direct investment in the Corporation's common stock.
The Company expects to contribute $90,000 to the pension plan in 2007.
Estimated future benefit payments are as follows:
Year Amount
----
(Dollars in thousands)
2007 .......................................... $ 195
2008 .......................................... -
2009 .......................................... 170
2010 .......................................... -
2011 .......................................... 12
Years 2012 through 2016 .......................... 411
The Corporation maintains no other post-retirement or post-employment benefit
plans.
NOTE 15 - OFF-BALANCE-SHEET COMMITMENTS
The Bank is party to credit-related financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit and
standby letters of credit. Such commitments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets.
The Bank's exposure to credit loss is represented by the contractual notional
amount of these commitments. The Bank generally uses the same credit policies in
making these commitments as it does for on-balance-sheet instruments.
83
At December 31, 2006 and 2005, the following financial instruments were
outstanding whose contract amounts represent credit risk:
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Loan commitments ................................... $21,833 $13,386
Unfunded commitments under lines of credit ......... 49,104 42,974
Standby letters of credit .......................... 2,545 2,024
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 drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the borrower. 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 by the Bank 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. The Bank generally holds collateral supporting those
commitments 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. To reduce credit risk
related to the use of credit-related financial instruments, the Bank might deem
it necessary to obtain collateral. The amount and nature of the collateral
obtained is based on the Bank's credit evaluation of the customer. Collateral
held varies but may include cash, securities, accounts receivable, inventory,
property, plant and equipment and real estate.
In March 2007, the Bank entered into an agreement to construct a new branch
banking office on Clemson Road in northeast Richland County for a cost of
approximately $800,000. Completion of the project is expected by the fourth
quarter 2007.
NOTE 16 - EARNINGS PER SHARE
Basic earnings per share represent income available to common shareholders
divided by the weighted-average number of shares outstanding during the year.
Diluted earnings per share reflect additional common shares that would have been
outstanding if all dilutive potential stock options were exercised at the
beginning of each year and the proceeds used to purchase shares of the
Corporation's common stock at the average market price during the year. Dilutive
potential common shares that may be issued by the Corporation relate solely to
outstanding stock options.
84
Earnings per common share were computed based on the following:
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands, except per share)
Net income per share, basic
Numerator - net income ................................................... $ 5,009 $ 1,011 $ 3,209
========== ========== ==========
Denominator
Weighted average common shares issued and outstanding ................... 4,432,480 4,401,718 4,357,919
========== ========== ==========
Net income per share, basic ................................ $ 1.13 $ .23 $ .74
========== ========== ==========
Net income per share, assuming dilution
Numerator - net income ................................................... $ 5,009 $ 1,011 $ 3,209
========== ========== ==========
Denominator
Weighted average common shares issued and outstanding ................... 4,432,480 4,401,718 4,357,919
Effect of dilutive stock options ........................................ 72,041 100,017 114,500
---------- ---------- ----------
Total shares ............................................... 4,504,521 4,501,735 4,472,419
========== ========== ==========
Net income per share, assuming dilution .................... $ 1.11 $ .22 $ .72
========== ========== ==========
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Corporation's various
financial instruments. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. These techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. Accordingly, the
fair value estimates may not be realized in an immediate settlement of the
instrument. SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," as amended, excludes certain financial instruments and all
non-financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented may not necessarily represent the
underlying fair value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating
fair values of financial instruments as disclosed herein:
Cash and cash equivalents. The carrying amounts of cash and cash
equivalents approximate fair values.
Interest-bearing deposits with other banks. The carrying amounts of
interest-bearing deposits with banks approximate their fair values.
Securities available-for-sale and held-to-maturity. Fair values for
securities are based on quoted market prices. The market values of state
and local government securities are established with the assistance of an
independent pricing service. The values are based on data which often
reflect transactions of relatively small size and are not necessarily
indicative of the value of the securities when traded in large volumes.
85
Other investments. Fair values of other investments, consisting of
restricted securities, approximate the carrying amounts and are based on
the redemption provisions of the issuers.
