ITEM 1. BUSINESS
THE COMPANY
Flag Financial Corporation ("Flag" or the "Company") is a bank holding company headquartered in Atlanta, Georgia and is registered under the Bank Holding Company Act of 1956, as amended. The Company is the sole shareholder of Flag Bank (the "Bank") and was incorporated under the laws of the State of Georgia on February 9, 1993.
As a bank holding company, the Company facilitates the Bank's abilities to serve its customers' requirements for financial services. The holding company structure provides greater financial and operating flexibility than is available to the Bank. For example, the Company may assist the Bank in maintaining its required capital ratios by borrowing money and contributing the proceeds of the debt to the Bank as primary capital. Additionally, the Articles of Incorporation and Bylaws of the Company contain terms that provide a degree of anti-takeover protection to the Company that is currently unavailable to the Bank and its shareholders under regulations of the Federal Deposit Insurance Corporation (the "FDIC"), but is permissible for the Company under Georgia law.
Flag is also a service provider of mortgage, investment and insurance services though Flag Mortgage, Flag Investment Services and Flag Insurance Services. All of these services are provided by a division of Flag Bank.
Flag's website address is www.Flag.net. You may obtain free electronic copies of our annual reports and Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports at the investor relations section of our website. These reports are available on our website as soon as reasonably practicable after we electronically file them with the SEC.
THE BANK
Flag Bank is a state bank organized under the laws of the State of Georgia with banking offices in the following cities and counties: Atlanta (Fulton County, Dekalb County and Cobb County), Unadilla (Dooly County), Vienna (Dooly County), Montezuma (Macon County), Buena Vista (Marion County), LaGrange (Troup County), Hogansville (Troup County), Thomaston (Upson County), Stockbridge (Henry County) and Suwanee (Forsyth County), Georgia. Flag Bank was originally chartered in 1931 as the Citizens Bank and became a wholly-owned subsidiary of the Company through a series of acquisitions commencing in 1998.
Flag Mortgage operates as a division of Flag Bank and operates mortgage loan production offices in Atlanta (Fulton County), LaGrange (Troup County), Columbus (Muscogee County) and Newnan (Coweta County), Georgia.
BUSINESS OF THE BANK. The Bank's business consists primarily of attracting deposits from the general public and, with these and other funds, making residential mortgage loans, consumer loans, commercial loans, commercial real estate loans, residential construction loans and securities investments. In addition to deposits, sources of funds for the Banks' loans and other investments include amortization and prepayment of loans, loan origination and commitment fees, sales of loans or participations in loans, fees received for servicing loans sold to others and advances from the Federal Home Loan Bank of Atlanta ("FHLBA"). The Bank's principal sources of income are interest and fees collected on loans, including fees received for originating and selling loans and for servicing loans sold to others, and, to a lesser extent, interest and dividends collected on other investments and service charges on deposit accounts. The Bank's principal expenses are interest paid on deposits, interest paid on FHLBA advances, employee compensation and office expenses and other overhead expenses.
While the Bank attempts to avoid concentrations of loans to a single industry or based on a single type of collateral, the various types of loans the Bank makes have certain risks associated with them. Consumer and commercial loans present risks which, among other things, include fraud, bankruptcy, economic downturn, deteriorated or non-existing collateral, changes in interest rates and customer financial problems. Real estate construction loans present risks related to, among other things, whether the builder is able to sell the property, whether the buyer is able to obtain permanent financing and the nature of changing economic conditions. Real estate mortgage loans present risks involving, among other things, economic and demographic changes, deterioration of collateral and customer financial problems.
The Company's primary asset is its stock in the Bank. Accordingly, its financial performance is determined primarily by the results of operations of the Bank. For information regarding the consolidated financial condition and results of operations of the Company as of December 31, 2002 and 2001 and for the three years in the period ended December 31, 2002, see "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Consolidated Financial Statements of the Company, and the related notes presented in Part II hereof. All average balances presented in this report were derived based on daily averages.
EMPLOYEES
As of December 31, 2002, the Company (including the Bank) had 230 full-time and 20 part-time employees. The employees are not represented by any collective bargaining unit, and the Company considers its relationship with its employees to be good.
COMPETITION
The banking business in Georgia is highly competitive. The Bank competes not only with other banks and thrifts that are located in the same counties as the Bank and in surrounding counties, but also with other financial service organizations including credit unions, finance companies, and certain governmental agencies. To the extent that the Bank must maintain non-interest earning reserves against deposits, it may be at a competitive disadvantage when compared with other financial service organizations that are not required to maintain reserves against substantially equivalent sources of funds. Also, other financial institutions with which the Bank competes may have substantially greater resources and lending capabilities due to the size of the organization. SUPERVISION AND REGULATION
Both the Company and the Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws are generally intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to us.
THE COMPANY
Since the Company owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956. As a result, the Company is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve.
ACQUISITIONS OF BANKS. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve's prior approval before:
- acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank's voting shares;
- acquiring all or substantially all of the assets of any bank; or
- merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or, substantially lessen competition or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve's consideration of financial resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if adequately capitalized and adequately managed, the Company or any other bank holding company located in Georgia may purchase a bank located outside of Georgia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Georgia may purchase a bank located inside Georgia. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. For example, Georgia law prohibits a bank holding company from acquiring control of a financial institution until the target financial institution has been incorporated for three years. Because the Bank has been incorporated for more than three years, this limitation does not apply to the Bank or to the Company.
CHANGE IN BANK CONTROL. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring "control" of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is refutably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
- the bank holding company has registered securities under Section 12 of the Securities Act of 1934; or
- no other person owns a greater percentage of that class of voting securities immediately after the transaction.
Our common stock is registered under the Securities Exchange Act of 1934. The regulations provide a procedure for challenging any rebuttable presumption of control.
PERMITTED ACTIVITIES. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:
- banking or managing or controlling banks; and
- any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.
Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
- factoring accounts receivable;
- making, acquiring, brokering or servicing loans and usual related activities;
- leasing personal or real property;
- operating a non-bank depository institution, such as a savings association;
- trust company functions;
- financial and investment advisory activities;
- conducting discount securities brokerage activities;
- underwriting and dealing in government obligations and money market instruments;
- providing specified management consulting and counseling activities;
- performing selected data processing services and support services;
- acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
- performing selected insurance underwriting activities.
Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company's continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.
In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, permitting the bank holding company to engage in additional activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:
- lending, trust and other banking activities;
- insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;
- providing financial, investment, or advisory services;
- issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;
- underwriting, dealing in or making a market in securities;
- other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;
- foreign activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad;
- merchant banking through securities or insurance affiliates; and
- insurance company portfolio investments.
To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least satisfactory. Additionally, the Company must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days' written notice prior to engaging in a permitted financial activity. While the Company meets the qualification standards applicable to financial holding companies, the Company has not elected to become a financial holding company at this time.
SUPPORT OF SUBSIDIARY INSTITUTIONS. Under Federal Reserve policy, the Company is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy, the Company might not be inclined to provide it. In addition, any capital loans made by the Company to the Bank will be repaid only after its deposits and various other obligations are repaid in full. In the unlikely event of the Company's bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
THE BANK
Because the Bank is a commercial bank chartered under the laws of the State of Georgia, it is primarily subject to the supervision, examination and reporting requirements of the FDIC and the Georgia Department of Banking and Finance. The FDIC and Georgia Department of Banking and Finance regularly examine the Bank's operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Additionally, the Bank's deposits are insured by the FDIC to the maximum extent provided by law. The Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations.
BRANCHING. Under current Georgia law, the Bank may open branch offices throughout Georgia with the prior approval of the Georgia Department of Banking and Finance. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Georgia. The Bank and any other national or state-chartered bank generally may branch across state lines by merging with banks in other states if allowed by the applicable states' laws. Georgia law, with limited exceptions, currently permits branching across state lines through interstate mergers.
Under the Federal Deposit Insurance Act, states may "opt-in" and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Currently, Georgia has not opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia. This provides a limited barrier of entry into the Georgia banking market, which protects us from an important segment of potential competition. However, because Georgia has elected not to opt-in, our ability to establish a new start-up branch in another state may be limited. Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if their home state has also elected to opt-in. Consequently, until Georgia changes its election, the only way we will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.
PROMPT CORRECTIVE ACTION. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) in which all institutions are placed.
Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital levels for each category.
An institution that is categorized as undercapitalized, significantly undercapitalized or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company's obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary's assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.
FDIC INSURANCE ASSESSMENTS. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the "undercapitalized" category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institution's primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. Assessments range from 0 to 27 cents per $100 of deposits, depending on the institution's capital group and supervisory subgroup. In addition, the FDIC imposes assessments to help pay off the $780 million in annual interest payments on the $8 billion Financing Corporation bonds issued in the late 1980s as part of the government rescue of the thrift industry. This assessment rate is adjusted quarterly and is set at 1.68 cents per $100 of deposits for the first quarter of 2003.
The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve or the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank and the Company. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
OTHER REGULATIONS. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. For example, under the Soldiers' and Sailors' Civil Relief Act of 1940, a lender is generally prohibited from charging an annual interest rate in excess of 6% on any obligation for which the borrower is a person on active duty with the United States military.
