ITEM 1 - BUSINESS
Community Bancshares, Inc. (the "Company") is registered as a bank holding company with the Federal Reserve Board under the Bank Holding Act. The Company was organized in 1983 and commenced business in February, 1985, with the acquisition of the Bank of Blountsville. On August 8, 1997, the Company merged its two bank operating subsidiaries, Community Bank, an Alabama banking corporation ("Community Bank"), and Community Bank, a Tennessee banking corporation ("Community Bank (Tennessee)"), with the survivor being the Alabama banking corporation. The majority of the bank's loans are to individuals and small to mid-size businesses in Alabama and Tennessee.
Community Bank operated through twenty-three locations in Blount, Dekalb, Lauderdale, Limestone, Madison, Marion, Marshall, Morgan, Perry, and Winston Counties in Alabama, and Giles County, Tennessee during all of 1997. Two additional Alabama locations were opened during 1997: a location in the Guntersville Wal-Mart on October 20; and Fort Payne Wal-Mart (Dekalb County) on November 10. Additionally, another Alabama bank location was opened in the Hartselle Wal-Mart (Morgan County) on January 20, 1998. This brings the bank subsidiary to a total of 26 locations in 11 counties of both Alabama and Tennessee.
Community Bank also operates three subsidiaries, Community Appraisals, Inc., Community Insurance Corp., and 1st Community Credit Corporation. Community Appraisals, Inc. is engaged in the business of appraising real estate. Community Insurance Corp. currently acts as an agent for selling title insurance, life insurance, and property and casualty insurance. 1st Community Credit Corporation, after opening a new office in Arab, Alabama (Marshall County) on November 10, 1997, operates finance company offices in 7 Alabama communities.
The Company maintains its principal executive offices at Main Street, P.O. Box 1000, Blountsville, Alabama 35031.
SUBSIDIARY BANK
Community Bank conducts a general commercial banking business at twenty-six locations in eleven counties in Alabama and Tennessee. The present locations are Blountsville, Oneonta, Snead, West Blount, Cleveland and Oneonta (Walmart location) in Blount County; Rainsville and Fort Payne (Walmart location) in DeKalb County; Pulaski(Downtown) and Pulaski (East College) in Giles County, Tennessee; Rogersville in Lauderdale County; Elkmont in Limestone County; Gurley, Meridianville and New Hope in Madison County; Hamilton in Marion County; Arab (Downtown), Arab (Parkway) and Guntersville (Walmart location) in Marshall County; Falkville, Hartselle and Hartselle (Walmart location) in Morgan County; Uniontown in Perry County; and Haleyville, Haleyville-Village East and Double Springs in Winston County.
The subsidiary bank performs banking services customary for full service banks of similar size and character for their customers in Alabama and Tennessee. Such services include the receipt of demand and time deposit accounts, the extension of personal and commercial loans and the furnishing of personal and commercial checking accounts. Title insurance, life insurance, and appraisal services are available through the wholly-owned subsidiaries of Community Bank.
ACQUISITIONS
On September 25, 1995, Community Bank executed a definitive agreement to acquire certain assets and liabilities of the Haleyville, Alabama location of Compass Bank. On January 12, 1996, the agreement was consummated, with Community Bank assuming liabilities of $31.3 million in exchange for assets of $12.4 million, a premium of $2.2 million, and cash of $16.7 million. On November 3, 1995, Community Bank executed a definitive agreement with Compass Bank for a similar acquisition, the Uniontown, Alabama location, consummated on July 16, 1996 with the acquisition of assets of $29.7 million and payment of a premium of $261,000, the assumption of liabilities totaling $12.3 million, and a cash payment of $17.7 million.
On December 9, 1996, 1st Community Credit Corporation consummated an agreement with the Charter Financial Group to acquire assets, primarily finance receivables, totaling $1.9 million, for a cash payment, including a purchase premium of $333 thousand, of $2.2 million.
Effective August 1, 1997, the Company's wholly-owned subsidiary, Community Insurance, Inc., acquired a controlling interest in Southern Select Insurance, Inc., a property and casualty insurance general agency located in Birmingham, Alabama. Community Insurance paid $382,564 for 51% of the common stock of Southern Select, paying a premium of $344,341. The primary purpose of the acquisition was to acquire the management, product lines, and markets of Southern Select. Southern Select serves as the general agent to over 140 insurance agencies across Alabama. Its operations were not material to the consolidated financial statements of the Company as of December 31, 1997.
COMPETITION
The banking business in northern Alabama and southern Tennessee is highly competitive with respect to loans, deposits and other services and is dominated by a number of major banks and bank holding companies which have numerous offices and affiliates operating over wide geographic areas. The bank subsidiaries compete for deposits, loans and other business with these banks as well as with savings and loan associations, credit unions, mortgage companies, insurance companies and other local financial institutions. Many of the major commercial banks operating in the subsidiaries' service areas offer services such as international banking, and investment and trust services, which are not offered by the subsidiaries.
EMPLOYEES
At December 31, 1997, the Company and its subsidiaries had approximately 320 full-time equivalent employees. The Company and its subsidiaries provide a variety of group life, health and accident insurance, retirement and stock ownership plans (ESOP) and other benefit programs for their employees. The Company maintains continuing educational and training programs for its employees designed to prepare them for positions of increasing responsibility in management or operations. Membership and participation in professional and industry organizations is encouraged and supported by the Company.
SUPERVISION AND REGULATION
THE COMPANY
The banking industry is highly regulated. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provision. The following factors affect the Company's operations.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is registered with, and subject to supervision by, the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of Atlanta (collectively, the "Federal Reserve"). The Company is required to file periodic reports and such additional information as the Federal Reserve may require pursuant to the BHC act. The Federal Reserve may also examine the Company and its subsidiaries.
The BHC Act requires Federal Reserve approval before the Company may acquire substantially all the assets of any bank if by the acquisition the Company would own or control more than five percent of the voting shares of the bank, or for a merger or consolidation with another bank holding company. The Company may however, engage in or acquire an interest in a company that engages in activities which the Federal Reserve has determined by regulation or order to be so closely related to banking or managing or controlling banks as to be properly incident thereto.
The Federal Reserve has adopted a risk-based capital adequacy assessment system for bank holding companies. Assets are weighted by a risk factor and a ratio is calculated by dividing qualifying capital by the risk-weighted assets. Tier I capital generally includes common stock and retained earnings. Total capital is comprised of Tier I capital and Tier II capital, which includes certain allowances for loan losses, certain subordinated debt and perpetual preferred stock. The Company's Tier I and Total Capital ratios exceeded the required minimum levels as of December 31, 1997.
The Company is a legal entity which is separate and distinct from its subsidiaries. Federal law restricts extensions of credit by its subsidiary banks to the Company or its affiliates. Dividends to shareholders of the Company may be paid only from dividends paid to the Company by its subsidiaries.
THE SUBSIDIARIES
Deposits in the bank subsidiary are insured by the Federal Deposit Insurance Corporation ("FDIC") and therefore they are subject to examination by the FDIC. The Company can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly controlled FDIC-insured subsidiary or any assistance by the FDIC to any commonly controlled FDIC-insured subsidiary in danger of default.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") implemented a number of provisions applicable to insured banks and bank holding companies. Federal bank regulatory agencies are required to establish standards for safety and soundness of banks and bank holding companies relating internal controls and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth and compensation. The FDICIA also requires bank holding companies to guarantee compliance with any capital restoration plans entered into by a subsidiary bank and the FDIC. The activities of insured state banks, including non-subsidiary equity investment, is generally limited under the FDICIA to those permitted for national banks.
The FDICIA also requires regulations to be adopted by federal banking agencies establishing minimum loan to value ratios for all real estate mortgage and construction loans. The FDICIA requires regulations to limit risks posed by an insured bank's "exposure" to another bank. Exposure includes extension of credit, purchases of securities issued by the other bank, or acceptance of securities issued by the other bank as collateral for an extension of credit. Regulations pursuant to FDICIA limit such exposure.
The Community Reinvestment Act of 1977 ("CRA") and its implementing regulations are intended to encourage regulated financial institutions to meet the credit needs of their local community or communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of such financial institutions. The regulations provide that the appropriate regulatory authority will assess CRA reports in connection with applications for establishment of domestic branches, acquisitions of banks or mergers involving bank holding companies. Regulators are placing increased emphasis on CRA assessments. An unsatisfactory CRA rating may serve as a basis to deny an application to acquire or establish a new bank, to establish a new branch or to expand banking services.
The Equal Credit Opportunity Act ("ECOA") requires non-discrimination in banking services. The federal enforcement agencies have recently cited institutions for red-lining (refusing to extend credit to residents of a specific geographic area known to be comprised predominantly of minorities) or reverse red-lining (extending credit to minority applicants on terms less favorable than those offered to non-minority applicants). Violations can result in the assessment of substantial civil penalties.
Community Bank is subject to regulation and examination by the Alabama Superintendent of Banks (the "Superintendent"). State regulations in Alabama relate to such matters as loans, mortgages, consolidations, required reserves, allowable investments, issuance of securities, payment of dividends, establishment of branches, filing of periodic reports and other matters affecting the business of the respective banks.
The Supervisory Policy Statement on Securities Activities developed under the auspices of the Federal Financial Institutions Examination Council ("FFIEC") was adopted by the Federal Reserve Bank and became effective on February 10, 1992. This policy addresses the selection of securities dealers and requires depository institutions to establish prudent policies and strategies for securities transactions. The policy statement also addresses unsuitable investment practices and establishes a framework for identifying when mortgage derivative products are high-risk mortgage securities which must be reported as securities held for sale or trading.