Loans held for sale. The carrying amounts approximate their fair values.
Loans. Fair values for performing loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair values for
non-performing loans are estimated using discounted cash flow analyses or
underlying collateral values, where applicable.
Accrued interest. The carrying amounts of accrued interest receivable and
payable approximate fair value.
Deposits. The fair values disclosed for demand deposits are equal to the
amount payable on demand at the reporting date (that is, their carrying
amounts). Fair values for certificates of deposit and other time deposits
are estimated using a discounted cash flow calculation that applies
interest rates currently offered on certificates to a schedule of
aggregated expected monthly maturities of time deposits.
Short-term borrowings. The carrying amounts of federal funds purchased and
borrowings under repurchase agreements approximate their fair values
because of the associated variable interest rates.
Long-term debt. The fair value of fixed-rate long-term debt is estimated
using discounted cash flow analyses based on the Corporation's current
incremental borrowing rates for similar types of borrowing arrangements.
The fair value of variable-rate long-term debt is estimated at the carrying
amount of the debt.
Off-balance-sheet commitments. Fair values for off-balance-sheet
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standings. The vast majority of loan commitments
do not involve the charging of a fee, and costs associated with outstanding
letters of credit are not material. For loan commitments and standby
letters of credit, the committed interest rates are either variable or
approximate current interest rates offered for similar commitments.
Therefore, the estimated fair values of these off-balance-sheet commitments
are nominal.
86
The estimated fair values and related carrying or notional amounts of the
Corporation's financial instruments at December 31, 2006 and 2005, are as
follows:
December 31,
------------
2006 2005
---- ----
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
of Assets of Assets of Assets of Assets
(Liabilities) (Liabilities) (Liabilities) (Liabilities)
------------- ------------- ------------- -------------
(Dollars in thousands)
Cash and cash equivalents .................................. $ 46,724 $ 46,724 $ 51,991 $ 51,991
Interest bearing deposits with other banks ................. 1,926 1,926 1,038 1,038
Securities available-for-sale .............................. 84,783 84,783 58,701 58,701
Securities held-to-maturity ................................ 1,750 1,750 1,850 1,820
Other investments .......................................... 3,246 3,246 2,980 2,980
Loans held for sale ........................................ 9,235 9,235 12,447 12,447
Loans, net ................................................. 405,058 404,383 402,343 394,544
Accrued interest receivable ................................ 3,821 3,821 3,134 3,134
Deposits ................................................... (483,621) (484,172) (464,209) (464,673)
Short-term borrowings ...................................... (12,948) (12,948) (8,975) (8,975)
Long-term debt ............................................. (26,188) (27,236) (32,196) (34,110)
Accrued interest payable ................................... (1,578) (1,578) (1,212) (1,212)
Off-balance-sheet commitments
Loan commitments ......................................... $ (21,833) $ - $ (13,386) $ -
Unfunded commitments under lines of credit ............... (49,104) - (42,974) -
Standby letters of credit ................................ (2,545) - (2,024) -
NOTE 18 - CONTINGENCIES
The Corporation is subject at times to claims and lawsuits arising out of the
normal course of business. As of December 31, 2006, no claims or lawsuits were
pending or threatened which, in the opinion of management, are likely to have a
material effect on the Corporation's consolidated financial statements.
NOTE 19 - REGULATORY MATTERS
The Bank is subject to dividend restrictions set forth by various banking
regulators. Under such restrictions, the Bank may not, without prior approval,
declare dividends in excess of the sum of the current year's earnings (as
defined) plus the retained earnings (as defined) from the prior two years. In
addition, dividends paid by the Bank to the Corporation would be prohibited if
the effect thereof would cause the Bank's capital to be reduced below applicable
minimum capital requirements. At December 31, 2006, the dividends that the Bank
could declare without the approval of its primary bank regulator amounted to
approximately $5,606,000. The Bank is also restricted by law as to the amount it
lends to any non-depository affiliate, including the Corporation and CRM. Such
loans are subject to the requirements of Section 23A of the Federal Reserve Act
including a general limitation to not more than 10% of capital and specified
ratios of the fair market value of allowable collateral to loan amounts. There
were no such loans outstanding during 2006.