The Bank's loan operations are also subject to federal laws applicable to credit transactions, such as the:
- Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
- Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
- Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
- Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
- Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
- Soldiers' and Sailors' Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service; and
- Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
In addition to the federal and state laws noted above, the Georgia Fair Lending Act ("GFLA") became effective on October 1, 2002. GFLA imposes new restrictions and procedural requirements on most mortgage loans made in Georgia, including home equity loans and lines of credit. While many of the GFLA requirements will apply regardless of the interest rate or charges on the loan, "high cost home loans," as defined by GFLA, are subject to the most requirements.
Due to the high compliance burdens associated with high cost home loans in Georgia, the Company has determined that it will not make such loans in Georgia in 2003.
However, because the Company generally has not made a significant number of "high cost home loans" in prior years, ceasing to make high cost loans should not have a significant impact on the Company's lending volume. With respect to our other lending, we have implemented procedures to comply with GFLA.
The deposit operations of the Bank are subject to:
- The Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
- The Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services.
CAPITAL ADEQUACY
The Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of the Company, and the FDIC and Georgia Department of Banking and Finance, in the case of the Bank. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The Bank is also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2002 our ratio of total capital to risk-weighted assets was 11.3% and our ratio of Tier 1 Capital to risk-weighted assets was 10.1%.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve's risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2002, our leverage ratio was 7.6%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.
The Bank and the Company are also both subject to leverage capital guidelines issued by the Georgia Department of Banking and Finance, which provide for minimum ratios of Tier 1 capital to total assets. These guidelines are substantially similar to those adopted by the Federal Reserve in the case of the Company and those adopted by the FDIC in the case of the Bank.
Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements. See "-Prompt Corrective Action."
PAYMENT OF DIVIDENDS
The Company is a legal entity separate and distinct from the Bank. The principal sources of the Company's cash flow, including cash flow to pay dividends to its shareholders, are dividends that the Bank pays to its sole shareholder, the Company. Statutory and regulatory limitations apply to the Bank's payment of dividends to the Company as well as to the Company's payment of dividends to its shareholders.
The payment of dividends by the Company and the Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. If, in the opinion of the federal banking regulator, the Bank were engaged in or about to engage in an unsafe or unsound practice, the federal banking regulator could require, after notice and a hearing, that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution's capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. See "-Prompt Corrective Action" above.
The Georgia Department of Banking and Finance also regulates the Bank's dividend payments and must approve dividend payments that would exceed 50% of the Bank's net income for the prior year. Our payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.
At December 31, 2002, the Bank was unable to pay dividends to the Company without prior regulatory approval.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES
The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:
- a bank's loans or extensions of credit to affiliates;
- a bank's investment in affiliates;
- assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
- loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
- a bank's guarantee, acceptance or letter of credit issued on behalf of an affiliate.
The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank's capital and surplus and, as to all affiliates combined, to 20% of a bank's capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.
The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.
The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.
PRIVACY
Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.
ANTI-TERRORISM LEGISLATION
In the wake of the tragic events of September 11th, on October 26, 2001, the President signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and "know your customer" standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps-
- to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;
- to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;
- to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and
- to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions must establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
- the development of internal policies, procedures, and controls;
- the designation of a compliance officer;
- an ongoing employee training program; and
- an independent audit function to test the programs.
Pursuant to the mandate of the USA PATRIOT Act, the Secretary of the Treasury issued regulations effective April 24, 2002 applicable to financial institutions. Because all federally insured depository institutions are required to have anti-money laundering programs, the regulations provide that a financial institution which is subject to regulation by a "federal functional" is in compliance with the regulations if it complies with the rules of its primary federal regulator governing the establishment and maintenance of anti-money laundering programs.
Under the authority of the USA PATRIOT Act, the Secretary of the Treasury adopted rules on September 26, 2002 increasing the cooperation and information sharing between financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Under the new rules, a financial institution is required to:
- expeditiously search its records to determine whether it maintains or has maintained accounts, or engaged in transactions with individuals or entities, listed in a request submitted by the Financial Crimes Enforcement Network ("FinCEN");
- notify FinCEN if an account or transaction is identified;
- designate a contact person to receive information requests;
- limit use of information provided by FinCEN to: (1) reporting to FinCEN, (2) determining whether to establish or maintain an account or engage in a transaction and (3) assisting the financial institution in complying with the Bank Secrecy Act; and
- maintain adequate procedures to protect the security and confidentiality of FinCEN requests.
Under the new rules, a financial institution may also share information regarding individuals, entities, organizations and countries for purposes of identifying and, where appropriate, reporting activities that it suspects may involve possible terrorist activity or money laundering. Such information-sharing is protected under a safe harbor if the financial institution:
- notifies FinCEN of its intention to share information, even when sharing with an affiliated financial institution;
- takes reasonable steps to verify that, prior to sharing, the financial institution or association of financial institutions with which it intends to share information has submitted a notice to FinCEN;
- limits the use of shared information to identifying and reporting on money laundering or terrorist activities, determining whether to establish or maintain an account or engage in a transaction, or assisting it in complying with the Bank Security Act; and
- maintains adequate procedures to protect the security and confidentiality of the information.
Any financial institution complying with these rules will not be deemed to have violated the privacy requirements discussed above.
The Secretary of the Treasury also adopted a new rule on September 26, 2002 intended to prevent money laundering and terrorist financing through correspondent accounts maintained by U.S. financial institutions on behalf of foreign banks. Under the new rule, financial institutions:
- are prohibited from providing correspondent accounts to foreign shell banks;
- are required to obtain a certification from foreign banks for which they maintain a correspondent account stating the foreign bank is not a shell bank and that it will not permit a foreign shell bank to have access to the U.S. account;
- must maintain records identifying the owner of the foreign bank for which they may maintain a correspondent account and its agent in the Unites States designated to accept services of legal process;
- must terminate correspondent accounts of foreign banks that fail to comply with or fail to contest a lawful request of the Secretary of the Treasury or the Attorney General of the United States, after being notified by the Secretary or Attorney General.
The new rule applies to correspondent accounts established after October 28, 2002.
PROPOSED LEGISLATION AND REGULATORY ACTION
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation's financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
EFFECT OF GOVERNMENTAL MONETARY POLICES
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank's monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.
ITEM 2.
ITEM 2. PROPERTIES
The executive offices of the Company are located at 3475 Piedmont Road, N.E., Suite 550, Atlanta, Georgia 30305. The Company leases this property. The Company and the Bank conduct business from facilities primarily owned by the Bank, all of which are in good condition and are adequate for the Bank's current and foreseeable needs. The Company and Flag Bank provide services or perform operational functions at 24 locations, of which 16 locations are owned and 8 are leased. See "Item 1 - Business" for a list of the locations in which the Company and the Bank have offices.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and the Bank are periodically involved as plaintiff or defendant in various other legal actions in the ordinary course of their business. We do not believe that such litigation presents a material risk to the Company's business, financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Company to a vote of its shareholders during the fourth quarter of 2002.
PART II --------
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
As of December 31, 2002, the Company had 811 shareholders of record. The following table sets forth the high and low sales prices for the Flag common stock, as reported by the Nasdaq Stock Market, and the cash dividends paid per share of common stock for the periods indicated.
Subject to board approval, the Company pays quarterly dividends on the first business day of January, April, July and October. See "Item 1 - Business - - Supervision and Regulation - Payment of Dividends" for information regarding regulatory restrictions on the Company's ability to pay dividends.
During the first and second quarters of 2002, the Company issued a total of 1,272,000 shares of common stock and 1,272,000 warrants to purchase common stock to directors and members of senior management in a private placement under Rule 506 of the Securities Act of 1933, as amended. The purchase prices of the common stock and the exercise prices of the warrants are set forth below:
The increased prices represent adjustments necessary to match the price of the securities with the market price of the common stock at the time of the sale. The purchase price of the warrants was $1.00 per warrant in each case. The total number of securities authorized for issuance was 1.3 million shares and 1.3 million warrants.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is derived from and should be read in conjunction with our consolidated financial statements, which are included elsewhere in this report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Flag Financial Corporation ("Flag") is a bank holding company that owns 100 percent of the common stock of Flag Bank (the "Bank"). The Bank is a full-service, retail oriented bank primarily engaged in retail banking, small business, residential and commercial real estate lending, and mortgage banking.
The following discussion focuses on significant changes in the financial condition and results of operations of Flag during the three years ended December 31, 2002. This discussion and the financial information contained herein are presented to assist the reader in understanding and evaluating the financial condition, results of operations, and future prospects of Flag and should be read as a supplement to and in conjunction with the Consolidated Financial Statements and Related Notes.
RECENT ACQUISITIONS
Effective November 8, 2002, the Bank acquired six branches located in metropolitan Atlanta from Encore Bank. Included in the purchase were real estate, personal property and other assets used in the operation of the branches, and $96 million in deposits. The Bank did not purchase or assume any loans in the transaction.
Effective November 12, 2002, Flag acquired a specialized real estate lending business from Atlanta-based Bankers' Capital Group, LLC (BCG), including approximately $23 million in loans subject to various participation interests. Principals of BCG include Flag Chairman and Chief Executive Officer, Joseph W. Evans, board member William H. Anderson and executives and board members J. Thomas Wiley, Jr. and Stephen W. Doughty. None of these individuals participated in Flag's evaluation or approval of the transaction in view of their positions as principals of BCG.