On September 28, 1994, the President signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 ("IBBEA"). Beginning September 29, 1995, IBBEA permits adequately capitalized and managed bank holding companies to acquire control of banks in states other than their home states, subject to federal regulatory approval, without regard to whether such a transaction is prohibited by the laws of any state. IBBEA permits states to continue to require that an acquired bank have been in existence for a certain minimum time period, which may not exceed five years. A bank holding company may not, following an interstate transaction, control more than 10% of the nation's total bank deposits or 30% of bank deposits in the relevant state (unless the state enacts legislation to raise the 30% limit). States retain ability to adopt legislation to effectively lower the 30% limit.
Beginning June 1, 1997, federal banking regulators may approve merger transactions involving banks located in different states, without regard to laws of any state prohibiting such transactions; except that, mergers may not be approved with respect to banks located in states that, prior to June 1, 1997, enacted legislation prohibiting mergers by banks located in such state with out-of-state institutions. Federal banking regulators may permit an out-of-state bank to open new branches in another state if such state has enacted legislation permitting interstate branching. Affiliated institutions are authorized to accept deposits for existing accounts, renew time deposits, and close and service loans for affiliated institutions without being deemed an impermissible branch of the affiliate.
GOVERNMENTAL MONETARY POLICIES
The Federal Reserve System regulates the national supply of bank credit. The instruments on monetary policy used by the Federal Reserve to implement these objectives are: open market operations in U. S. Government securities, changes in discount rate, reserve requirements on member bank's deposits and funds availability regulations. The Company and its subsidiaries are affected by the credit policies of monetary authorities. These instruments are used in varying combinations to influence the overall growth of bank loans. The earnings and growth of the Company and subsidiaries will be subject to the influence of economic conditions generally and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The nature and timing of any changes in such policies and their impact on the Company cannot be predicted.
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ITEM 1 - STATISTICAL DISCLOSURE
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ITEM 2
ITEM 2 - PROPERTIES
The main offices of the Company are housed in a colonial style two story building owned by Community Bank and located on U. S. Highway 231 in Blountsville, Alabama.
The main office of Community Bank is located at 68149 Main Street, Blountsville, Alabama, in a one story brick building constructed in 1975 and which was extensively remodeled during 1994. The premises are owned by Community Bank. Community Bank's administrative, operational, legal, and accounting functions are housed in facilities built at the same location as the Company's main office during 1997. The bank subsidiary owns or leases buildings that are used in the normal course of business in ten counties in North Alabama, namely Blount, DeKalb, Lauderdale, Limestone, Madison, Marion, Marshall, Morgan, Perry and Winston, and in Giles County, Tennessee.
For information with respect to the amounts at which bank premises, equipment and other real estate are carried and relating to commitments under leases, see Consolidated Financial Statements.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
While the Company and its subsidiaries are from time to time parties to various legal proceedings arising from the ordinary course of business, management believes, after consultation with legal counsel, that there are no proceedings threatened or pending against the Company or its subsidiaries that will, individually or in the aggregate, have a material adverse effect on the business or consolidated financial condition of the Company.
ITEM 4
ITEM 4 - SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders by solicitation of proxies or otherwise during the fourth quarter of 1997.
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PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Company Common Stock ("Shares") was held by approximately 1,295 shareholders of record at December 31, 1997. There is no established trading market for Company Shares, which have been traded inactively in private transactions. Therefore, no reliable information is available as to trades of Company Shares, or as to the prices at which such Shares have traded. Management has reviewed the limited information available as to the ranges at which Shares have sold. The following data regarding Shares is provided for information purposes only, and should not be viewed as indicative of the actual or market value of Shares.
A cash dividend of $1.00 per share was declared by the Company's Board of Directors on January 8,1998 to shareholders of record at January 8, 1998, and was paid on January 12, 1998. Management continues to anticipate retaining substantially all earnings to finance the Company's growth. The payment of dividends on Shares is subject to the prior payment of principal and interest on the Company's long-term debt, sufficient earnings and capital in the subsidiaries and to regulatory restrictions. See "Financial and Statistical Information" and Consolidated Financial Statements and related notes.
6 - SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the last five years. All averages are daily averages.
ITEM 7
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this discussion is to focus on the significant changes in the financial condition and results of operations of the Company and its subsidiaries during the past three years. This discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere in this report.
The discussion of net interest income in this financial review is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets.
SUMMARY
The Company's principal market areas are located in North Central Alabama (in the counties of Blount, Dekalb, Lauderdale, Limestone, Madison, Marion, Marshall, Morgan and Winston), Western Alabama (Perry County) and in South Central Tennessee (in Giles County). All of the Company's banking facilities are located in relatively rural areas, placing an emphasis on personal service. None of the banks are located in urban areas.
Management believes that the economies of the areas in which we serve are healthy and expanding, but not at a pace that threatens stability. With the exception of the Blount County, Alabama and Perry County, Alabama markets, each of the markets shares one common characteristic: they are separate and distinct economies, but are close enough to Huntsville, Alabama to share in the economic and employment benefits of that city. Blount County is close enough to Birmingham, Alabama for the same circumstances to apply.
Despite the apparent dependency upon the military and aerospace industries, the Huntsville MSA possesses a significant diversity. Jobs are created in significant proportion in the manufacture of durable goods, machinery, and transportation equipment, as well as in retail and services. Agriculture, in the form of soybeans, hay, corn, cotton, tobacco, dairy and poultry farming makes up a significant portion of the economy as well. The Huntsville MSA had an average unemployment rate of 5.2% in 1994, and the counties served by the Company had unemployment averaging 5.6%, both lower than the average of 6.0% experienced in the entire state of Alabama. In the Company's markets, the increase in the per capita income over the last ten years has surpassed the rate for the state, as has population growth over the last year. The current economic prospects in our markets are good, and the Company attempts to assist those prospects by returning the deposits of our customers to the communities from which they come in the form of loans.
The Company's net income of $3,512,278 for 1997 was 1.5 percent more than 1996's amount of $3,458,986, which was 28 percent more than the $2,704,798 earned during 1995. When stated as changes in earnings per share, 1997 represented a 5 percent decrease from 1996 compared to a 10 percent decrease in 1996 over 1995. The start-up costs associated with de novo branches of the bank subsidiary have had a significant impact on the growth of the Company's net earnings, with operating losses of over $600,000 in both 1997 and 1996.
The continued growth in Company earnings is a response to management's emphasis on quality loans and investments with good yields while keeping expenses in line. The losses sustained by Community Bank in its de novo branches have been fully anticipated and projected prior to opening. The expected growth of these new locations become a significant factor to the Company's future earnings.
A stock offering of $9 million commenced in October, 1993 and closed fully sold in February, 1994. Another offering of approximately $6 million was completed during the first half of 1996. This additional capital and the retained earnings generated have placed the Company in the strongest capital position since its inception for future growth and expansion.
EARNING ASSETS
Average earning assets in 1997 increased 11 percent over 1996 primarily as a result of increases in the loan portfolio. The mix of average earning assets shifted slightly from the loan portfolio during 1997 as loans averaged 77 percent of the total for 1997, up from 73 percent during 1996. As a percentage of total average earning assets, investments securities averaged 19 percent and other earning asset categories averaged 4 percent for 1996. In the previous year, the comparable mix was 23 percent in investment securities and 4 percent in the other earning asset categories. The increased volume in earning assets contributed to the higher net interest income reported by the Company. Average earning assets for 1996 increased 28 percent over 1995.
Average loans increased 17 percent in 1997 with much of the increase concentrated in the real estate financing areas. Total loans outstanding at year-end were up 1 percent over the previous year-end level. Real estate-mortgage loans increased 6 percent and consumer loans decreased 4 percent from year-end 1996 to year-end 1997. Commercial, financial and agricultural loans, which made up 20 percent of the total loans, decreased 2 percent when compared to the previous year. Real estate-construction loans decreased 34 percent but had little effect due to representing only 1 percent of total loans.
Total loans at year-end 1996 grew 36 percent over 1995 and average loans grew 24 percent over the same period.
The Company has intentionally avoided the growing national market in loans to finance leveraged buy-outs, participating in no nationally syndicated leveraged buy-out loans. Concurrently, it has avoided exposure to lesser developed country ("LDC") debt, having no LDC loans in its portfolio.
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The following table shows the classification of loans by major category at December 31, 1997 and for each of the preceding four years. The second table provides maturities of certain loan classifications and an analysis of these loans maturing in over one year.
SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY
INVESTMENT PORTFOLIO
The composition of the Company's investment securities portfolio reflects the Company's investment strategy of maximizing portfolio yields subject to risk and liquidity considerations. The primary objectives of the Company's investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling the Company's interest rate position while at the same time producing adequate levels of interest income. On January 1, 1994, the Company transferred selected securities to an available for sale category to appropriately reflect the nature of the Company's holdings that are available for sale should liquidity needs dictate, and on December 1, 1995, the entire portfolio was classified as available for sale. Management of the maturity of the portfolio is necessary to provide liquidity and to control interest rate risk. During 1997 gross investment securities sales were $5.0 million and maturities were $6.6 million, representing 6.1 percent and 8.1 percent, respectively, of the average portfolio for the year. Losses associated with the sales totaled $2,590, accounting for 0.1 percent of noninterest income. Gross unrealized gains in the portfolio amounted to $964,038 at year end 1997 and unrealized losses amounted to $247,883. Average investment securities decreased 8.0 percent from 1996.
Mortgage-backed securities have varying degrees of risk of impairment of principal, as opposed to U.S. Treasury and U.S. government agency obligations, which are considered to contain virtually no default or prepayment risk. Impairment risk is primarily associated with accelerated prepayments, particularly with respect to longer maturities purchased at a premium and interest-only strip securities. The Company's mortgage-backed security portfolio as of December 31, 1997 or 1996 contains no interest-only strips and the amount of unamortized premium on mortgage-backed securities is only $281,029. The recoverability of the Company's investment in mortgage-backed securities is reviewed periodically, and if necessary, appropriate adjustments would be made to income for impaired values.