87
The Corporation (on a consolidated basis) and the Bank are each subject to
various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material adverse effect on the Corporation's and
the Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Corporation and the Bank
must meet specific capital guidelines that involve quantitative measures of
their assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital to
average assets (as defined). Management believes, as of December 31, 2006 and
2005, that the Corporation and the Bank met all capital adequacy requirements to
which they are subject.
As of December 31, 2006, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set
forth in the table. There are no conditions or events since the notifications
that management believes have changed the Bank's category. The Corporation's and
the Bank's actual capital amounts and ratios are presented in the following
table.
88
Minimum for Minimum to be
Actual Capital Adequacy Well Capitalized
------ ---------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2006 ........................................... (Dollars in thousands)
Tier 1 Capital (to Average Assets)
Consolidated ...................................... $57,005 10.1% $22,624 4.0% NA NA
Community Resource Bank ........................... 49,238 8.8% 22,419 4.0% $28,024 5.0%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ...................................... $57,005 13.6% $16,752 4.0% NA NA
Community Resource Bank ........................... 49,238 11.8% 16,631 4.0% $24,946 6.0%
Total Capital (to Risk Weighted Assets)
Consolidated ...................................... $61,667 14.7% $33,505 8.0% NA NA
Community Resource Bank ........................... 53,885 13.0% 33,262 8.0% $41,577 10.0%
December 31, 2005
Tier 1 Capital (to Average Assets)
Consolidated ...................................... $52,370 9.6% $21,880 4.0% NA NA
ONB ............................................... 18,008 8.2% 8,784 4.0% $10,979 5.0%
SNB ............................................... 10,060 7.1% 5,700 4.0% 7,125 5.0%
FNB ............................................... 7,155 8.9% 3,210 4.0% 4,012 5.0%
BOR ............................................... 7,721 8.2% 3,784 4.0% 4,729 5.0%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated ...................................... $52,370 12.7% $16,438 4.0% NA NA
ONB ............................................... 18,008 11.1% 6,499 4.0% $ 9,749 6.0%
SNB ............................................... 10,060 9.1% 4,416 4.0% 6,624 6.0%
FNB ............................................... 7,155 10.1% 2,829 4.0% 4,243 6.0%
BOR ............................................... 7,721 12.4% 2,488 4.0% 3,733 6.0%
Total Capital (to Risk Weighted Assets)
Consolidated ...................................... $57,592 14.0% $32,877 8.0% NA NA
ONB ............................................... 19,974 12.3% 12,999 8.0% $16,248 10.0%
SNB ............................................... 11,518 10.4% 8,831 8.0% 11,039 10.0%
FNB ............................................... 8,040 11.4% 5,657 8.0% 7,071 10.0%
BOR ............................................... 8,501 13.7% 4,977 8.0% 6,221 10.0%
89
NOTE 20 - CONDENSED FINANCIAL STATEMENTS
Presented below are the condensed financial statements for Community Bankshares,
Inc. (Parent Company only):
COMMUNITY BANKSHARES, INC. (PARENT COMPANY ONLY)
December 31,
------------
2006 2005
---- ----
(Dollars in thousands)
Condensed Balance Sheets
Assets
Cash ............................................................................. $ 4,541 $ 1,364
Investment in banking subsidiaries ............................................... 54,868 48,646
Investment in nonbanking subsidiaries ............................................ 1,806 1,797
Securities available-for-sale, at fair value ..................................... 96 96
Loans to nonbanking subsidiary ................................................... - 3,813
Premises and equipment - net ..................................................... 1,633 3,263
Goodwill ......................................................................... 921 921
Other assets ..................................................................... 96 2,167
------- -------
Total assets ................................................................. $63,961 $62,067
======= =======
Liabilities
Short-term borrowings ............................................................ $ - $ 2,000
Long-term debt ................................................................... 10,310 10,310
Other liabilities ................................................................ 1,027 765
Shareholders' equity ................................................................. 52,624 48,992
------- -------
Total liabilities and shareholders' equity ................................... $63,961 $62,067