See Note 2 in the Notes to Consolidated Financial Statements for additional information regarding the Encore and BCG transactions.
Effective December 31, 2001, Flag sold selected loans, deposits and property of its bank branches in Milan and McRae, Georgia.
Effective September 30, 2000, Flag sold the loans, deposits and property of its bank branches in Cobbtown, Metter and Statesboro, Georgia.
Effective September 30, 2000, Flag sold the loans, deposits and property of its bank branches in Blackshear, Homerville and Waycross, Georgia.
On December 29, 2000, Flag acquired certain loans, deposits and property of bank branches in Montezuma, Oglethorpe, Cusseta and Buena Vista, Georgia.
RESULTS OF OPERATIONS
Flag recorded a net loss in 2002 of $1,994,000 or $0.24 per share, compared to net income of $4,010,000 or $0.51 per share in 2001 and net income of $4,284,000 or $0.52 per share in 2000.
Flag's net loss in 2002 resulted primarily from the $6,044,000 after tax charge taken in the first quarter to effect its management restructuring, loss on the early repayment of Federal Home Loan Bank (FHLB) advances, and a larger than normal addition to the provision for loan losses. Flag recorded after tax extraordinary items related to the early repayment of FHLB advances totaling $165,000 and $696,000 in 2002 and 2001, respectively.
NET INTEREST INCOME
Net interest income (the difference or spread between interest income on earning assets and interest expense on borrowed funds) is the largest component of Flag's operating income. Flag manages net interest income in a manner that realizes the largest spread while accepting certain levels of credit, liquidity and interest rate risks. Managing these risks requires systems and processes to identify and evaluate these risks at various levels in the organization. Net interest income was $24.3 million in 2002, compared to $24.0 million and $25.0 million in 2001 and 2000, respectively. Flag's margin has been pressured downward over the past few years by a decreasing interest rate environment. Flag's refinancing of FHLB advances in 2001 and 2002, coupled with aggressive repricing efforts on the deposit base, helped Flag reduce interest rate expense by approximately 38% during 2002, and more than offset decreases in interest income. Net interest margin increased to 4.86% in 2002 compared to 4.83% and 4.99% in 2001 and 2000, respectively.
Total interest income in 2002 was $36.7 million, compared to $44.5 million and $46.4 million in 2001 and 2000, respectively. Yields on average earning assets in 2002 decreased to 7.28% from 8.87% in 2001 and 9.18% in 2000. The falling interest rate environment, evidenced by a prime rate of 4.25% at the end of 2002 versus 8.50% at the beginning of 2000, has been the largest contributor to lower yields on earning assets.
Total interest expense in 2002 was $12.4 million, compared to $20.6 million and $21.4 million in 2001 and 2000, respectively. Aggressive repricing of deposit accounts, accompanied by early repayment and refinancing of FHLB debt, has allowed Flag to significantly reduce interest expense over the time frame discussed. Flag's total deposits cost 2.81%, 4.06%, and 4.17% in 2002, 2001 and 2000, respectively, while FHLB and other borrowings cost 2.16%, 5.70% and 6.34% over the same time periods. (see TABLES 1 & 2).
CONSOLIDATED AVERAGE BALANCES, INTEREST, AND RATES
TABLE 1 presents for the three years ended December 31, 2002, average balances of interest-earning assets and interest-bearing liabilities, and the weighted average interest rates earned and paid on those balances. In addition, interest rate spreads, net interest margins and the ratio of interest-earning assets versus interest-bearing liabilities for those years are presented. Average interest-earning assets were $511.7 million in 2002 versus $508.8 million in 2001 and $510.9 million in 2000. Average interest-bearing liabilities were $453.5 million in 2002 versus $443.3 million and $440.3 million in 2001 and 2000, respectively. . Flag's ratio average earning assets to average total assets was 91.2% in 2002, 90.7% in 2001 and 90.2% in 2000
TABLE 2 shows the change in net interest income from 2001 to 2000 and from 2000 to 1999 due to changes in volumes and rates.
NON-INTEREST INCOME
Total non-interest income decreased to $7.4 million in 2002 from $10.7 million in 2001 and $12.0 million in 2000. The decrease in other income in 2002 resulted largely from the absence of a gain on the sale of branches. Flag recorded gains on the sale of branches in 2001 of $3.3 million and $5.1 million in 2000.
Service charges on deposit accounts decreased during 2002 to $3.5 million from $3.9 million in 2001and $3.5 million in 2000. The decrease in 2002 from 2001 is due largely to the sale of two branch offices in December 2001 with approximately $31 million in deposits. The increase in 2001 over 2000 levels relates in part to increased demand deposits and lower earnings credits.
Mortgage banking activities includes origination fees, service release premiums and the gain on the sale of mortgage loans originated solely for the purpose of being sold. The lower interest rate environment, coupled with more effective originators, helped Flag improve the income from its mortgage banking activities in 2002 by 21% as compared to 2001. Total income from mortgage banking activities increased to $2.9 million in 2002 from 2001 and 2000 levels of $2.4 million and $1.7 million, respectively.
Effective December 31, 2001, Flag sold selected loans, deposits and property of its branches in Milan and McRae, Georgia and recognized a gain on sale of approximately $3.3 million.
During 2000, Flag sold the loans, deposits and property of its bank branches in Cobbtown, Metter and Statesboro, Georgia and recognized a gain on sale of approximately $2.0 million. Flag also sold the loans, deposits and property of its bank branches in Blackshear, Homerville and Waycross, Georgia and recognized a gain on sale of approximately $3.1 million.
NON-INTEREST EXPENSES
Salary and employee benefits increased during 2002 to $18.6 million from $13.9 million in 2001 and $14.4 million in 2000. The increase in 2002 relates largely to the management restructuring undertaken in the first quarter of 2002, in which Flag took a special charge related to buyouts of employment contracts and severance of approximately $3.1 million. The decrease in 2001 compared to 2000 relates to the lower number of staff due to the sale of branch offices during 2000.
Occupancy expenses continued a trend, decreasing to $3.6 million in 2002 from $3.8 million in 2001 and $4.3 million in 2000. This positive trend for Flag is the result of an effort to consolidate branch offices to improve individual branch performance as well as that of the consolidated company. This effort has resulted in 16 offices being closed or sold since the beginning of 2000.
Professional fees increased to $1.8 million from $1.2 million in 2001 and were flat against 2000 levels of $1.7 million. The higher amounts in 2002 relate to approximately $350,000 of professional fees related to the management restructuring and private placement effected in the first quarter, whereas the higher amounts in 2000 relate to the professional fees incurred in conjunction with branch divestiture in six markets. Other expenses increased slightly over the prior year to $3.8 million from $3.7 million. Other expenses were $5.0 million in 2000 and relate in part to increased operating and conversion expense associated with the disposition of branches in six markets.
INVESTMENT SECURITIES
The composition of the investment securities portfolio reflects management's strategy of maintaining an appropriate combination of liquidity, interest rate risk and yield. Flag seeks to maintain an investment portfolio with minimal credit risk, investing mostly in obligations of the US Treasury or other state and federal governmental agencies.
Investment securities increased to $138.9 million at December 31, 2002 from $131.5 million at December 31, 2001. At December 31, 2002, all investment securities outstanding were classified as available-for-sale. The increase in investments resulted from the investment of a portion of the proceeds received from the acquisition of branch offices from Encore Bank in November 2002. At December 31, 2002, gross unrealized gains in the total portfolio amounted to $3.2 million and gross unrealized losses amounted to $58,000.
TABLE 3 reflects the carrying amount of the investment securities portfolio for the past three years.
LOANS
Gross loans increased to $381.7 million in 2002 from $376.3 million at December 31, 2001. Gross loans decreased during the first half of 2002 to approximately $339.5 million as Flag chose to exit lower yielding and higher risk relationships. Flag's focus on existing markets, correspondent lending and the line of business purchased from BCG helped outstanding loans grow 12.5% during the second half of 2002.
TABLE 4 shows the changes in the makeup of Flag's loan portfolio from 1998 through 2002.
TABLE 5 represents the expected maturities for commercial, financial, and agricultural loans and real estate construction loans at December 31, 2002. The table also presents the rate structure for these loans that mature after one year.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
TABLE 6 presents an analysis of activities in the allowance for loan losses for the past five years. An allowance for possible losses is provided through charges to Flag's earnings in the form of a provision for loan losses. The provision for loan losses was $4.5 million in 2002, $2.5 million in 2001 and $3.6 million in 2000. Flag's increase in the provision for loan losses during 2002 was needed to replenish the allowance for loan losses due to the higher than normal amount of net charge-offs experienced. The provision for loan losses included approximately $1.0 million in 2001 for certain large agricultural credits and approximately $1.8 million in 2000 related to retained loans in the branch divestitures and one agricultural credit in South Georgia.
Management determines the level of the provision for loan losses based on outstanding loan balances, the levels of non-performing assets, and reviews of assets classified as substandard, doubtful, or loss and larger credits, together with an analysis of historical loss experience and current economic conditions.
As shown in Table 6, the year-end allowance for loan losses decreased to $6.9 million at December 31, 2002, from $7.3 million at December 31, 2001. The decrease in the allowance during 2002 was the result of higher charge-offs of problem loans during 2002 than experienced in 2001. Net charge-offs were $5.0 million in 2002, $1.7 million in 2001, and $3.2 million in 2000. The allowance for loan losses was 1.80% of gross loans at December 31, 2002, versus 1.95% and 1.68% at December 31, 2001 and 2000, respectively.