The carrying amount of investment securities at the end of each of the last three years is set forth in the following table. All securities have been classified as securities available for sale since December 1, 1995.
INVESTMENT PORTFOLIO
Average taxable securities were 84.8 percent of the portfolio in 1997 and 82.0 percent in 1996 while tax-exempt securities were 15.2 percent in 1997 and 18.0 percent in 1996. Average taxable securities decreased 4.9 percent while average tax-exempt securities decreased 22.3 percent in 1997. Average investment securities for 1997 decreased 8.0 percent from 1996 average levels. Period-end securities for 1997 decreased 2.1 percent from the previous year due to deposit growth in excess of loan demand growth.
The maturities and weighted average yields of the investments in the 1997 portfolio of investment securities are presented below. Taxable equivalent adjustments (using a 34 percent tax rate) have been made in calculating yields on tax-exempt obligations. The average maturity of the investment portfolio is 9.66 years with an average yield of 6.22 percent. Mortgage-backed securities have been included in the maturity table based upon the guaranteed payoff date of each security.
INVESTMENT PORTFOLIO MATURITY SCHEDULE
There were no securities held by the Company, whose aggregate value on December 31, 1997 exceeded ten percent of the Company's consolidated shareholders' equity at that date. (1)
- ---------------- (1) Securities which are payable from and secured by the same source of revenue or taxing authority are considered to be securities of a single issuer. Securities of the U. S. Government and U. S. Government agencies and corporations are not included.
Average Federal funds sold increased 21.1 percent, reflecting the increased cash available from deposit growth in excess of loan growth. During 1996, average Federal Funds increased 48.8 percent from 1995 levels. As a percentage of average earning assets, these funds represented 3.2 percent for 1997 compared to 3.0 percent for 1996.
The average balance of interest-bearing deposits with other banks decreased 1.5 percent from 1996 to 1997. The average balance from 1995 to 1996 decreased 18.3 percent. Total average earning assets as compared to total average assets for 1997 and 1996 were 89.3 and 90.0 percent, respectively.
There has been no significant impact on the Company's financial statements as a result of the provisions of Statement of Financial Accounting Standards No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.
DEPOSITS AND BORROWED FUNDS
The Company's primary source of funds is derived from its deposits. Continued enhancement of existing products and emphasis upon better customer service fuels the growth in the deposit base. Emphasis has been placed upon attracting consumer deposits. It is the Company's intent to expand its consumer base in order to continue to fund asset growth.
The portion of the Company's average liabilities represented by interest-bearing deposits increased in both 1997 and 1996 by 13.6 percent and 27.5 percent, respectively. During the same periods, average noninterest-bearing deposits increased 8.8 percent and 50.1 percent, respectively. Customer confidence and satisfaction is evidenced by the increase in total average deposits of 12.9 percent in 1997 and 30.2 percent in 1996. The largest dollar increase was in the time deposits category.
Average interest-bearing demand deposits rose 18.4 percent while average savings deposits decreased 0.9 percent, and average time deposits increased 15.7 percent. The two categories of lowest cost deposits comprised the following percentages of total deposits during 1997 and 1996, respectively: average noninterest-bearing demand deposits - 13.0 percent and 13.5 percent; and average interest-bearing demand deposits - 15.6 percent and 14.9 percent. Of total time deposits, approximately 32.7 percent were large denomination certificates of deposit. The maturities of the time certificates of deposit and other time deposits of $100,000 or more issued by the Company at December 31, 1997 are summarized in the table below.
MATURITIES OF LARGE TIME DEPOSITS
Borrowed funds consist primarily of short-term borrowings and long-term debt. Short-term borrowings at year-end 1997 and 1996 consisted of the U. S. Treasury Tax and Loan Note Option account, federal funds purchased (1996 only), and securities sold under agreements to repurchase. Long-term debt consisted of various commitments with scheduled maturities from one to twenty years.
The following table sets forth expected debt service for the next five years based on interest rates and repayment provisions as of December 31, 1997.
MATURITIES OF LONG-TERM DEBT
LIQUIDITY MANAGEMENT
Liquidity is defined as the ability of a company to convert assets into cash or cash equivalents without significant loss. Liquidity management involves maintaining the Company's ability to meet the day-to-day cash flow requirements of the subsidiary Banks' customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the production and growth needs of the communities it serves.
The primary function of assets and liabilities management is not only to assure adequate liquidity in order for the Company to meet the needs of its customer base, but to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that the Company can also meet the investment requirements of its shareholders. Daily monitoring of the sources and uses of funds is necessary to maintain an acceptable cash position that meets both requirements. In a banking environment, both assets and liabilities are considered sources of liquidity funding and both are, therefore, monitored on a daily basis.
Dividends paid by Community Bank are the primary source of funds available to the Company for debt repayment, payment of dividends to its stockholders and other needs. Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the Alabama Superintendent of Banks is required to pay dividends in excess of the Bank's earnings retained in the current year plus retained net profits for the preceding two years. At December 31, 1997, Community Bank could have declared dividends of $7,105,317 without approval of regulatory authorities.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments or sales of investment and trading account securities. Real estate-construction and commercial, financial and agricultural loans that mature in one year or less equaled approximately $34.7 million or 10.6 percent of the total loan portfolio at December 31, 1997 and investment securities maturing in one year or less equaled $5.3 million or 6.2 percent of the portfolio. Other sources of liquidity include short-term investments such as Federal funds sold and maturing interest-bearing deposits with other banks.
The liability portion of the balance sheet provides liquidity through various customers' interest-bearing and noninterest-bearing deposit accounts. Funds are also available through the purchase of federal funds from other commercial banks from available lines of up to $7,000,000. Liquidity management involves the daily monitoring of the sources and uses of funds to maintain an acceptable company cash position.
INTEREST RATE SENSITIVITY MANAGEMENT
Interest rate sensitivity is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to change in interest rates either at replacement or maturity during the life of the instruments. Sensitivity is measured as the difference between the volume of assets and liabilities in the Company's current portfolio that are subject to repricing in future time periods. The differences are known as interest sensitivity gaps and are usually calculated separately for segments of time ranging from zero to thirty days, thirty-one to ninety days, ninety-one days to one year, one to five years, over five years and on a basis. The following tables show interest sensitivity gaps for these different intervals as of December 31, 1997.
INTEREST RATE SENSITIVITY ANALYSIS
- ----------------- (1) Excludes nonaccrual loans and securities. (2) Excludes matured certificates which have not been redeemed by the customer and on which no interest is accruing. (3) Demand and savings deposits are assumed to be subject to movement into other deposit instruments in equal amounts during the 0-30 day period, the 31-90 day period, and the 91-365 day period.
The above table indicates that in a rising interest rate environment, the Company's earnings may be adversely affected in the 0-365 day periods where liabilities will reprice faster than assets.
As seen in the preceding table, for the first 30 days of repricing opportunity there is an excess of interest-bearing liabilities over earning assets of $6.2 million. For the first 365 days, interest-bearing liabilities exceed earning assets by $161.9 million. During this one year time frame, 80.4 percent of all interest bearing will reprice compared to 21.0 percent of all interest-earning assets. Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remain the same, thus impacting net interest income. It should be noted, therefore, that a matched interest-sensitive position by itself will not ensure maximum net interest income. Management continually evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in the general level of interest rates.
CAPITAL RESOURCES
A strong capital position is vital to the continued profitability of the Company because it promotes depositor and investor confidence and provides a solid foundation for future growth of the organization. The Company has provided the majority of its capital requirements through the retention of earnings.
During the last quarter of 1993 and the first quarter of 1994, the Company offered a maximum of 600,000 shares of its $.10 par value common stock at $15 per share with the anticipation of raising up to $9,000,000 of capital. On February 11, 1994 the offering was closed upon full subscription of all 600,000 shares offered for sale, raising $8,916,742 of capital after reduction for offering costs. During 1995, the Company began a stock offering of up to 312,161 shares of its $.10 par value stock at $20 per share with the anticipation of raising up to $6.2 million of capital. On June 13, 1996 the offering was closed upon full subscription of all shares offered for sale, raising $6,175,898 of capital after reduction for offering costs.
The proceeds of both offerings are available for debt reduction, capital enhancement and future growth and expansion of the Company.
Bank regulatory authorities are placing increased emphasis on the maintenance of adequate capital. In 1990, new risk-based capital requirements became effective. The guidelines take into consideration risk factors, as defined by regulators, associated with various categories of assets, both on and off the balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk-adjusted assets to determine the risk-based capital ratios. The Company's Tier 1 capital, which consists of common equity, amounted to $32.6 million at December 31, 1997. Tier II capital components include supplemental capital components such as qualifying allowance for loan losses and qualifying subordinated debt. Tier I capital plus the Tier II capital components is referred to as Total Risk-based capital and was $36.4 million at year-end 1997. The percentage ratios, as calculated under the guidelines were 10.63 percent and 11.86 percent for Tier I and Total Risk-based capital, respectively, at year-end 1997. Both levels currently exceed the minimum ratios of four percent and eight percent, respectively.
Applying the current guidelines to the preceding two years also resulted in capital ratios exceeding the minimum requirements.
Other important indicators of capital adequacy in the banking industry are the leverage ratio and the tangible leverage ratio. The leverage ratio is defined as the ratio the Company's shareholders equity, minus goodwill bears to total average assets minus goodwill. The Company's leverage ratios as of December 31, 1997, 1996, and 1995 exceeded the regulatory minimum requirement of 4%.
The table following illustrates the company's regulatory capital ratios at December 31, 1997, 1996 and 1995 under the year end 1997 requirements.
CAPITAL ADEQUACY RATIOS
In addition to regulatory requirements, a certain level of capital growth must be achieved to maintain appropriate ratios of equity to total assets. The following table summarizes these and other key ratios for the Company for each of the last three years.