======= =======
90
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Condensed Statements of Income
Income
Management fees from subsidiaries ......................................... $ 249 $ 3,086 $ 2,286
Dividends received from banking subsidiaries .............................. 2,480 4,266 2,679
Interest income ........................................................... 241 428 180
Other income .............................................................. 4 4 16
------- ------- -------
Total income .......................................................... 2,974 7,784 5,161
------- ------- -------
Expenses
Salaries and employee benefits ............................................ - 1,868 1,397
Premises and equipment .................................................... 48 683 628
Supplies .................................................................. - 80 109
Directors' fees ........................................................... - 62 53
Interest expense .......................................................... 890 675 408
Other expenses ............................................................ 203 1,447 918
------- ------- -------
Total expenses ........................................................ 1,141 4,815 3,513
------- ------- -------
Income before income taxes and equity in
undistributed earnings of subsidiaries .................................... 1,833 2,969 1,648
Income tax (benefit) .......................................................... (246) (441) (364)
Equity in undistributed (loss) earnings of banking subsidiaries ............... 2,920 (2,507) 1,664
Equity in undistributed earnings (loss) of nonbanking subsidiary .............. 10 108 (467)
------- ------- -------
Net income .................................................................... $ 5,009 $ 1,011 $ 3,209
======= ======= =======
91
Years Ended December 31,
------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Condensed Statements of Cash Flows
Operating activities
Net income ................................................................ $ 5,009 $ 1,011 $ 3,209
Adjustments to reconcile net income to net
cash provided by operating activities
Equity in undistributed (earnings) loss
of subsidiaries ............................................. (2,930) 2,399 (1,197)
Depreciation and amortization ................................. 48 354 332
Decrease (increase) in other assets ........................... 2,071 (2,071) 83
Increase in other liabilities ................................. 262 9 332
-------- -------- --------
Net cash provided by
operating activities ..................................... 4,460 1,702 2,759
-------- -------- --------
Investing activities
Net decrease (increase) in loans to nonbanking subsidiaries ............... 3,813 1,070 (4,883)
Investment in SCB Capital Trust ........................................... - - (310)
Investments in banking subsidiaries ....................................... (719) (3,000) (3,000)
Investment in nonbanking subsidiary ....................................... - (218) (126)
Purchases of premises and equipment ....................................... (826) (2,580) (360)
-------- -------- --------
Net cash provided (used) by investing activities ............ 2,268 (4,728) (8,679)
-------- -------- --------
Financing activities
(Decrease) increase in short-term borrowings, net ......................... (2,000) 2,000 (635)
Proceeds of issuing long-term debt ........................................ - - 10,310
Sale of common stock ...................................................... 16 14 -
Exercise of stock options ................................................. 385 146 640
Cash dividends paid ....................................................... (1,952) (1,761) (1,744)
-------- -------- --------
Net cash provided (used) by financing activities ............ (3,551) 399 8,571
-------- -------- --------
(Decrease) increase in cash and cash equivalents .............................. 3,177 (2,627) 2,651
Cash and cash equivalents, beginning .......................................... 1,364 3,991 1,340
-------- -------- --------
Cash and cash equivalents, ending ............................................. $ 4,541 $ 1,364 $ 3,991
======== ======== ========
92
NOTE 21 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Years Ended December 31,
------------------------
2006 2005
---- ----
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Interest and dividend income ..................... $ 9,722 $ 9,616 $ 9,103 $ 8,613 $ 8,464 $ 8,295 $ 7,696 $ 7,151
Interest expense ................................. 4,307 4,072 3,736 3,386 3,157 2,929 2,503 2,216
------- ------- ------- ------- ------- ------- ------- -------
Net interest income .............................. 5,415 5,544 5,367 5,227 5,307 5,366 5,193 4,935