Management believes that the allowance for loan losses is both adequate and appropriate. However, the future level of the allowance for loan losses is highly dependent upon loan growth, loan loss experience, and other factors, which cannot be anticipated with a high degree of certainty. .
ASSET QUALITY
At December 31, 2002, non-performing assets totaled $11.1 million compared to $20.5 million at the end of 2001. The decrease in 2002 is attributed to a combination of Flag's comprehensive loan review program, its intense management of problem assets, and the larger than normal amount of net charge-offs for the year. At December 31, 2002, there were no commitments to advance additional funds on any loan classified "non-accrual."
TABLE 7 summarizes the non-performing assets for each of the last five years.
RISK ELEMENTS
There may be additional loans within Flag's loan portfolio that may become classified as conditions may dictate; however, management was not aware of any such loans that are material in amount at December 31, 2002. At December 31, 2002, management was unaware of any known trends, events, or uncertainties that will have, or that are reasonably likely to have a material effect on the Bank's or Flag's liquidity, capital resources, or operations.
DEPOSITS AND BORROWINGS
Total deposits increased approximately $69.1 million during 2002, totaling $509.7 million at December 31, 2002 compared to $440.6 million at December 31, 2001. The increase in Flag's deposit base in 2002 is attributable to the acquisition of the six banking offices with approximately $100 million in deposits in north metropolitan Atlanta in the fourth quarter with approximately $96 million in deposits.
The maturities of time deposits of $100,000 or more issued by the Bank at December 31, 2002, are summarized inTABLE 8.
At December 31, 2002, the Bank was a shareholder in the Federal Home Loan Bank of Atlanta ("FHLB"). Through this affiliation, advances totaling $58.0 million were outstanding at rates competitive with time deposits of like maturities. Management anticipates continued utilization of this short- and long-term source of funds to minimize interest rate risk and to fund competitive fixed rate loans to customers.
During 2002, Flag repaid $8.4 million in fixed rate advances from the FHLB prior to their original maturity date, incurring a prepayment penalty totaling approximately $266,000. In 2001, Flag repaid approximately $26 million in advances with prepayment penalties totaling approximately $1.1 million. These advances were repaid in both years due to a falling interest rate environment in which Flag could obtain new borrowings at significantly lower rates.
ASSET-LIABILITY MANAGEMENT
A primary objective of Flag's asset and liability management program is to control exposure to interest rate risk (the exposure to changes in net interest income due to changes in market interest rates) so as to enhance its earnings and protect its net worth against potential loss resulting from interest rate fluctuations.
Historically, the average term to maturity or repricing (rate changes) of assets (primarily loans and investment securities) has exceeded the average repricing period of liabilities (primarily deposits and borrowings). TABLE 9 provides information about the amounts of interest-earning assets and interest-bearing liabilities outstanding as of December 31, 2002 that are expected to mature, prepay, or reprice in each of the future time periods shown (i.e., the interest rate sensitivity). As presented in this table, at December 31, 2002, the liabilities subject to rate changes within one year exceeded our assets subject to rate changes within one year. This mismatched condition suggests that an increasing rate environment would be detrimental to Flag's margin. However, interest bearing liabilities are not as sensitive to changing rates as are Flag's assets, so management believes a rising interest rate scenario would not result in a decrease in net interest income. Management assumptions and theories regarding the interest rate risk are the products of systems that project net interest income under various scenarios and considers the sensitivity of individual components of the balance sheet. This approach is believed to produce more accurate results than the approach summarized in the following table.
Management carefully measures and monitors interest rate sensitivity and believes that its operating strategies offer protection against interest rate risk. As required by various regulatory authorities, Flag's Board of Directors has established an interest rate risk policy, which sets specific limits on interest rate risk exposure. Adherence to this policy is reviewed by Flag's executive committee and presented at least annually to the Board of Directors.
Management has maintained positive ratios of average interest-earning assets to average interest-bearing liabilities. As represented in TABLE 1 this ratio, based on average balances for the respective years, was 113% in 2002, 115% in 2001 and 116% in 2000.
TABLE 10 represents the expected maturity of investment securities by maturity date and average yields based on amortized cost at December 31, 2002. It should be noted that the composition and maturity/repricing distribution of the investment portfolio is subject to change depending on rate sensitivity, capital needs, and liquidity needs.
LIQUIDITY
The objective of liquidity management is to ensure that sufficient funding is available, at reasonable cost, to meet the ongoing operational cash needs of Flag and to take advantage of income producing opportunities as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of Flag to maintain a sufficient level of liquidity in all expected economic environments. Liquidity is defined as the ability of a bank to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining Flag's ability to meet the daily cash flow requirements of the Bank's customers, both depositors and borrowers.
The primary objectives of asset/liability management are to provide for adequate liquidity in order to meet the needs of customers and to maintain an optimal balance between interest-sensitive assets and interest-sensitive liabilities, so that Flag can also meet the investment requirements of its shareholders as market interest rates change. Daily monitoring of the sources and use of funds is necessary to maintain a position that meets both requirements
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and the maturities and sales of securities. Mortgage loans held for sale totaled $12.6 million at December 31, 2002, and typically turn over every 45 days as the closed loans are sold to investors in the secondary market. Real estate-construction and commercial loans that mature in one year or less amounted to $77.5 million, or 19.7% of the total loan portfolio at December 31, 2002. Other short-term investments such as federal funds sold are additional sources of liquidity.
The liability section of the balance sheet provides liquidity through depositors' interest bearing and non-interest bearing deposit accounts. Federal funds purchased, FHLB advances, other borrowings and securities sold under agreements to repurchase are additional sources of liquidity and represent Flag's incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet other short-term liquidity needs.
As disclosed in Flag's consolidated statements of cash flows included in the consolidated financial statements, net cash used by operating activities was $6.8 million during 2002. The major uses of cash by operating activities were the changes in mortgage loans held for sale and the changes in other assets and liabilities. Net cash provided by investing activities of $48.5 million consisted primarily of funds acquired in the acquisition of the six north-metro Atlanta branch offices and proceeds from sales and maturities of investment securities, offset by net changes in loans, interest bearing deposits in other banks and purchases of investment securities. Net cash used by financing activities was $23.5 million, and consisted mostly of the net change in deposits and the increase in amounts due to the FHLB.
In the opinion of management, Flag's liquidity position at December 31, 2002 is sufficient to meet its expected cash flow requirements. Reference should be made to the consolidated statements of cash flows appearing in the consolidated financial statements for the three-year analysis of the changes in cash and cash equivalents resulting from operating, investing and financing activities.
CAPITAL RESOURCES AND DIVIDENDS
Stockholders' equity at December 31, 2002 increased 12.5% to $60.7 million from $54.0 million at December 31, 2001. This increase is largely due to the 1,300,000 share private placement approved by Flag's Board of Directors during the first quarter of 2002. During 2002, 1,272,000 shares and 1,272,000 warrants had been sold for $11.7 million to the Company's management or employees.
Flag continued its stock repurchase program during 2002. Flag repurchased 338,960 shares of its common stock in 2002, 755,257 shares of its common stock in 2001 and 145,244 shares of its common stock in 2000.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA") requires federal banking agencies to take "prompt corrective action" with regard to institutions that do not meet minimum capital requirements. As a result of FDICIA, the federal banking agencies introduced an additional capital measure called the "Tier 1 risk-based capital ratio." The Tier 1 ratio is the ratio of core capital to risk adjusted total assets. Note 12 to the Consolidated Financial Statements presents a summary of FDICIA's capital tiers compared to Flag's and the Bank's actual capital levels. The Bank exceeded all requirements of a "well-capitalized" institution at December 31, 2002.
Provision for Income Taxes
The benefit for income taxes was $2.0 million in 2002, compared to a provision for income taxes of $1.8 million in 2001 and of $1.4 million in 2000. The effective tax rate in 2002 was higher than the Federal statutory rate of 34% due to interest income on tax exempt securities and general business credits. Also, during 2002 the amount of loss before income taxes was lower than the earnings before income taxes in prior years. The effect of tax exempt interest income and general business credits is greater in years that income (loss) before taxes is lower. The tax rates for 2001 and 2000 are lower than the statutory Federal rate of 34% primarily due to interest income on tax exempt securities and general business credits. See Flag's consolidated financial statements for an analysis of income taxes.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power over time due to inflation.
Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation. The liquidity and maturity structures of Flag's assets and liabilities are critical to the maintenance of acceptable performance levels.
RECENT ACCOUNTING PRONOUNCEMENTS
Accounting standards that have been issued or proposed by the Financial Accounting Standards Board and other standard setting entities that do not require adoption until a future date are not expected to have a material impact on Flag's consolidated financial statements upon adoption.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's net interest income and the fair value of its financial instruments (interest-earning assets and interest-bearing liabilities) are influenced by changes in market interest rates. The Company actively manages its exposure to interest rate fluctuations through policies established by its senior management and Board of Directors. The Company's senior management implements asset/liability management policies, develops and implements strategies to improve balance sheet positioning and net interest income and regularly assesses the interest rate sensitivity of the Bank.