RETURN ON EQUITY AND ASSETS
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income is the principal source of a financial institution's earnings stream and represents the difference or spread between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest-bearing liabilities materially impact net interest income. All discussions in this section assume a taxable equivalent basis unless otherwise noted.
Net interest income for 1997 increased 12.8 percent from 1996 and 28.8 percent in 1996 over 1995. Increased volume in 1997 and 1996 accounted for the majority of the increase. The schedule on pages 25 and 26 provides the detail changes in interest income, interest expense and net interest income due to changes in volume and rate.
Interest income increased 12 percent in 1997 and 27.7 percent in 1996. The 1997 increase is due both to the 11.3 percent increase in average earning assets and the 5 basis point rise in the average yield on earning assets. The increase in interest income in 1996 was attributable to the 27.4% increase in average earning assets. Interest income on loans increased 16.5 percent primarily due to increased volume. Interest income on investment securities decreased 9.7 percent from 1996 to 1997 as a result of decreased average balances outstanding.
Total interest expense increased 12.1 percent due to the effect of a 13.0 percent increase in volume of average interest-bearing liabilities, offset by the effect of a 4 basis point decrease in the rate paid. The rise of interest on deposits and short-term borrowings was due to an increase in volume which exceeded declines in deposit rates.
The trend in net interest income is also evaluated in terms of average rates using the net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield returned on average earning assets and the average rate paid for funds used to support those earning assets, including both interest-bearing and noninterest-bearing sources. The net interest margin for 1997 was 4.46 percent as compared to 4.44 percent for 1996.
The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing sources of funds. The interest rate spread eliminates the impact of noninterest-bearing funds and gives a more direct perspective to the effect of market interest rate movements. The net interest spread for 1997 increased 9 basis points to 3.94 percent from the 1996 spread of 3.85 percent as the yields on earning assets increased as the cost of interest-bearing liabilities decreased. See the accompanying schedules entitled "Rate/Volume Variance Analysis" and "Consolidated Average Balances, Interest Income/Expenses and Yields/Rates" for more information.
The following tabulation presents certain net interest income data without modification for assumed tax equivalency:
1997 was characterized by relatively stable interest rates. Despite the flat rate environment, net interest income increased by 12.8 percent due to the 11.3 percent increase in average earning asset volume.
Absolute changes in net interest income from 1996 to 1997 and from 1995 to 1996 were $2.1 million and $3.6 million, respectively, as reported in the Consolidated Statements of Income. The net interest margin increased to 4.32 percent in 1997 from 4.26 percent in 1996 and the interest rate spread increased to 3.80 percent for 1997 from 1996's 3.67 percent.
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CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES Taxable Equivalent Basis (in Thousands)
- -------------------- (1) Average loans include nonaccrual loans. All loans and deposits are domestic. (2) Tax equivalent adjustments have been based on an assumed tax rate of 34 percent, and do not give effect to the disallowance for federal income tax purpose of interest expense related to certain tax-exempt earning assets.
RATE/VOLUME VARIANCE ANALYSIS Taxable Equivalent Basis
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
PROVISION FOR LOAN LOSSES, NET CHARGE-OFFS AND ALLOWANCE FOR LOAN LOSSES
The provision for loan losses, which is charged to operations, is based on the growth of the loan portfolio, the amount of net loan losses incurred and management's estimation of potential future losses based on an evaluation of the risk in the loan portfolio. The provision for loan losses decreased 7.4 percent in 1997 compared to a decrease of 23.3 percent in 1996; there was a decrease of 12.1 percent in the allowance for loan losses at December 31, 1997 as compared to December 31, 1996. Net loan charge-offs decreased 6.1 percent in 1997 after increasing 168.6 percent in 1996. Net charge-offs on consumer loans amounted to 64 percent of total net charge-offs for 1997 compared to 53 percent in 1996 and 80 percent in 1995. Management believes that the $2,131,354 in the allowance for loan losses at December 31, 1997 (.65% of total net outstanding loans at that date) was adequate to absorb known risks in the portfolio based upon the Company's historical experience. No assurance can be given, however, that increased loan volume, adverse economic conditions or other circumstances will not result in increased losses in the Company's loan portfolio.
The following table sets forth certain information with respect to the Company's loans, net of unearned income, and the allowance for loan losses for the five years ended December 31, 1997.
Summary of Loan Loss Experience
In assessing adequacy, management relies predominantly on its ongoing review of the loan portfolio, which is undertaken both to ascertain whether there are probable losses which must be charged off and to assess the risk characteristics of the portfolio in the aggregate. This review takes into consideration the judgments of the responsible lending officers and senior management, and also those of bank regulatory agencies that review the loan portfolio as part of the regular bank examination process.
In evaluating the allowance, management also considers the loan loss experience of Community Bank, the amount of past due and nonperforming loans, current and anticipated economic conditions, lender requirements and other appropriate information.
Management allocated the reserve for loan losses to specific loan classes as follows:
ALLOCATION OF LOAN LOSS RESERVE
(1) The Company had no foreign loans.
NONPERFORMING ASSETS
Nonperforming assets as of December 31, 1997 increased 49.2 percent from year-end 1996. Nonperforming loans include loans classified as nonaccrual or renegotiated and those past due 90 days or more for which interest is still being accrued. There were no commitments to lend any additional funds on nonaccrual or renegotiated loans at December 31, 1997. The following table summarizes the Company's nonperforming assets for each of the last five years.
NONPERFORMING ASSETS
The ratio of loan loss allowance to total nonperforming assets decreased by 41.4% from 1996 to 1997, to 0.78. The ratio of total nonperforming loans to total loans doubled from 1996 to 1997, and total nonperforming assets to total assets increased by 0.2% from 1996 to 1997, placing it at a slightly higher level than in the previous three years. Each of these ratios compare favorably with industry averages, and management is aware of no factors which should suggest that they are prone to increases in future periods.
For the years ended December 31, 1997, 1996 and 1995, the difference between the gross interest income that would have been recorded in such period if nonaccruing loans had been current in accordance with their original terms and the amount of interest income on those loans that was included in such period's net income was negligible.
There were no concentrations of loans exceeding 10% of total loans which are not otherwise disclosed as a category of loans.
It is the general policy of the Company's subsidiary bank to stop accruing interest income and place the recognition of interest on a cash basis when any commercial, industrial or real estate loan is past due as to principal or interest and the ultimate collection of either is in doubt. Accrual of interest income on consumer installment loans is suspended when any payment of principal or interest, or both, is more than ninety days delinquent. When a loan is placed on a nonaccrual basis any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest or a guarantor assures payment of interest.
There has been no significant impact on the Company's financial statements as a result of the provisions of Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, or Statement of Accounting Standards No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.
NONINTEREST INCOME
Noninterest income for 1997 totaled $4,890,980 as compared to $4,447,235 in 1996 and $3,716,891 in 1995. These amounts are primarily from service charges on deposit accounts, debt cancellation fees and fees on services to customers. Service charge increases are primarily a reflection of the deposit growth of the Company as it has expanded into new markets, and the result that deposit growth has on deposit account service charges and NSF income. The insurance commissions increased in 1997 as a result of the activities of the Company's Community Insurance unit in the areas of title insurance and life insurance, overcoming significant decreases in credit life insurance commissions. Service charges and bank club dues were up a combined 12.7%, primarily due to the continued geographic expansion of the Company's bank subsidiary, leading to increases in the types of transaction accounts which create these kinds of fees.
NONINTEREST INCOME
NONINTEREST EXPENSES
Noninterest expenses totaled $17,422,661 in 1997 which represents a 16.9 percent increase over 1996 noninterest expenses, which were 23.7 percent higher than in 1995. Salaries and benefits increased $1,267,391 (13.9%) to in 1997 reflecting the increased personnel costs of completing the staffing of the new Alabama bank locations and finance offices. Director and committee fees, which were $465,775 in 1996 and $286,550 in 1995 increased 37.0% in 1997 to $638,120. Occupancy expense increased 43.4% to $1,477,721 in 1997 primarily as a result of the building and renovation of several bank locations. Furniture and equipment expense increased 20.8% in 1997 from the 1996 amount, to $1,213,978, compared to a 20.6% increase in 1996. Other operating expenses increased 13.0% to $3,690,116 during 1997. From 1995 to 1996, other operating expenses increased 14.5%.
NONINTEREST EXPENSES
INCOME TAXES
The Company attempts to maximize its net income through active tax planning. This planning resulted in a provision for income taxes of $1,451,419 (29.3%) for 1997, on pre-tax income of $4,945,355. The tax for 1996 was $1,426,344 (29.2%) on income of $4,885,330 and for 1995 was $430,997 (13.7%) on income of $3,135,795. These tax amounts and rates are lower than the statutory Federal tax rate of 34 percent primarily due to investments in loans and securities earning interest income that is exempt from Federal taxation. The effective tax rate for 1995 also decreased due to an adjustment in the deferred tax valuation allowance and the recognition of a deferred tax benefit from the donation of a capital asset which exceeded its tax basis by approximately $290,000. As proportionately fewer available funds are invested in tax-exempt assets, the effective tax rate will more closely approximate the statutory Federal tax rate. In 1997 the effective tax rate was 86.2 percent of the statutory Federal tax rate compared to 85.9 percent in 1996. A more detailed explanation of income tax expense is included in the accompanying notes to the Consolidated Financial Statements.
IMPACT OF INFLATION AND CHANGING PRICES
A bank's asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of a bank are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company's ability to react to changes in interest rates and by such reaction to reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services. As discussed previously, management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
Various information shown elsewhere in this Annual Report will assist in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends. In particular, the summary of net interest income, the maturity distributions, the composition of the loan and security portfolios and the data on the interest sensitivity of loans and deposits should be considered.