Provision for loan losses ........................ 995 665 675 615 6,302 2,300 585 450
------- ------- ------- ------- ------- ------- ------- -------
Net interest income after provision .............. 4,420 4,879 4,692 4,612 (995) 3,066 4,608 4,485
Noninterest income ............................... 2,354 1,958 2,060 1,933 1,897 2,295 2,044 1,777
Gains (losses) on sales of securities ............ - - - 1 - - - (10)
Noninterest expenses ............................. 5,062 4,906 4,632 4,627 4,598 4,449 4,225 4,119
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before income taxes ................ 1,712 1,931 2,120 1,919 (3,696) 912 2,427 2,133
Provision for income taxes ....................... 478 730 747 718 (1,214) 330 876 773
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) ................................ $ 1,234 $ 1,201 $ 1,373 $ 1,201 $(2,482) $ 582 $ 1,551 $ 1,360
======= ======= ======= ======= ======= ======= ======= =======
Earnings (loss) per share
Basic ............................................ $ 0.28 $ 0.27 $ 0.31 $ 0.27 $ (0.56) $ 0.13 $ 0.35 $ 0.31
Diluted .......................................... 0.27 0.27 0.30 0.27 (0.56) 0.13 0.35 0.30
In early 2005 management hired a Chief Credit Officer, enhanced its loan
administration process and engaged the services of a new external loan review
firm. The new loan review firm's initial series of reviews were completed during
the second and third quarter of 2005. Based on those reviews, and further work
conducted by management, significant increases were recorded in the
Corporation's loan loss provision during the last two quarters of 2005. Loan
loss provision expense was significantly reduced during 2006 as a result of
these and other initiatives. In the fourth quarter of 2006, the Bank recognized
a gain of $514,000 on the sale of $8,100,000 from its loan portfolio.
93
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
There were no disagreements with or changes in accountants.
Item 9A. 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 Corporation's disclosure controls and procedures (as
defined in 17 C.F.R. Sections 240.13a-15(e) or 240.15d-15(e)), the Corporation's
chief executive officer and chief financial officer concluded that such controls
and procedures, as of the end of the period covered by this annual report, were
effective.
No disclosure is required under 17 C.F.R. Section 229.308(a) or (b).
There has been no change in the Corporation's internal control over financial
reporting during the most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, the Corporation's internal control
over financial reporting.
Item 9A(T). Controls and Procedures
This item is not yet applicable.
Item 9B. Other Information
No information required to be disclosed in a report on Form 8-K during the
fourth quarter of 2006 was not so disclosed.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information set forth under the captions "Management - Directors,"
"Management - Executive Officers," "Committees of the Board of Directors - Audit
Committee" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Proxy Statement to be used in conjunction with the 2007 Annual Meeting of
Shareholders (the "Proxy Statement"), which will be filed within 120 days of the
Corporation's fiscal year end, is incorporated herein by reference.
Audit Committee Financial Expert
The Corporation's board of directors has determined that the
Corporation does not have an "audit committee financial expert," as that term is
defined by Item 407(d)(5) of Regulation S-K promulgated by the Securities and
Exchange Commission, serving on its audit committee. The Corporation's audit
committee is a committee of directors who are independent of the Corporation and
its management. After reviewing the experience and training of all of the
Corporation's independent directors, the board of directors has concluded that
no independent director meets the SEC's very demanding definition. Therefore, it
would be necessary to find a qualified individual willing to serve as both a
director and member of the audit committee and have that person elected by the
shareholders in order to have an "audit committee financial expert" serve on the
Corporation's audit committee. The Corporation's audit committee is, however,
authorized to use consultants to provide financial accounting expertise in any
instance where members of the committee believe such assistance would be useful.
94
Accordingly, the Corporation does not believe that it needs to have an "audit
committee financial expert" on its audit committee.
Code of Ethics
The Corporation has adopted a code of ethics (as defined by C.F.R.
229.406) that applies to its principal executive officer and principal financial
officer. The code of ethics is posted on the Corporation's website at
www.communitybanksharesinc.com.