The Company utilizes an interest rate simulation model to monitor and evaluate the impact of changing interest rates on net interest income and the market value of its investment portfolio. The ALCO policy limits the maximum percentage changes in net interest income and investment portfolio equity, assuming a simultaneous, instantaneous change in interest rate. These percentage changes are as follows:
Changes in Percentage Percent Change in Interest Rates Change in Net Market Value of (In Basis Points) Interest Income Portfolio Equity ----------------- --------------- ----------------- 300 20% 20% 200 20% 20% 100 20% 20%
As of December 31, 2002, the Company was in compliance with its ALCO policy.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are included herein:
Report of Independent Certified Public Accountants Consolidated Balance Sheets as of December 31, 2002 and 2001 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors Flag Financial Corporation Atlanta, Georgia
We have audited the accompanying consolidated balance sheets of Flag Financial Corporation and subsidiary as of December 31, 2002 and 2001, and the related statements of operations, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of Flag's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Flag Financial Corporation and subsidiary as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ Porter Keadle Moore, LLP
Atlanta, Georgia January 24, 2003
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation ----------------------- The consolidated financial statements include the accounts of Flag Financial Corporation ("Flag") and its wholly-owned subsidiary, Flag Bank (the "Bank"). All significant intercompany accounts and transactions have been eliminated in consolidation. Flag is a bank holding company formed in 1994 whose business is conducted by the Bank. Flag is subject to regulation under the Bank Holding Company Act of 1956. The Bank is primarily regulated by the Georgia Department of Banking and Finance ("DBF") and the Federal Deposit Insurance Corporation ("FDIC"). The Bank provides a full range of commercial, mortgage and consumer banking services in West-Central, Middle and South Georgia and metropolitan Atlanta, Georgia.
The accounting principles followed by Flag and its subsidiary, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America ("GAAP") and with general practices within the banking industry. In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from those estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses, the valuation of real estate acquired in connection with or in lieu of foreclosure on loans, the valuation allowance for mortgage servicing rights and valuation allowances associated with the realization of deferred tax assets which are based on future taxable income.
Cash and Cash Equivalents ---------------------------- Cash equivalents include amounts due from banks, interest-bearing demand deposits with banks and federal funds sold. Generally, federal funds are sold for one-day periods. As of December 31, 2002, the Company maintained cash balances with financial institutions totaling $5,500,000 that exceeded federal deposit insurance limits.
Investment Securities ---------------------- Flag classifies its securities in one of three categories: trading, available-for-sale, or held-to-maturity. Trading securities are securities held for the purpose of generating profits on short-term differences in price. Securities held-to-maturity are those securities for which Flag has the ability and intent to hold to maturity. All other securities are classified as available-for-sale. As of December 31, 2002 and 2001, all of Flag's investment securities were classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized holding gains and losses on trading securities are included in earnings in the period in which the gain or loss occurs. Unrealized holding gains and losses, net of the related tax effect, on securities available-for-sale are excluded from earnings and are reported as a separate component of stockholders' equity until realized. Transfers of securities between categories are recorded at fair value at the date of transfer.
A decline in the market value of any available-for-sale or held-to-maturity investment below cost that is deemed other than temporary is charged to earnings and establishes a new cost basis for the security.
Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield. Realized gains and losses are included in earnings and the cost of securities sold are derived using the specific identification method.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Other Investments ------------------ Other investments include Federal Home Loan Bank ("FHLB") stock, other equity securities with no readily determinable fair value and an investment in a limited partnership. Flag owns a 43% interest in a limited partnership, which invests in multi-family real estate and passes low income housing credits to the investors. Flag recognizes these tax credits in the year received. These investments are carried at cost, which approximates fair value.
Mortgage Loans Held-for-Sale ------------------------------ Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. The amount by which cost exceeds market value is accounted for as a valuation allowance. Changes, if any, in the valuation allowance are included in the determination of net earnings in the period in which the change occurs. Flag has recorded no valuation allowance related to its mortgage loans held-for-sale as their cost approximates market value. Gains and losses from the sale of loans are determined using the specific identification method.
Loans and Interest Income ---------------------------- Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding unpaid principal balances, net of the allowance for loan losses, deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.
Flag considers a loan impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate or at the loan's observable market price, or the fair value of the collateral of the loan if the loan is collateral dependent. Interest income from impaired loans is recognized using a cash basis method of accounting during the time within that period in which the loans were impaired.
Allowance for Loan Losses ---------------------------- The allowance for loan losses is established through provisions for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collection of the principal is unlikely. The allowance is an amount which, in management's judgment, will be adequate to absorb losses on existing loans that may become uncollectible. The allowance is established through consideration of such factors as changes in the nature and volume of the portfolio, adequacy of collateral, delinquency trends, loan concentrations, specific problem loans, and economic conditions that may affect the borrower's ability to pay.
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Flag's allowance for loan losses. Such agencies may require Flag to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Other Real Estate Owned -------------------------- Real estate acquired through foreclosure is carried at the lower of cost (defined as fair value at foreclosure) or fair value less estimated costs to dispose. Fair value is defined as the amount that is expected to be received in a current sale between a willing buyer and seller other than in a forced or liquidation sale. Fair values at foreclosure are based on appraisals. Losses arising from the acquisition of foreclosed properties are charged against the allowance for loan losses. Subsequent writedowns are provided by a charge to operations through the allowance for losses on other real estate in the period in which the need arises.
Premises and Equipment ------------------------ Premises and equipment are stated at cost less accumulated depreciation. Major additions and improvements are charged to the asset accounts while maintenance and repairs that do not improve or extend the useful lives of the assets are expensed currently. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for the period.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Premises and Equipment, continued ------------------------------------ Depreciation expense is computed using the straight-line method over the following estimated useful lives:
Income Taxes ------------- Deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.
In the event the future tax consequences of differences between the financial reporting bases and the tax bases of Flag's assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such assets is required. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the ability to realize the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.
A deferred tax liability is not recognized for portions of the allowance for loan losses for income tax purposes in excess of the financial statement balance, as described in note 9. Such a deferred tax liability will only be recognized when it becomes apparent that those temporary differences will reverse in the foreseeable future.
Stock-Based Compensation ------------------------- At December 31, 2002, Flag sponsors stock-based compensation plans, which are described more fully in Note 11. Flag accounts for these plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings (loss) and earnings (loss) per share if Flag had applied the fair value recognition provisions of Statement of Financing Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation (in thousands, except per share amounts).
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Net Earnings Per Common Share --------------------------------- Flag is required to report earnings per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants on the face of the statements of operations. Basic earnings per common share are based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per share. Additionally, Flag must reconcile the amounts used in the computation of both "basic earnings per share" and "diluted earnings per share". Antidilutive stock options and warrants have not been included in the diluted earnings per share calculations. Antidilutive stock options and warrants totaled 2,152,427, 603,624, and 896,198 as of December 31, 2002, 2001 and 2000, respectively. For 2002, the potential effect of outstanding options and warrants would be antidilutive, and therefore is not presented. Earnings per common share amounts for the years ended December 31, 2001 and 2000 are as follows (in thousands, except share and per share amounts):
Derivative Instruments and Hedging Activities ------------------------------------------------- Flag recognizes the fair value of derivatives as assets or liabilities in the financial statements. The accounting for the changes in the fair value of a derivative depends on the intended use of the derivative instrument at inception. The change in fair value of instruments used as fair value hedges is accounted for in the income of the period simultaneous with accounting for the fair value change of the item being hedged. The change in fair value of the effective portion of cash flow hedges is accounted for in comprehensive income rather than income, and the change in fair value of foreign currency hedges is accounted for in comprehensive income as part of the translation adjustment. The change in fair value of derivative instruments that are not intended as a hedge is accounted for in the income of the period of the change.
Accumulated Other Comprehensive Income ----------------------------------------- At December 31, 2002 and 2001, accumulated other comprehensive income consisted of net unrealized gains on investment securities available-for-sale of $1,924,000 and $1,239,000, respectively; and net gains on derivatives of $75,000 and $374,000, respectively.
------ FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Goodwill and Intangible Assets --------------------------------- Effective January 1, 2002, Flag adopted SFAS No. 141, "Business Combinations", SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 147, "Acquisitions of Certain Financial Institutions". SFAS No. 141 requires all business combinations completed after its adoption to be accounted for under the purchase method of accounting and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 addresses the accounting for goodwill and intangible assets subsequent to their initial recognition. Upon adoption of SFAS No. 142, goodwill and some intangible assets will no longer be amortized and will be tested for impairment at least annually. SFAS No. 147 requires that the acquisition of all or a part of a financial institution that meets the definition of a business combination shall be accounted for in accordance with SFAS No. 141.
Reclassifications ----------------- Certain reclassifications have been made to the 2001 and 2000 financial statements to conform with classifications for 2002.
(2) BUSINESS COMBINATIONS Branch Purchases ----------------- On November 8, 2002, Flag acquired the Atlanta banking facilities of Encore Bank ("Encore Branches") for a total purchase price of $12,905,000, which was all paid in cash. The results of the Encore Branches have been included in the consolidated financial statements since that date. The Encore Branches provide an excellent platform for Flag to continue the metro Atlanta expansion strategy.
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition (in thousands):
The deposit intangible is subject to amortization and has a weighted-average useful life of approximately ten years. The goodwill recorded is expected to be fully deductible for tax purposes.