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MANAGEMENT'S STATEMENT OF RESPONSIBILITY FOR FINANCIAL INFORMATION
Community Bancshares, Inc.
The management of Community Bancshares, Inc. is responsible for the preparation, integrity, and objectivity of the consolidated financial statements, related financial data, and other information in this annual report. The consolidated financial statements are prepared in accordance with generally accepted accounting principles and include amounts based on management's best estimates and judgement where appropriate. Financial information appearing throughout this annual report is consistent with the consolidated financial statements.
In meeting its responsibility both for the integrity and fairness of these statements and information, management depends on the accounting systems and related internal accounting controls that are designed to provide reasonable assurances that (i) transactions are authorized and recorded in accordance with established procedures, (ii) assets are safeguarded, and (iii) proper and reliable records are maintained.
The concept of reasonable assurance is based on the recognition that the cost of internal control systems should not exceed the related benefits. As an integral part of internal control systems, the Company maintains a professional staff of internal auditors who monitor compliance and assess the effectiveness of internal control systems and coordinate audit coverage with independent certified public accountants.
The responsibility of the Company's independent certified public accountants is limited to an expression of their opinion as to the fairness of the consolidated financial statements presented. Their opinion is based on an audit conducted in accordance with generally accepted auditing standards as described in their report.
The Board of Directors is responsible for insuring that both management and the independent certified public accountants fulfill their respective responsibilities with regard to the consolidated financial statements. The Audit Committee meets periodically with both management and the independent certified public accountants to assure that each is carrying out its responsibilities. The independent certified public accountants have full and free access to the Audit Committee and Board of Directors and may meet with them, with and without management being present, to discuss auditing and financial reporting matters.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Regulation S-X and by Item 302 of Regulation S-K are set forth in the pages listed below.
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES Financial Statements
[DUDLEY, HOPTON-JONES, SIMS & FREEMAN PLLP LETTERHEAD]
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Shareholders of Community Bancshares, Inc.
We have audited the consolidated statements of financial condition of Community Bancshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Community Bancshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles.
Birmingham, Alabama February 13, 1998 DUDLEY, HOPTON-JONES, SIMS & FREEMAN PLLP
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Other real estate of $808,150, $1,328,284 and $387,958 was acquired in 1997, 1996 and 1995, respectively, through foreclosure. Other assets acquired in 1997 by foreclosure amounted to $471,027.
Long-term debt was increased and equity was decreased $1,200,000 on January 1, 1994 to reflect the existence of leveraged, unreleased ESOP shares. Upon the pledging of additional shares to obtain additional ESOP debt of $1,260,007 on May 17, 1996 and $137,918 on October 2, 1995, long-term debt was increased and equity was decreased again. The debt was reduced and shares were released by $116,989 and $135,314, respectively, during each of the years ended December 31, 1997 and 1996 as a result of payments made by the Company's ESOP on the outstanding ESOP debt.
Investment securities of $40,504,243 were transferred during 1995, to securities available for sale in accordance with the provisions of SFAS 115.
In August of 1997, the Company issued 11,770 shares of its common stock to the owners of Southern Select Insurance, Inc. as a portion of the consideration given in exchange for 51% of its issued and outstanding common stock.
See notes to consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
December 31, 1997, 1996 and 1995
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation The consolidated financial statements include the accounts of Community Bancshares, Inc. and its wholly owned subsidiaries (the "Company"), Community Bank, Community Appraisals, Inc., Community Insurance Corp.(including its 51% ownership of Southern Select Insurance, Inc.) and 1st Community Credit Corporation collectively, the "Bank". All significant intercompany balances and transactions have been eliminated. Investments in subsidiaries are carried at the parent company's equity in the underlying net assets.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements 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 relate to the determination of the allowance for loan losses. While management uses available information to recognize losses on loans, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowances based on their judgements about information available to them at the time of their examination.
Investments in Securities The Company's investments in securities are classified in two categories and accounted for as follows:
- Securities Held to Maturity. Bonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using methods which approximate level yields over the period to maturity.
- Securities Available for Sale. Securities available for sale consist of bonds, notes, debentures, and certain equity securities not classified as securities held to maturity.
The Company and its subsidiaries have no trading securities. Effective December 1, 1995, the Company reclassified all of its investments in securities as securities available for sale.
Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in a separate component of shareholders's equity until realized.
Gains and losses on the sale of securities available for sale are determined using the specific-identification method.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Revenue Recognition Interest on loans is accrued and credited to operations based upon the principal amount outstanding, except for interest on certain consumer loans which is recognized over the term of the loan using a method which approximates level yields.
Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the loan is impaired. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.
Allowance for Loan Losses The allowance for loan losses is maintained at a level believed adequate by management to absorb potential loan losses in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current domestic and international economic conditions, volume, growth and composition of the loan portfolio, and other relevant factors. Loans deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance.
Loan Fees The Company accounts for loan fees and origination costs in accordance with FASB Statement No. 91, entitled: Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Direct Costs of Leases. The basic requirement of this statement calls for the Company to treat loan fees, net of direct costs, as an adjustment to the yield of the related loan over the term of the loan.
Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation. Expenditures for additions and major improvements that significantly extend the useful lives of the assets are capitalized. Expenditures for repairs and maintenance are charged to expense as incurred. The carrying value of assets traded in are used to adjust the carrying values of the new assets acquired by trade. Assets which are disposed of are removed from the accounts and the resulting gains or losses are recorded in operations.
Depreciation is provided generally by accelerated and straight-line methods based on the estimated useful lives of the respective assets.
Other Real Estate Other real estate comprises properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of cost or fair market value based on appraised value at the date acquired. Loan losses arising from the acquisition of such properties are charged against the allowance for loan losses. An allowance for losses on other real estate is maintained for subsequent valuation adjustments on a specific property basis.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Earnings Per Common Share Basic earnings per common share are computed by dividing earnings available to stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common stock had been converted to common stock, as prescribed by SFAS No. 128, Earnings per Share. The following reconciles the weighted average number of shares outstanding:
Income Taxes Provisions for income taxes are based on amounts reported in the statement of income (after exclusion of non-taxable income such as interest on state and municipal securities) and include deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled as prescribed in SFAS No. 109, Accounting for Income Taxes. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
The Company and its subsidiaries file a consolidated federal income tax return. Each subsidiary provides for income taxes on a separate-return basis, and remits to the Company amounts determined to be currently payable.
Pension and Employee Stock Ownership Plans The Company and its subsidiaries have various employee benefit plans which cover substantially all employees. Pension expense is determined based on an actuarial valuation. The Company contributes amounts to the pension fund sufficient to satisfy funding requirements of the Employee Retirement Income Security Act. Contributions to the Employee Stock Ownership Plan are determined by the Board of Directors.
Intangibles Intangibles consist primarily of legal organizational costs and core deposits intangible. Organizational costs are generally amortized over 5 years using the straight-line method. The core deposits intangible represents premiums paid on the purchase of deposit liabilities. The asset is stated at cost, net of accumulated amortization, which is provided using the straight-line method over the estimated useful life of approximately 15 years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Off Balance Sheet Financial Instruments In the ordinary course of business the Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.
The Company also has available as a source of short-term financing the purchase of federal funds from other commercial banks from available lines of up to $7,000,000.
Debt Cancellation Contracts The Company began issuing debt cancellation contracts on certain of its loan customers as of October 1, 1995. The contract represents an agreement by the Company to cancel the debt of the borrower upon said borrower's death. Contracts may not be written on loans in excess of $15,000 per borrower. The Company charges fees equivalent to that authorized by the state banking authorities, and, after the establishment of an original reserve account of $150,000, sets aside 30% of all realized fees as a reserve for potential claims. The reserve for debt cancellation contracts totaled $135,139 and $282,081 at December 31, 1997 and 1996.
Cash Flow Information For purposes of the statements of cash flows, the Company considers cash, due from banks and federal funds sold as cash and cash equivalents.
Effect of New Financial Accounting Standards The Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 114, Accounting by Creditors for Impairment of a Loan. SFAS No. 114, as amended by SFAS No. 118, became effective January 1, 1995 and requires that impaired loans that are within the scope of this Statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, or, as a practical expedient, at the loans observable market price or the fair value of the collateral if the loan is collateral dependent.
The adoption of SFAS No. 114 did not have a material effect on financial position and results of operations.
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. SFAS No. 123, became effective for years beginning after December 15, 1995, and allows for the option of continuing to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and the related Interpretations or selecting the fair value method of expense recognition as described if SFAS No. 123. The Company has elected to follow APB No. 25 in accounting for its employee stock options.
The Company also adapted SFAS No. 128, Earnings Per Share, during 1997. See Note 1 - Earnings per Share, and Note 11. - Prior Period Restatement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS
The subsidiary banks are required to maintain average reserve balances either in vault cash or on deposit with the Federal Reserve Bank. The amount of those reserves required at December 31, 1997 was approximately $7,526,000.
NOTE 3 - INVESTMENT SECURITIES
Effective January 1, 1994, the Company applied the accounting and reporting requirements of Statement of Financial Accounting Standards No. 115 ("SFAS 115"), Accounting for Certain Investments in Debt and Equity Securities. This pronouncement requires that all investments in debt securities be classified as either HELD TO MATURITY SECURITIES, which are reported at amortized cost; TRADING SECURITIES, which are reported at fair value, with unrealized gains and losses included in earnings; or AVAILABLE FOR SALE SECURITIES, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity (net of deferred tax effect).
The Company has no trading securities. During 1995, the Financial Accounting Standards Board issued a report clarifying several provisions of SFAS 115. The report authorized entities to "reassess the appropriateness of the classifications of all securities" that were held when the current rule took effect, without risking the classification of other securities, for a limited period of time from November 15, 1995 to December 31, 1995. Effective December 1, 1995, the Company transferred all securities from its held to maturity category to its available for sale category, a change affecting securities with a total amortized cost of $40,504,243 and a fair value at the time of the transfer of $40,470,589.