Item 11. Executive Compensation
The information set forth under the caption "Management Compensation"
in the 2007 Proxy Statement is incorporated herein by reference; provided,
however, pursuant to the Instructions to Item 407(e)(5) of Regulation S-K the
"Compensation Committee Report" shall be deemed to be "furnished" and not
"filed" and will not be deemed incorporated by reference into any filing under
the Securities Act of 1933 or the Securities Exchange Act of 1934 as a result of
being so furnished.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The information set forth under the caption "Security Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement is incorporated
herein by reference.
Equity Compensation Plan Information. The following table sets forth
aggregated information as of December 31, 2006 about all of the Corporation's
compensation plans (including individual compensation arrangements) under which
equity securities of the Corporation are authorized for issuance.
Number of securities
remaining available for
Weighted average future issuance under
Number of securities to exercise price of equity compensation
be issued upon exercise outstanding plans (excluding
of outstanding options, options, warrants securities reflected in
warrants and rights and rights columns (a))
Stock option plan (a) (b) (c)
----------------- ---------------------- ----------------- -----------------------
Equity compensation plans approved by security holders ........ 437,981 $ 14.41 347,619
Equity compensation plans not approved by security holders .... NA NA NA
Total ......................................................... 437,981 $ 14.41 347,619
The Corporation's 1997 Stock Option Plan, and issuance of up to 785,600 shares
under that plan, have previously been approved by shareholders.
95
Item 13. Certain Relationships and Related Transactions and Director
Independence
The information set forth under the captions "Certain Relationships and
Related Transactions" and "Governance Matters - Board Member Independence" in
the Proxy Statement is incorporated herein by reference. Each member of our
Audit, Compensation and Governance and Nominating Committee is independent as
defined in the American Stock Exchange's listing standards.
Item 14. Principal Accountant Fees and Services
The information set forth under the caption "Independent Registered
Public Accounting Firm - Fees Billed by Independent Auditors" and "- Audit
Committee Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Auditors" in the Proxy Statement is incorporated herein by
reference.
96
Item 15. Exhibits and Financial Statement Schedules
(a) (1) All financial statements:
Consolidated Balance Sheets, December 31, 2006 and 2005
Consolidated Statements of Income, Years Ended December 31, 2006, 2005 and
2004
Consolidated Statements of Changes in Shareholders' Equity, Years Ended
December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows, Years Ended December 31, 2006, 2005
and 2004
Notes to Consolidated Financial Statements
(2) Financial statement schedules:
Quarterly Data for 2006 and 2005
(3)
Exhibit No. Description
(from item 601 of
S-K)
3.1 Articles of Incorporation, as amended (incorporated by
reference to exhibits filed in the Registrant's Form 10-QSB
for the quarter ended September 30, 1997).
3.2 Bylaws, as amended (incorporated by reference to
Registrant's Form 8-K, filed February 4, 2005).
4 Stock certificate (incorporated by reference to exhibits
filed in the Registrant's Registration Statement on Form
S-2, filed September 11, 1995, Commission File No.
33-96746).
10.1 1997 Stock Option Plan, as amended (incorporated by
reference to exhibits to Registrant's Form S-8 (File No.
333-118119)).
10.2 Lease for site of Florence National Bank (incorporated by
reference to Registrant's Form 10-K for the year ended
December 31, 1999).
10.3 Indenture, dated as of March 1, 2004, between Registrant and
Wells Fargo Bank, National Association (incorporated by
reference to exhibits filed with Registrant's Form 10-Q for
the quarter ended March 31, 2004 ("First Quarter 2004 Form
10-Q")).
10.4 Amended and Restated Declaration of Trust, dated March 10,
2004, among the Trustees and Administrators named therein
and SCB Capital Trust I (incorporated by reference to the
First Quarter 2004 Form 10-Q).
10.5 Guaranty Agreement, dated as of March 10, 2004, between
Registrant and Wells Fargo Bank, National Association
(incorporated by reference to the First Quarter 2004 Form
10-Q).
97
10.6 Form of Employment Agreement between the Corporation and
Samuel L. Erwin (incorporated by reference to the 2004 Form
10-K).
10.7 Form of Employment Agreement between the Corporation and
each of William W. Traynham and Michael A Wolfe
(incorporated by reference to the 2004 Form 10-K).