Other Acquisitions and Dispositions -------------------------------------- On November 12, 2002, Flag acquired the assets and the lending line of business of Bankers Capital Group, LLC ("BCG"). BCG is a company owned by certain members of management of Flag who purchased common stock and warrants during 2002 as described in note 10. The results of this line of business have been included in the consolidated financial statements since the date of acquisition. BCG is a commercial loan origination company, specializing in higher-yielding, non-traditional financing. As a result of the acquisition, Flag expects this line of business to become a source of high-yielding assets.
The aggregate purchase price paid for BCG was $1,405,000 in cash, which was paid at the time of closing, and $1,500,000, which is contingently payable based on the future performance of BCG. If paid, the contingent consideration will increase the amount of goodwill recorded by Flag at the time that it is paid.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(2) BUSINESS COMBINATIONS, CONTINUED Other Acquisitions and Dispositions, continued -------------------------------------------------- The following table summarizes the estimated fair values of the assets acquired at the date of acquisition (amounts in thousands):
The goodwill recorded is expected to be fully deductible for tax purposes.
During 2001, Flag sold the loans, deposits and property of its branches in McRae and Milan, Georgia and recognized a gain of approximately $3,285,000.
During 2000, Flag sold the loans, deposits, and property of its bank branches in Cobbtown, Metter and Statesboro, Georgia and recognized a gain on sale of approximately $2,011,000. Flag also sold the loans, deposits, and property of its bank branches in Blackshear, Homerville and Waycross, Georgia and recognized a gain on sale of approximately $3,069,000. Also during 2000, Flag acquired certain loans, deposits and property of bank branches in Montezuma, Oglethorpe, Cusseta and Buena Vista, Georgia for a net purchase price of approximately $5,462,000.
Intangible Assets and Goodwill --------------------------------- As a result of these business combinations, Flag has recorded intangible assets. As of December 31, 2002, Flag had recorded deposit intangible assets that are subject to amortization totaling $900,000 with accumulated amortization of $15,000. Flag recognized amortization expense on this intangible of $15,000 during the year ended December 31, 2002 and expects amortization expense to total $90,000 per year through 2012.
The changes in the carrying amount of goodwill for the year ended December 31, 2002, are as follows:
The majority of the goodwill recorded as of January 1, 2002, resulted from Flag's adoption of SFAS No. 147 and this amount resulted from previously recognized unidentified intangible assets reclassified as goodwill. Flag tests its goodwill for impairment on an annual basis using the expected present value of future cash flows. Flag initially applied SFAS No. 141 and 142 on January 1, 2002. The pro forma effect of the adoption of these statements is shown in the table below:
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) INVESTMENT SECURITIES Investment securities available-for-sale at December 31, 2002 and 2001 are summarized as follows (in thousands):
The amortized cost and estimated fair value of investment securities available-for-sale at December 31, 2002, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) INVESTMENT SECURITIES, CONTINUED Proceeds from sales of securities available-for-sale during 2002, 2001 and 2000 totaled approximately $17,723,000, $306,000,and $14,706,000, respectively. Gross gains of approximately $72,000 and gross losses of approximately $413,000 were realized on those sales during 2002. No gain or loss was realized on those sales during 2001. Gross losses of approximately $263,000 were realized on those sales for the year ended December 31, 2000.
Securities and interest-bearing deposits with a carrying value of approximately $103,853,000 and $94,443,000 at December 31, 2002 and 2001, respectively, were pledged to secure advances from FHLB, U.S. Government and other public deposits.
(4) LOANS Major classifications of loans at December 31, 2002 and 2001 are summarized as follows (in thousands):
Flag concentrates its lending activities in the origination of permanent residential mortgage loans, permanent residential construction loans, commercial mortgage loans, commercial business loans, and consumer installment loans. The majority of Flag's real estate loans are secured by real property located in West-Central, Middle and South Georgia and metropolitan Atlanta, Georgia.
Flag has recognized impaired loans of approximately $1,513,0000 and $10,259,000 at December 31, 2002 and 2001, respectively, with a total allowance for loan losses related to these loans of approximately $910,000 and $2,893,000, respectively. The average balance of impaired loans was approximately $4,236,000, $3,650,000 and $977,000 during 2002, 2001 and 2000, respectively. Interest income on impaired loans of approximately $88,000, $480,000 and $839,000 was recognized for cash payments received in 2002, 2001 and 2000, respectively.
Activity in the allowance for loan losses is summarized as follows for the years ended December 31, 2001, 2000 and 1999 (in thousands):
Mortgage loans secured by 1-4 family residences totaling approximately $50,700,000 and $33,519,000 were pledged as collateral for outstanding FHLB advances as of December 31, 2002 and 2001, respectively.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(5) PREMISES AND EQUIPMENT Premises and equipment at December 31, 2002 and 2001 are summarized as follows (in thousands):
Depreciation expense approximated $2,037,000, $2,273,000, and $3,573,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
(6) TIME DEPOSITS At December 31, 2002, contractual maturities of time deposits are summarized as follows (in thousands):
(7) ADVANCES FROM FEDERAL HOME LOAN BANK Advances from FHLB are collateralized by FHLB stock, certain investment securities and certain first mortgage loans. Advances from FHLB outstanding at December 31, 2002 mature and bear fixed interest rates as follows (in thousands):
In 2002 and 2001, Flag repaid $9,434,000 and $26,000,000, respectively, in advances from the FHLB prior to their original maturity date and incurred a prepayment penalty of approximately $266,000 and $1,123,000, respectively. These advances were repaid due to a falling interest rate environment in which Flag could obtain new borrowings at significantly lower rates. These redemptions of debt have been recorded as an extraordinary item, net of income taxes of approximately $101,000 and $427,000, in the 2002 and 2001 statements of operations, respectively.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(8) OTHER BORROWINGS Other borrowings as of December 31, 2001 consisted of a line of credit with a bank with a total commitment amount of $5,000,000. The line of credit bore interest at .5% below the prime rate and was secured by common stock of the Bank. The line of credit was repaid in 2002 and expired on October 1, 2002.
(9) INCOME TAXES The following is an analysis of the components of income tax expense (benefit) for the years ended December 31, 2002, 2001 and 2000 (in thousands):
The differences between income tax expense (benefit) and the amount computed by applying the statutory federal income tax rate to earnings (loss) before taxes for the years ended December 31, 2002, 2001 and 2000 are as follows (in thousands):
The following summarizes the net deferred tax asset. The deferred tax asset is included as a component of other assets at December 31, 2002 and 2001 (in thousands).
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(9) INCOME TAXES, CONTINUED As of December 31, 2002, Flag had federal and state net operating loss carryforwards totaling $5,157,000 and $6,452,000, respectively, that will begin to expire in 2017 unless previously utilized.
The Internal Revenue Code ("IRC") was amended during 1996 and the IRC section 593 reserve method for loan losses for thrift institutions was repealed. Effective January 1, 1996, certain banks that have been merged into the Bank began to compute their tax bad debt reserves under the rules of IRC section 585, which apply to commercial banks. In years prior to 1996, these banks obtained tax bad debt deductions approximating $2.9 million in excess of their financial statement allowance for loan losses for which no provision for federal income tax was made. These amounts were then subject to federal income tax in future years pursuant to the prior IRC section 593 provisions if used for purposes other than to absorb bad debt losses. Effective January 1, 1996, approximately $2.9 million of the excess reserve is subject to recapture only if the Bank ceases to qualify as a bank pursuant to the provisions of IRC section 585.
(10) STOCKHOLDERS' EQUITY During 2002, the Company sold 1,272,000 shares of common stock through a private placement at a price between $9.10 and $10.10 per share. The private placement resulted in total proceeds of $11,707,740 and was completed on May 17, 2002. The proceeds of this offering were used for general corporate purposes.
Shares of preferred stock may be issued from time to time in one or more series as established by resolution of the Board of Directors of Flag, up to a maximum of 10000000 shares. Each resolution shall include the number of shares issued, preferences, special rights and limitations as determined by the Board.
(11) EMPLOYEE AND DIRECTOR BENEFIT PLANS Defined Contribution Plan --------------------------- Flag sponsors the Flag Financial Profit Sharing Thrift Plan that is qualified pursuant to IRC section 401(k). The plan allows eligible employees to defer a portion of their income by making contributions into the plan on a pretax basis. The plan provides a matching contribution based on a percentage of the amount contributed by the employee. The plan also provides that the Board of Directors may make discretionary profit-sharing contributions up to 15% of eligible compensation to the plan. The plan allows participants to direct up to 75% of their account balance and/or contributions to be invested in the common stock of Flag. The trustee of the plan is required to purchase the Flag stock at market value and may not acquire more than 25% of the issued and outstanding shares. During the years ended December 31, 2002, 2001 and 2000, the Company contributed approximately $430,000, $420,000, and $391,000, respectively, to this plan under its matching provisions.
Directors' Retirement Plan ---------------------------- The Bank sponsors a defined contribution postretirement benefit plan to provide retirement benefits to certain of their Board of Directors and to provide death benefits for their designated beneficiaries. Under this plan, the Bank purchased split-dollar whole life insurance contracts on the lives of each Director. The increase in cash surrender value of the contracts, less the Bank's cost of funds, constitutes their contribution to the plan each year. In the event the insurance contracts fail to produce positive returns, the Bank has no obligation to contribute to the plan. At December 31, 2002 and 2001, the cash surrender value of the insurance contracts was approximately $4,629,000 and $4,478,000, respectively. Expenses incurred for benefits were approximately $6,000 and $8,250, during 2002 and 2001, respectively.