At December 31, 1997, the Company's available-for-sale securities reflected net unrealized gains of $716,155, which resulted in an increase in stockholders' equity of $429,693, net of deferred tax expense, as opposed to net unrealized losses of $255,937 and a resultant decrease in stockholders' equity of $153,562, net of deferred tax benefit, at December 31, 1996. At December 31, 1995, the investment securities reflected $1,243,146 of net unrealized gains in available for sale securities, with an increase to stockholders' equity, net of deferred tax liability, of $745,887.
The carrying amounts of investment securities as shown in the consolidated statements of financial condition of the Company and their approximate fair values at December 31, 1997 and 1996 are presented below.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 3 - INVESTMENT SECURITIES - CONTINUED
The contractual maturities of securities available for sale at December 31, 1997 are shown 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 3 - INVESTMENT SECURITIES - CONTINUED
Mortgage-backed securities have been included in the maturity tables based upon the guaranteed payoff date of each security.
Gross realized gains and losses on investments in debt securities available for sale for each of the three years in the period ended December 31, 1997 were as follows:
The carrying value of investment securities pledged to secure public funds on deposit, securities sold under agreements to repurchase, and for other purposes as required by law amounted to approximately $73,920,000 and $67,875,000 at December 31, 1997 and 1996, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 4 - LOANS
The subsidiary banks grant loans to customers primarily in North Central Alabama and South Central Tennessee.
The major classifications of loans as of December 31, 1997 and 1996 were as follows:
As of December 31, 1997, there were no loans which the Bank had specifically classified as impaired. Other nonaccrual loans at December 31, 1997 and 1996 amounted to approximately $1,093,000 and $565,000, respectively. For the year ended December 31, 1997 and 1996 the difference between gross interest income that would have been recorded in such period if nonaccruing loans had been current in accordance with their original terms and the amount of interest income on those loans that was included in such period's net income was negligible.
The Bank has no commitments to loan additional funds to the borrowers of nonaccrual loans.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for each of the three years in the period ended December 31, 1997 were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment at December 31, 1997 and 1996 is as follows:
The provisions for depreciation charged to occupancy and furniture and equipment expense for the years ended December 31, 1997, 1996 and 1995 were $1,249,420, $976,519 and $811,339, respectively. The Bank capitalized $174,181 in interest cost related to building construction in 1997.
NOTE 7 - DEPOSITS
The major classifications of deposits as of December 31, 1997 and 1996 were as follows:
The maturities of time certificates of deposit and other time deposits of $100,000 or more issued by the Company at December 31, 1997 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 8 - LONG TERM DEBT
At December 31, 1997 and 1996, the Company had notes payable totaling $7,397,612, and $8,281,449, respectively.
On December 17, 1992, the Company entered into a loan agreement with a regional bank for amounts up to $6,500,000. At December 31, 1997 and 1996, the amounts outstanding were $3,557,509 and $4,269,010, respectively, due December 17, 2002, bearing interest at a floating prime, collateralized by 100% of the common stock of the subsidiary banks. The note agreement contains provisions which limit the Company's right to transfer or issue shares of subsidiary banks' stock. Principal payments of $59,292 are due monthly; however, the Company has the option of postponing up to twenty-four monthly principal payments, provided that no more than six consecutively scheduled installments are deferred.
On November 3, 1993, the Trustees of the Company's ESOP (Note 16) executed a promissory note of $1,200,000 in order to purchase common stock from the Company's public offering of new common stock. The note was originally secured by 80,000 shares of purchased stock. On October 2, 1995, the ESOP acquired 7,455 additional shares with the proceeds of a second promissory note, collateralized by the acquired shares. On May 17, 1996, these two notes were refinanced and an additional 58,000 shares of stock were obtained by the ESOP with a promissory note with a beginning balance of $2,183,805. The Company has guaranteed this debt; accounting and reporting guidelines mandate that the debt be recognized on the Company's statement of condition, with an offsetting charge against equity. As principal payments are made by the ESOP, the debt and offsetting charge against equity are reduced. This note was originally secured by 117,847 shares of the Company's common stock. The note bears interest at a floating rate, with principal and interest payments of $24,302 due monthly through June 17, 2018, with all remaining principal, if any, due upon that date. The shares securing the note are released on a prorata basis by the lender as monthly payments of principal and interest are made. The outstanding balance of this note was $2,002,902 at December 31, 1997, secured by 102,305 of unreleased shares of Company stock.
On October 4, 1994, the Company entered into a twenty year, subordinated installment capital note due October 1, 2014 for the purchase of treasury stock. Monthly principal and interest payments of $15,506 are made on the note, which bears interest at the fixed rate of 7%. The Company maintains the right to prepay the note at its sole discretion. The balance of the note was $1,837,201 and $1,892,548 at December 31, 1997 and 1996.
Maturities of long-term debt following December 31, 1997 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 9 - OTHER OPERATING EXPENSES
Other operating expenses consist of the following:
NOTE 10 - INCOME TAXES
Federal and state income taxes receivable and (payable) as of December 31, 1997 and 1996 included in other assets and other liabilities, respectively, were as follows:
The components of the net deferred income tax asset and (liability) included in other assets and other liabilities, respectively, are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 10 - INCOME TAXES - CONTINUED
The tax effects of each type of income and expense item that gave rise to deferred taxes are:
The components of income tax expense for each of the years ended December 31, 1997, 1996 and 1995 were:
The principal sources of temporary differences resulting in deferred income taxes included in the accompanying consolidated statements of income and the tax effect of each are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 10 - INCOME TAXES - CONTINUED
Tax effects of securities transactions resulted in an increase (decrease) in income taxes for 1997, 1996 and 1995 of ($1,036), $3,004 and $106,376, respectively.
The following is a reconciliation of the difference in the effective tax rate and the federal statutory rate:
NOTE 11 - PRIOR PERIOD RESTATEMENT
Earnings per share amounts for 1996 have been restated to give effect to the application of Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per Share, which was adopted by the Company during 1997.The effect of the restatement on earnings per share was an increase of $0.07 per share for 1996. 1995 earnings per share was not affected.
NOTE 12 - SHAREHOLDERS' EQUITY
On January 9, 1995, the Board of Directors passed a resolution authorizing the preparation of a Registration Statement for the proposed sale of 312,161 shares of the Company's $.10 par value common stock, consisting of the Company's 115,978 shares of treasury stock and 196,183 newly issued shares. On June 13, 1996, the offering was closed upon full subscription of all shares offered for sale, raising $6,175,898 of capital after reduction for offering costs. break55 On March 28, 1996, the Company issued a total of 135,000 options to purchase its common shares to its directors. The options were distributed among the directors based upon their years of service and their positions of leadership with the Company. Each of the stock option agreements contained an option price of $20.00 per share, the market value of the shares at the time of issuance. In March of 1997, an additional 51,500 options were issued with an option price of $25.00 per share. The options are exercisable between April 1, 1996 and March 31, 2001 (1996 options) and between April 1, 1997 and March 31, 2002 (1997 options), and are treated as non-qualified options under the provisions of the Internal Revenue Code. The agreements also contain a provision whereby the Company shall compensate the optionee in cash for any federal or state tax liability incurred upon the exercise of the options.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 12 - SHAREHOLDERS' EQUITY - CONTINUED
The following sets forth certain information regarding stock options for the years ended December 31, 1997, 1996, and 1995:
In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, Accounting and Disclosure of Stock-Based Compensation ("SFAS 123"). SFAS 123 is effective for years beginning after December 15, 1995, and allows for the option of continuing to follow Accounting Principles Board Opinion No. 25, Accounting for Stocks Issued to Employees, and the related Interpretations or selecting the minimum value method of expense recognition as described in SFAS 123.The Company has elected to apply APB Opinion No. 25 in accounting for its incentive stock options, accordingly, no compensation cost has been recognized by the Company. Proforma earnings and earnings per share as if the minimum value method had been applied in measuring compensation costs is presented below for the years ended December 31:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 12 - STOCKHOLDER'S EQUITY - CONTINUED
These options are assumed to be exercised in the calculation of diluted average common shares outstanding, causing the equivalent average number of shares outstanding on a diluted basis to be 135,376 greater than that used to calculate basic earnings per share for 1997. Average shares outstanding when assuming dilution were greater than average shares outstanding for basic earnings per share by 97,187 for 1996. Diluted shares and basic shares were the same for 1995. The dilutative effect on earnings per share for the years ended December 31, 1997 and 1996 was $.13 and $.10, respectively. There was no dilutative effect on the book value of the Company's common shares at December 31, 1997 or 1996.
The Company's options outstanding have a weighted average contractual life of 3.54 years. The weighted average fair value of options granted was $0.84 in 1997 and $2.11 in 1996 . The fair value of each grant is estimated using the minimum value method with the following assumptions used for grants in 1997 and 1996: expected annual dividend of $1.00 per share per year; expected option life of 5 years; no expected volatility; and a risk free interest rate of 6.00%.
The effects of applying SFAS 123 for providing proforma disclosures are not likely to be representative of the effects on reported earnings for future years, nor are the dividend estimates representative of commitments on the part of the Company's Board.
In January of 1998, the Board of Directors of the Company declared a dividend of $1.00 per share to shareholders of record as of January 8, 1998; a dividend of $.75 per share was declared and paid in January of 1997, and a dividend of $.50 was paid in January of 1996. The payment of dividends on common stock is subject to the prior payment of principal and interest on the Company's long-term debt, maintenance of sufficient earnings and capital of the subsidiaries and to regulatory restrictions. (See Notes 8 and 16).