21 Subsidiaries of the registrant (incorporated by reference to
the 2004 Form 10-K).
23 Consent of J. W. Hunt and Company, LLP
31.1 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Executive
Officer
31.2 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Financial
Officer
32 18 U.S.C. Section 1350 Certifications
98
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATED: March 26, 2007
By: s/ Samuel L. Erwin
----------------------------------
Samuel L. Erwin
Chief Executive Officer
By s/ William W. Traynham, Jr.
----------------------------------
William W. Traynham, Jr.
Chief Financial Officer
99
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
s/ E. J. Ayers, Jr. Date: March 26, 2007
----------------------------------
E. J. Ayers, Jr., Director
s/Alvis J. Bynum Date: March 26, 2007
----------------------------------
Alvis J. Bynum, Director
----------------------------------
Martha Rose C. Carson, Director
s/ Anna O. Dantzler Date: March 26, 2007
----------------------------------
Anna O. Dantzler, Director
s/ Thomas B. Edmunds Date: March 26, 2007
----------------------------------
Thomas B. Edmunds, Director
s/ Samuel L. Erwin Date: March 26, 2007
----------------------------------
Samuel L. Erwin, Director
s/ Charles E. Fienning Date: March 26, 2007
----------------------------------
Charles E. Fienning, Director
s/ J. M. Guthrie Date: March 26, 2007
----------------------------------
J. M. Guthrie, Director
s/ Richard L. Havekost Date: March 26, 2007
----------------------------------
Richard L. Havekost, Director
s/ John V. Nicholson Date: March 26, 2007
----------------------------------
John V. Nicholson, Director
s/ Samuel F. Reid, Jr. Date: March 26, 2007
----------------------------------
Samuel F. Reid, Jr., Director
100
s/ Charles P. Thompson, Jr. Date: March 26, 2007
----------------------------------
Charles P. Thompson, Jr., Director
----------------------------------
Wm. Reynolds Williams, II, Director
101
EXHIBIT INDEX
Exhibit No. Description
(from item 601 of
S-K)
3.1 Articles of Incorporation, as amended (incorporated by
reference to exhibits filed in the Registrant's Form 10-QSB
for the quarter ended September 30, 1997).
3.2 Bylaws, as amended (incorporated by reference to
Registrant's Form 8-K, filed February 4, 2005).
4 Stock certificate (incorporated by reference to exhibits
filed in the Registrant's Registration Statement on Form
S-2, filed September 11, 1995, Commission File No.
33-96746).
10.1 1997 Stock Option Plan, as amended (incorporated by
reference to exhibits to Registrant's Form S-8 (File No.
333-118119)).
10.2 Lease for site of Florence National Bank (incorporated by
reference to Registrant's Form 10-K for the year ended
December 31, 1999).
10.3 Indenture, dated as of March 1, 2004, between Registrant and
Wells Fargo Bank, National Association (incorporated by
reference to exhibits filed with Registrant's Form 10-Q for
the quarter ended March 31, 2004 ("First Quarter 2004 Form
10-Q")).
10.4 Amended and Restated Declaration of Trust, dated March 10,
2004, among the Trustees and Administrators named therein
and SCB Capital Trust I (incorporated by reference to the
First Quarter 2004 Form 10-Q).
10.5 Guaranty Agreement, dated as of March 10, 2004, between
Registrant and Wells Fargo Bank, National Association
(incorporated by reference to the First Quarter 2004 Form
10-Q).
10.6 Form of Employment Agreement between the Corporation and
Samuel L. Erwin (incorporated by reference to the 2004 Form
10-K).
10.7 Form of Employment Agreement between the Corporation and
each of William W. Traynham and Michael A Wolfe
(incorporated by reference to the 2004 Form 10-K).
21 Subsidiaries of the registrant (incorporated by reference to
the 2004 Form 10-K).
23 Consent of J. W. Hunt and Company, LLP
31.1 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Executive
Officer
31.2 Rule 13a-14(a) / 15d-14(a) Certifications of Chief Financial
Officer
32 18 U.S.C. Section 1350 Certifications
102