Stock Option Plan and Warrants ---------------------------------- Flag sponsors an employee stock incentive plan and a director stock incentive plan. The plans were adopted for the benefit of directors and key officers and employees in order that they may purchase Flag stock at a price equal to the fair market value on the date of grant. A total of 1,314,000 shares were reserved for possible issuance under the employee plan and 266,938 shares were reserved under the director plan. The options generally vest over a four-year period and expire after ten years.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(11) EMPLOYEE AND DIRECTOR BENEFIT PLANS, CONTINUED Stock Option Plan and Warrants, continued ---------------------------------- In connection with the Company's private placement in 2002, warrants for 1,236,000 shares were issued to the purchasers of the common stock for $1 per warrant. The warrants allow each holder to purchase one additional share of common stock for each share purchased in connection with the private placement and were issued as of the date of issuance of common stock sold in the private placement. The warrants will be exercisable for a period of ten years following issuance at the private placement price of $9.10 per share.
A summary of activity in the warrants and stock option plans is presented below:
A summary of options and warrants outstanding as of December 31, 2002 is presented below:
The fair value of each option is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions: dividend yield of 2.35%, volatility of .2973 to .9803; risk free interest rate ranging from 3.85% to 6.00% and an expected life of 5 years. The weighted average grant-date fair value of options and warrants granted in 2002, 2001 and 2000 was $1.82, $1.79, and $5.21, respectively.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(12) REGULATORY MATTERS Flag and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, action by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002 that Flag and the Bank meet all capital adequacy requirements to which they are subject.
Minimum ratios required by the Bank to ensure capital adequacy are 8% for total capital to risk weighted assets and 4% each for Tier 1 capital to average assets. Minimum ratios required by the Bank to be well capitalized under prompt corrective action provisions are 10% for total capital to risk weighted assets, 6% for Tier 1 capital to risk weighted assets and 5% for Tier 1 capital to average assets. Minimum amounts required for capital adequacy purposes and to be well capitalized under prompt corrective action provisions are presented below for Flag and the Bank. Prompt corrective action provisions do not apply to bank holding companies.
Banking regulations limit the amount of dividends the Bank can pay to Flag without prior regulatory approval. These limitations are a function of excess regulatory capital and net earnings in the year the dividend is declared. In 2003, the Bank cannot pay dividends without prior regulatory approval.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(13) COMMITMENTS AND CONTINGENCIES Flag is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its cost of funds. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
Commitments to originate first mortgage loans and to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. The Bank's loans are primarily collateralized by residential and other real properties, automobiles, savings deposits, accounts receivable, inventory and equipment.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. Most letters of credit extend for less than one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Flag's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. All standby letters of credit are secured at December 31, 2002 and 2001.
In connection with its private placement of common stock, in 2002 Flag agreed to guarantee loans used to fund the purchase of stock and warrants by certain employees. The loans approximate $2,427,000 and the guarantees are collateralized by the stock and warrants purchased.
Flag maintains an overall interest rate risk-management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by certain movements in interest rates. Flag views this strategy as a prudent management of interest rate sensitivity, such that earnings are not exposed to undue risk presented by changes in interest rates.
Derivative instruments that are used as part of Flag's interest rate risk-management strategy include interest rate contracts. As a matter of policy, Flag does not use highly leveraged derivative instruments for interest rate risk management. During 2001, Flag settled a previously outstanding interest rate contract. The gain realized upon settlement is being recognized over the original life of the contract.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(13) COMMITMENTS AND CONTINGENCIES, CONTINUED By using derivative instruments, Flag is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in a derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes Flag, and, therefore, creates a repayment risk for Flag. When the fair value of a derivative contract is negative, Flag owes the counterparty and, therefore, it has no repayment risk. Flag minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically.
Flag's derivative activities are monitored by its asset/liability management committee as part of that committee's oversight of Flag's asset/liability and treasury functions. Flag's asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the overall interest-rate risk management.
For the year ended December 31, 2002, there were no material amounts recognized which represented the ineffective portion of cash flow hedges. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted.
(14) RELATED PARTY TRANSACTIONS Flag conducts transactions with its directors and executive officers, including companies in which they have beneficial interest, in the normal course of business. It is the policy of Flag that loan transactions with directors and executive officers be made on substantially the same terms as those prevailing at the time for comparable loans to other persons. The following is a summary of activity for related party loans for 2002 (in thousands).
At December 31, 2002, deposits from directors, executive officers and their related interests aggregated approximately $2,904,000. These deposits were taken in the normal course of business at market interest rates.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(15) FLAG FINANCIAL CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(15) FLAG FINANCIAL CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION, CONTINUED
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(16) QUARTERLY OPERATING RESULTS (UNAUDITED) The following is a summary of the unaudited condensed consolidated quarterly operating results of Flag for the years ended December 31, 2002 and 2001 (amounts in thousands, except per share amounts):
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS Flag is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of Flag's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of Flag or the Bank, but rather a good-faith estimate of the increase or decrease in value of financial instruments held by Flag since purchase, origination or issuance.
Cash and Cash Equivalents and Interest-Bearing Deposits ------------------------------------------------------------- For cash, due from banks, federal funds sold and interest-bearing deposits with other banks the carrying amount is a reasonable estimate of fair value.
Securities Available-for-Sale ------------------------------ Fair values for securities available-for-sale are based on quoted market prices.
Other investments ------------------ The carrying value of other investments approximates fair value.
Loans and Mortgage Loans Held-for-Sale ------------------------------------------ The fair value of fixed rate 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. For variable rate loans, the carrying amount is a reasonable estimate of fair value.
Cash Surrender Value of Life Insurance ------------------------------------------- The carrying value of cash surrender value of life insurance approximates fair value.
Deposits -------- The fair value of demand deposits, savings accounts, NOW accounts, certain money market deposits, advances from borrowers and advances payable to secondary market is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
Federal Funds Purchased, Repurchase Agreements and Other Borrowings -------------------------------------------------------------------------- For federal funds purchased and repurchase agreements, the carrying amount is a reasonable estimate of fair value.
Advances from the Federal Home Loan Bank ---------------------------------------------- The fair value of the FHLB fixed rate borrowings are estimated using discounted cash flows, based on the current incremental borrowing rates for similar types of borrowing arrangements.
Commitments to Originate First Mortgage Loans, Commitments to Extend ---------------------------------------------------------------------- Credit and Standby Letters of Credit ---------------------------------------- Because commitments to originate first mortgage loans, commitments to extend credit and standby letters of credit are generally short-term and at variable rates, the contract value and estimated fair value associated with these instruments are immaterial.
Interest Rate Contracts ------------------------- The fair value of interest rate contracts is obtained from dealer quotes. These values represent the amount the Company would receive to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties.
FLAG FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED Limitations ----------- Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time Flag's entire holdings of a particular financial instrument. Because no market exists for a significant portion of Flag's financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include the mortgage banking operation, deferred income taxes, premises and equipment and purchased core deposit intangible. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The carrying amount and estimated fair values of Flag's financial instruments at December 31, 2002 and 2001 are as follows (In Thousands):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III --------
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors and executive officers of the Company is set forth under the captions "Proposal 1 - Election of Directors-Nominees, - Information Regarding Nominees and Continuing Directors and - Executive Officers" in the Company's Proxy Statement for its 2002 Annual Meeting of Shareholders to be held on April 15, 2003. Such information is incorporated herein by reference.
Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, by directors and executive officers of the Company and the Bank is set forth under the caption "Compliance with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement referred to above. Such information is incorporated herein by reference. To the Company's knowledge, no person was the beneficial owner of more than 10% of the Company's common stock during 2002.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation is set forth under the captions "Proposal 1- Election of Directors- Director Compensation" and "Executive Compensation" in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
Information regarding ownership of the Company's common stock by management and beneficial owners of 5% of the Company's common stock is set forth under the caption "Proposal 1 - Election of Directors - Management Stock Ownership" in the Proxy Statement referred in Item 10 above and is incorporated herein by reference.
The following table provides information regarding compensation plans under which equity securities of the Company are authorized for issuance. All data is presented as of December 31, 2002.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain transactions between the Bank and directors and executive officers of the Company and the Bank is set forth under the caption "Related Party Transactions" in the Proxy Statement referred to in Item 10 above and is incorporated herein by reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) that is required to be included in the Company's periodic filings with the Securities and Exchange Commission. There have been no significant changes in the Company's internal controls or, to the Company's knowledge, in other factors that could significantly affect those internal controls subsequent to the date the Company carried out its evaluation, and there have been no corrective actions with respect to significant deficiencies or material weaknesses.
ITEM 15.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information relating to the fees paid to the Company's independent accountants is set forth under the captions "Audit Fees" and "Other Fees" in the Proxy Statement referred to in Item 10 above and is incorporated herein by reference.
PART IV -------
ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The list of financial statements is included at Item 8.
(a)(2) The financial statement schedules are either included in the financial statements or are not applicable.