NOTE 13 - COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company offers a variety of financial products to its customers to aid them in meeting their requirements for liquidity, credit enhancement, and interest rate protection. Generally accepted accounting principles recognize these transactions as contingent liabilities and, accordingly, they are not reflected in the accompanying financial statements. Commitments to extend credit, credit card arrangements, commercial letters of credit, and standby letters of credit all include exposure to some credit loss in the event of nonperformance of the customer. The Company's credit policies and procedures for credit commitments and financial guarantees are the same as those for extension of credit that are recorded on the consolidated statements of financial condition. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. The Company has not been required to perform on any financial guarantees nor has it incurred any losses on its commitments in either 1997 or 1996. Following is a discussion of these commitments:
Standby Letters of Credit: These agreements are used by the Company's customers as a means of improving their credit standings in their dealings with others. Under these agreements, the Company agrees to honor certain financial commitments in the event that its customers are unable to do so. As of December 31, 1997 and 1996, the Company has issued standby letters of credit of approximately $577,000 and $522,000, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 13 - COMMITMENTS AND CONTINGENCIES - CONTINUED
Management conducts regular reviews of these instruments on an individual customer basis, and the results are considered in assessing the adequacy of the Company's allowance for loan losses. Management does not anticipate any material losses as a result of these letters of credit.
Loan Commitments: As of December 31, 1997 and 1996, the Company had commitments outstanding to extend credit totaling approximately $18,049,000 and $6,471,000, respectively. These commitments generally require the customers to maintain certain credit standards. Management does not anticipate any material losses as a result of these commitments.
Litigation: The Company and its subsidiaries are parties to litigation and claims arising in the normal course of business. Management, after consultation with legal counsel, believes that the liabilities, if any, arising from such litigation and claims are not material to the consolidated financial statements.
NOTE 14 - CONCENTRATIONS OF CREDIT
All of the Company's loans, commitments and standby letters of credit have been granted to customers in the Company's market area. Substantially all such customers are depositors of the Company. Investments in state and municipal securities also involve governmental entities within the Company's market area. The concentrations of credit by type of loan are set forth in Note 4. The commitments to extend credit relate primarily to consumer cash lines which represented approximately $2,967,000 and $3,887,000 of the unused commitment balances at December 31, 1997 and 1996. All remaining commitments consist primarily of unused real estate draw lines.
The Company maintains its cash accounts at various commercial banks in Alabama. The total cash balances are insured by the FDIC up to $100,000. Total uninsured balances held at other commercial banks amounted to $6,791,718 and $2,449,619, at December 31, 1997 and 1996, respectively.
NOTE 15 - PENSION PLAN
The Company has a defined benefit plan that provides retirement and disability benefits for substantially all employees of the Company and its subsidiaries, and death benefits for their beneficiaries. Employees who are expected to work 1,000 hours in any calendar year become participants in the Pension Plan on January 1 of each year. All employees are eligible to become participants in the Pension Plan regardless of age on the date they begin employment and the normal retirement age is the later of age 65 or five years after the date of employment. In addition, participants in the Pension Plan accrue benefits after they have attained the normal retirement age.
Benefits under the Pension Plan depend upon a participant's years of credited service with the Company or any of its subsidiaries and his average monthly earnings for the five year period prior to the retirement or termination of employment. A participant is 20% vested in his accrued benefits after completion of two years of service. Vesting increases 20% per year for the next four years with the participant becoming fully vested upon completion of six years of service. An employee who completes ten years of service and attains age fifty-five is eligible for early retirement benefits. Plan assets consist primarily of corporate stocks and bonds.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 15 - PENSION PLAN - CONTINUED
The Company contributes amounts to the pension funds sufficient to satisfy funding requirements of the Employee Retirement Income Security Act.
Effective January 1, 1995, the Company established a nonqualified benefit plan called the Community Bancshares Benefit Restoration Plan, the purpose of which is to provide the amount of the benefit which would otherwise be paid under the Company's pension plan but which cannot be paid under that plan due to the limitations imposed by the Internal revenue Code of 1987. The costs of this plan are included with those of the regular pension plan in the schedules below.
Net pension cost for 1997, 1996 and 1995 is composed of the following:
The following table sets forth the funding status of the plan and the amount recognized in the Company's consolidated statements of financial condition at December 31:
The weighted average discount rate and rate of increase in future compensation levels used in determining actuarial present value of the projected benefit obligations were eight percent and six percent, respectively, for 1997 and 1996. The assumed long-term rate of return on plan assets in 1997 and 1996 was eight percent.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 16 - EMPLOYEE STOCK OWNERSHIP PLAN
The Company adopted an Employee Stock Ownership Plan (the "ESOP") effective as of January 1, 1985, which enables eligible employees of the Company and its subsidiaries to own Company common stock. Employees who work 1,000 hours in any consecutive twelve month period become participants in the ESOP on December 31 of that year, and remain eligible in every subsequent year in which 1,000 hours of work are completed. Employer contributions, which are made at the discretion of the Company's Board of Directors, are allocated to eligible participants in proportion to their eligible pay, which equals W-2 wages plus pre-tax reductions for the Company's cafeteria plan. The Internal Revenue Service imposes a limit ($160,000 in 1997) on the maximum amount of eligible pay under the plan.
On November 3, 1993, the ESOP's Trustees executed a promissory note of $1,200,000 in order to purchase common stock from the Company's public offering of new common stock. The note was originally secured by 80,000 shares of purchased stock. On October 2, 1995, the ESOP acquired 7,455 additional shares with the proceeds of a second promissory note, collateralized by the acquired shares. On May 17, 1996, these two notes were refinanced and an additional 58,000 shares of stock were obtained by the ESOP. These shares were funded with the same promissory note which provided funds to refinance the previously executed notes. This new note was originally secured by 117,847 shares of the Company's common stock. The shares securing the note are released on a prorata basis by the lender as monthly payments of principal and interest are made. The note is guaranteed by the Company. As of December 31, 1997, there were 102,305 unreleased shares with a fair value of approximately $3,069,000. These shares are subtracted from outstanding shares for earnings per share calculations.
Effective January 1, 1994, the Company applied the accounting and reporting requirements of Statement of Position No. 93-6, Employers' Accounting for Employee Stock Ownership Plans ("SOP 93-6"). Under the provisions of SOP 93-6, the employer must recognize the indebtedness of its sponsored ESOP on its financial statement and reduce its stockholder's equity for shares of stock which have not been released by a lender to the ESOP for allocation to its participating employees. The portion of payments made by the Company to the ESOP on behalf of its participating employees which are used to pay interest on the ESOP debt ($165,550 and $152,822 in 1997 and 1996, respectively) is classified as interest expense on the Company's income statement.
Dividends paid on released ESOP shares are credited to the accounts of the participants to whom the shares are allocated. Dividends on unreleased shares are treated as other income of the ESOP.
At December 31, 1997, the Company's financial statements reflect long term debt and a corresponding contra-equity account, as a result of the ESOP debt, of $2,002,902.
Company contributions to the ESOP amounted to $289,147, $288,878 and $254,687, for 1997, 1996 and 1995, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 17 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES
Dividends paid by Community Bank are the primary source of funds available to the Company for debt repayment, payment of dividends to its stockholders and other needs. Certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the Superintendent of Banks is required to pay dividends in excess of the Bank's earnings retained in the current year plus retained net profits for the preceding two years. At December 31, 1997, Community Bank could have declared dividends of $7,105,317 without approval of regulatory authorities.
NOTE 18 - REGULATORY CAPITAL
The Company and its subsidiary banks are subject to various regulatory capital requirements administered by the state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary - actions by regulators that, if taken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its subsidiary banks must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and its subsidiary banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997 and 1996, that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 1997 and 1996, the Company and both of its banking subsidiaries are classified as well capitalized under the financial institution regulatory framework. To be categorized as well capitalized the Company and each bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since year-end that management believes have changed the institution's category.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 18 - REGULATORY CAPITAL - CONTINUED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 19 - RELATED PARTY TRANSACTIONS
Loans: Certain directors, executive officers and principal shareholders, including their immediate families and associates were loan customers of the Bank during 1997 and 1996. Such loans are made in the ordinary course of business at normal credit terms, including interest rates and collateral and do not represent more than a normal risk of collection. Total loans to these persons at December 31, 1997 and 1996, amounted to $5,304,915 and $8,587,341, respectively. An analysis of activity during 1997 in loans to related parties resulted in additions of $5,377,436 representing new loans, reductions of $8,214,014, representing payments, and a decrease of $445,848 representing a change in the composition of related parties.
Leases: The Bank had lease agreements which expired in August 1995 with Com-Pac, a partnership composed of Kennon R. Patterson, Sr. and Bishop K. Walker, Jr., both of whom are directors and officers of the Company, for the lease of land and banking facilities. Lease expense on these properties amounted to $85,968 for the year ended December 31, 1995. Upon termination of the lease agreements, the Bank purchased the properties at the expiration of the leases for a total of $1,093,106.
Maintenance Contract: The Bank has a service contract with Heritage Farms, an unincorporated business owned by Kennon R. Patterson, Sr., a director and officer of the Company, for the upkeep and maintenance of the external grounds of nineteen of the Bank's locations. Maintenance expense under this contract amounted to $96,300 and $64,875 for the years ended December 31, 1997 and 1996, respectively, a monthly average of $422 and $318 per location. Royal Acres, a partnership composed of Kennon R. Patterson, Sr. and Bishop K. Walker, Jr., both of whom are directors and officers of the Company, held this contract for 1995. Maintenance expense under this contract amounted to $80,347 for the year ended December 31, 1995.
Interior Design: The Bank paid Heritage Interiors, a decorating and design firm owned and operated by the wife of Kennon R. Patterson, Sr., a director and officer of the Company, for the interior design, furniture, appliances, fixtures, carpets, wallcoverings, drapes, and accessories for new facilities at Cleveland and for the new administrative and operational complex at headquarters in Blountsville; for the extensive remodeling ,refurnishing and expansion of the Oneonta location; the decorating and furnishing of the new Wal-Mart locations in Guntersville, Fort Payne and Hartselle; and various facelifts and furnishings at other offices, totaling $1,186,287 in 1997. Payments for similar services totaled $377,897 in 1996 and $203,649 in 1995.
The purchases were made at a cost more favorable than could be obtained from unrelated parties.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 20 - LEASES
The Company has a number of operating lease agreements, involving land and buildings. These leases are noncancellable and expire on various dates through the year 2013. The leases provide for renewal options and generally require the Company to pay maintenance, insurance and property taxes. Options to purchase are also included in some leases. For the years ended December 31, 1997, 1996 and 1995, rental expense for operating leases was approximately $232,759, $176,942, and $160,588, respectively.
Future minimum lease payments for all leases at December 31, 1997 are as follows:
NOTE 21 - BUSINESS COMBINATIONS
On January 12, 1996, the Bank opened a branch bank in Haleyville, Alabama as a result of the acquisition of certain assets and the assumption of certain liabilities from Compass Bank. The Bank assumed liabilities of $31.3 million in exchange for assets of $12.4 million, a premium of $2.2 million, and cash of $16.7 million. on July 12, 1996, the Company acquired the assets and assumed the liabilities of the Uniontown, Alabama branch of a Compass Bank. The liabilities assumed in the transaction totaled $12.3 million, and non-cash assets acquired totaled $29.7 million. Accordingly, the resultant cash disbursement by the Company, including of the premium of $261,000 paid for the branch's deposits, was $17.7 million.
In late 1995, the Company incorporated 1st Community Credit Corporation as a subsidiary of Community Bank. This subsidiary was created for the purpose of establishing finance offices in selected north Alabama and south central Tennessee communities. It was operating 7 offices in north Alabama as of December 31, 1996.
Effective August 1, 1997, the Company's wholly-owned subsidiary, Community Insurance, Inc., acquired a controlling interest in Southern Select Insurance, Inc., a property and casualty insurance general agency located in Birmingham, Alabama. Community Insurance paid $382,564 for 51% of the common stock of Southern Select, paying a premium of $344,341. The primary purpose of the acquisition was to acquire the management, product lines, and markets of Southern Select. Its operations were not material to the consolidated financial statements of the Company as of December 31, 1997.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 22 - OTHER SHORT-TERM BORROWINGS
Other short-term borrowings at December 31, 1997 and 1996 consisted of the U.S. Treasury Tax and Loan Note Option account, federal funds purchased and securities sold under agreements to repurchase.
Information concerning securities sold under agreements to repurchase is summarized as follows:
NOTE 23 - SUBSEQUENT EVENT
On February 9, 1998, the Bank executed a Purchase and Assumption Agreement with First National Bank of West Point, Georgia to acquire certain assets and liabilities of their Uniontown, Alabama branch. The transaction should result in the addition of approximately $3 million of additional loans, $6 million of additional deposit liabilities, and $250,000 of intangible assets.
Management anticipates consummation of this agreement sometimes in mid-1998, assuming receipt of all necessary regulatory approvals.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 24 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and Short-Term Investments: For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Investment Securities: For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loan Receivables: For certain homogeneous categories of loans, such as some residential mortgages, credit card receivables, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposit Liabilities: The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposit of similar remaining maturities.
Long-term Debt: Rates currently available to the Bank for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.
Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written: The fair value of commitments and letters of credit is estimated to be approximately the same as the notional amount of the related commitment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 24 - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED
The estimated fair values of the Company's financial instruments as of December 31, 1997 and 1996 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 25 - CONDENSED PARENT COMPANY INFORMATION
STATEMENTS OF FINANCIAL CONDITION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 25 - CONDENSED PARENT COMPANY INFORMATION - CONTINUED
STATEMENTS OF INCOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 25 - CONDENSED PARENT COMPANY INFORMATION - CONTINUED
STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
COMMUNITY BANCSHARES, INC. AND SUBSIDIARIES
NOTE 25 - CONDENSED PARENT COMPANY INFORMATION - CONTINUED
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Long-term debt was increased and equity was decreased $1,200,000 on January 1, 1994 to reflect the existence of leveraged, unreleased ESOP shares. Upon the pledging of purchased shares to obtain additional ESOP debt of $1,260,007 on May 17, 1996 and of $137,918 on October 2, 1995, long-term debt was increased and equity was decreased. The debt was reduced and shares were released by $116,989 and $135,314, respectively, during each of the years ended December 31, 1997 and 1996 as a result of payments made by the Company's ESOP on the outstanding ESOP debt.
During 1994, treasury stock in the amount of $2,899,460 was acquired for cash and the assumption of a $2,000,000 subordinated capital installment note. All of the treasury stock was re-issued during 1995.
QUARTERLY RESULTS (UNAUDITED)
A summary of the unaudited results of operations for each quarter of 1997 and 1996 follows:
ITEM 9
ITEM 9 - DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is incorporated by reference from the sections entitled "Election of Directors" and "Executive Compensation and Other Information" in the Proxy Statement for the Annual Meeting of Shareholders to be held March 26, 1998 which is to be filed with the Securities and Exchange Commission.
ITEM 11
ITEM 11 - EXECUTIVE COMPENSATION
Information required by this item is incorporated by reference from the section entitled "Executive Compensation and Other Information" in the Proxy Statement for the Annual Meeting of Shareholders to be held March 26, 1998 which is to be filed with the Securities and Exchange Commission.
ITEM 12
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is incorporated by reference from the sections entitled "Holdings of Voting Securities" and "Election of Directors" in the Proxy Statement for the Annual Meeting of Shareholders to be held March 26, 1998 which is to be filed with the Securities and Exchange Commission.
ITEM 13
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is incorporated by reference from the section entitled "Executive Compensation and Other Information" in the Proxy Statement for the Annual Meeting of Shareholders to be held March 26, 1998 which is to be filed with the Securities and Exchange Commission.
PART IV
ITEM 14
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index of documents filed as part of this report:
Community Bancshares, Inc and Subsidiaries Financial Statements Page(s) ------- Auditor's Report....................................................... 35
Consolidated Statements of Financial Condition as of December 31, 1997 and 1996........................................... 36
Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995..................................... 37
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995..................................... 38
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995..................................... 39-40
Notes to Consolidated Financial Statements - December 31, 1997, 1996 and 1995..................................... 41-69
Quarterly Results (Unaudited).......................................... 70
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter ended December 31, 1997.
(C) Exhibits
Certain financial statements schedules and exhibits have been omitted because they are not applicable.
EXHIBIT 11 - STATEMENTS RE: COMPUTATION OF PER SHARE EARNINGS
COMMUNITY BANCSHARES, INC. COMPUTATION OF NET INCOME PER COMMON SHARE
The following tabulation presents the calculation of primary and fully diluted earnings per common share for the years ended December 31, 1997, 1996 and 1995.
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
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.
COMMUNITY BANCSHARES, INC.
Date: February 25, 1998 By /s/ Kennon R. Patterson, Sr. --------------------------- ------------------------------------ KENNON R. PATTERSON, SR. CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Date: February 25, 1998 By /s/ Paul W. Williams, CPA --------------------------- ------------------------------------ PAUL W. WILLIAMS, CPA CHIEF ACCOUNTING OFFICER
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Kennon R. Patterson, Sr. and Bishop K. Walker, Jr., and each of them, his true and lawful attorney-in-fact, as agent with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacity, to sign any or all amendments to this Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agents in full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as they might or could be in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, and their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
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 capacities and on the dates indicated.
Directors Date --------- ----
/s/ C.K. Copeland February 25, 1998 - ------------------------------------ ----------------------- C.K. COPELAND
/s/ Bryan A. Corr February 25, 1998 - ------------------------------------ ----------------------- BRYAN A. CORR
/s/ Glynn Debter February 25, 1998 - ------------------------------------ ----------------------- GLYNN DEBTER
/s/ Edward E. Ferguson February 25, 1998 - ------------------------------------ ----------------------- EDWARD E. FERGUSON
SIGNATURES, Continued
Directors Date --------- ----
/s/ Denny Kelly February 25, 1998 - ------------------------------------ --------------------- DENNY KELLY
/s/ John J. Lewis, Jr. February 25, 1998 - ------------------------------------ --------------------- JOHN J. LEWIS, JR.
/s/ Stacey W. Mann February 25, 1998 - ------------------------------------ --------------------- STACEY W. MANN
/s/ Loy McGruder February 25, 1998 - ------------------------------------ --------------------- LOY MCGRUDER
/s/ Hodge Patterson, III February 25, 1998 - ------------------------------------ --------------------- HODGE PATTERSON, III
/s/ Kennon R. Patterson, Jr. February 25, 1998 - ------------------------------------ --------------------- KENNON R. PATTERSON, JR.
/s/ Kennon R. Patterson, Sr. February 25, 1998 - ------------------------------------ --------------------- KENNON R. PATTERSON, SR.
/s/ Merritt Robbins February 25, 1998 - ------------------------------------ --------------------- MERRITT ROBBINS
/s/ Henry H. Sims February 25, 1998 - ------------------------------------ --------------------- HENRY H. SIMS
/s/ Robert O, Summerford February 25, 1998 - ------------------------------------ --------------------- ROBERT O. SUMMERFORD
/s/ Bishop K. Walker, Jr. February 25, 1998 - ------------------------------------ --------------------- BISHOP K. WALKER, JR.
/s/ Wayne Washam February 25, 1998 - ------------------------------------ --------------------- WAYNE WASHAM
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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
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EXHIBITS TO
ANNUAL REPORT AND FORM 10-K
Year Ended December 31, 1997
COMMUNITY BANCSHARES, INC.
P. O. BOX 1000
MAIN STREET
BLOUNTSVILLE, ALABAMA 35031
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