(a)(3) Exhibit List
EXHIBIT NO. DESCRIPTION - ----------- -----------
3.1 Articles of Incorporation of the Company, as amended through October 15, 1993 (incorporated by reference from Exhibit 3.1(i) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993)
3.2 Bylaws of the Company, as amended through March 30, 1998 (incorporated by reference from Exhibit 3.1(ii) to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
3.3 Amendment to Bylaws of the Company as adopted by resolution of Board of Directors on October 19, 1998 (incorporated by reference from Exhibit 3.3 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1998)
3.4 Amendment to Bylaws of the Company as adopted by resolution of the Board of Directors on December 20, 2000 (incorporated by reference from Exhibit 3.4 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
3.5 Amendment to Bylaws of the Company as adopted by resolution of the Board of Directors on February 19, 2001 (incorporated by reference from Exhibit 3.5 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
4.1 Instruments Defining the Rights of Security Holders (See Articles of Incorporation at Exhibit 3.1 hereto and Bylaws at Exhibits 3.2, 3.3, 3.4 and 3.5 hereto)
10.1* Amended and Restated Employment Agreement between J. Daniel Speight, Jr. and the Company dated as of February 21, 2002 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.2* Amended and Restated Employment Agreement between John S. Holle and the Company dated as of January 1, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000), as cancelled pursuant to the Cancellation Agreement between John S. Holle and the Company dated as of February 20, 2002, as amended as of March 26, 2002 (each incorporated by reference to exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.3* Amended and Restated Employment Agreement between Charles O. Hinely and the Company dated as of February 21, 2002 (incorporated by reference from Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001), as cancelled pursuant to the Cancellation Agreement between Charles O. Hinely and the Company dated as of July 31,
10.4* Employment Agreement between Stephen W. Doughty and the Company dated January 13, 2003
10.5* Employment Agreement between J. Thomas Wiley, Jr. and the Company dated January 13, 2003
10.6* Split Dollar Insurance Agreement between J. Daniel Speight, Jr. and Citizens Bank dated November 2, 1992 (incorporated by reference from Exhibit 10.7 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.7* Director Indexed Retirement Program for Citizens Bank dated January 13, 1995 (incorporated by reference from Exhibit 10.8 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.8* Form of Executive Agreement (pursuant to Director Indexed Retirement Program for Citizens Bank) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.9 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.9* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Director Indexed Retirement Program for Citizens Bank) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.10 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.10* Director Indexed Fee Continuation Program for First Federal Savings Bank of LaGrange effective February 3, 1995 (incorporated by reference from Exhibit 10.12 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.11* Form of Director Agreement (pursuant to Director Indexed Fee Construction Program for First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.13 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.12* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Director Indexed Fee Continuation Program of First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.14 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.13* Form of Indexed Executive Salary Continuation Plan Agreement by and between First Federal Savings Bank of LaGrange and individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.15 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.14* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Executive Salary Continuation Plan for First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.16 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.15* Indexed Executive Salary Continuation Plan Agreement by and between First Federal Savings Bank of LaGrange and William F. Holle, Jr. dated February 3, 1995 (incorporated by reference from Exhibit 10.17 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.16* Form of Deferred Compensation Plan by and between The Citizens Bank and individuals listed on exhibit cover page (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.17* Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated through March 30, 1998) (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.18* Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended through September 18, 1997) (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.19* First Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of March 15, 1999 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.20* Second Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of January 16, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.21* First Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of December 21, 1998 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.22* Second Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of October 25, 1999 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.23* Third Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated January 16, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.24* Third Amendment to Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of February 19, 2002 (incorporated by reference from exhibit of same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.25* Fourth Amendment to Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of February 19, 2002 (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 2002)
21 Subsidiaries (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
23 Consent of Porter Keadle Moore, LLP
99.1 Certifications by Chief Executive Officer and Chief Financial Officer ____________________
* The indicated exhibit is a compensatory plan required to be filed as an exhibit to this Form 10-K.
(b) Reports on Form 8-K filed during Fourth Quarter of 2002
Report on Form 8-K filed on November 22, 2002 reporting the Company's acquisition of six branches from Encore Bank.
(c) The Exhibits not incorporated herein by reference are submitted as a separate part of this report.
(d) Financial Statements Schedules: The financial statement schedules are either included in the financial statements or are not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
FLAG FINANCIAL CORPORATION (Registrant)
Date: March 27, 2003 By: /s/ Joseph W. Evans -------------------------- Joseph W. Evans Chief Executive Officer
Certification
I, Joseph W. Evans, Chief Executive Officer of Flag Financial Corporation, certify that:
1. I have reviewed the annual report on Form 10-K of Flag Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ Joseph W. Evans ---------------------- Joseph W. Evans Chief Executive Officer
Certification
I, J. Daniel Speight, Chief Financial Officer of Flag Financial Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Flag Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003
/s/ J. Daniel Speight ------------------------ J. Daniel Speight Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1934, this Report has been signed by the following persons in the capacities indicated on March 27, 2003:
Signature Title --------- -----
/s/ William H. Anderson, II Director - ---------------------------------------- William H. Anderson, II
/s/ H. Speer Burdette, III Director - ---------------------------------------- H. Speer Burdette, III
/s/ Stephen W. Doughty Vice Chairman, Chief Risk - ---------------------------------------- Management Officer and Director Stephen W. Doughty
/s/ David B. Dunaway Director - ---------------------------------------- David B. Dunaway
/s/ Joseph W. Evans Chairman, President and Chief - ---------------------------------------- Executive Officer Joseph W. Evans (principal executive officer)
/s/ James W. Johnson Director - ---------------------------------------- James W. Johnson
/s/ J. Daniel Speight Vice Chairman, Chief - ---------------------------------------- Financial Officer, Secretary J. Daniel Speight and Director (principal financial officer)
/s/ J. Thomas Wiley, Jr. Vice Chairman, Chief Banking - ---------------------------------------- Officer J. Thomas Wiley, Jr. and Director
/s/Dennis J. Zember Treasurer - ---------------------------------------- (principal accounting officer) Dennis J. Zember
EXHIBIT INDEX - --------------
The following exhibits are filed as part of or incorporated by reference in this report. Where such filing is made by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parentheses.
EXHIBIT NO. DESCRIPTION - ----------- -----------
3.1 Articles of Incorporation of the Company, as amended through October 15, 1993 (incorporated by reference from Exhibit 3.1(i) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993)
3.2 Bylaws of the Company, as amended through March 30, 1998 (incorporated by reference from Exhibit 3.1(ii) to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
3.3 Amendment to Bylaws of the Company as adopted by resolution of Board of Directors on October 19, 1998 (incorporated by reference from Exhibit 3.3 to the Annual Report on Form 10-K for the fiscal year ended December 31, 1998)
3.4 Amendment to Bylaws of the Company as adopted by resolution of the Board of Directors on December 20, 2000 (incorporated by reference from Exhibit 3.4 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
3.5 Amendment to Bylaws of the Company as adopted by resolution of the Board of Directors on February 19, 2001 (incorporated by reference from Exhibit 3.5 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
4.1 Instruments Defining the Rights of Security Holders (See Articles of Incorporation at Exhibit 3.1 hereto and Bylaws at Exhibits 3.2, 3.3, 3.4 and 3.5 hereto)
10.1* Amended and Restated Employment Agreement between J. Daniel Speight, Jr. and the Company dated as of February 21, 2002 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.2* Amended and Restated Employment Agreement between John S. Holle and the Company dated as of January 1, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000), as cancelled pursuant to the Cancellation Agreement between John S. Holle and the Company dated as of February 20, 2002, as amended as of March 26, 2002 (each incorporated by reference to exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001)
10.3* Amended and Restated Employment Agreement between Charles O. Hinely and the Company dated as of February 21, 2002 (incorporated by reference from Exhibit 10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001), as cancelled pursuant to the Cancellation Agreement between Charles O. Hinely and the Company dated as of July 31,
10.4* Employment Agreement between Stephen W. Doughty and the Company dated January 13, 2003
10.5* Employment Agreement between J. Thomas Wiley, Jr. and the Company dated January 13, 2003
10.6* Split Dollar Insurance Agreement between J. Daniel Speight, Jr. and Citizens Bank dated November 2, 1992 (incorporated by reference from Exhibit 10.7 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.7* Director Indexed Retirement Program for Citizens Bank dated January 13, 1995 (incorporated by reference from Exhibit 10.8 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.8* Form of Executive Agreement (pursuant to Director Indexed Retirement Program for Citizens Bank) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.9 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.9* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Director Indexed Retirement Program for Citizens Bank) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.10 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.10* Director Indexed Fee Continuation Program for First Federal Savings Bank of LaGrange effective February 3, 1995 (incorporated by reference from Exhibit 10.12 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.11* Form of Director Agreement (pursuant to Director Indexed Fee Construction Program for First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.13 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.12* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Director Indexed Fee Continuation Program of First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.14 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.13* Form of Indexed Executive Salary Continuation Plan Agreement by and between First Federal Savings Bank of LaGrange and individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.15 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.14* Form of Flexible Premium Life Insurance Endorsement Method Split Dollar Plan Agreement (pursuant to Executive Salary Continuation Plan for First Federal Savings Bank of LaGrange) for individuals listed on exhibit cover page (incorporated by reference from Exhibit 10.16 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.15* Indexed Executive Salary Continuation Plan Agreement by and between First Federal Savings Bank of LaGrange and William F. Holle, Jr. dated February 3, 1995 (incorporated by reference from Exhibit 10.17 to Amendment No. 1 to the Company's Annual Report on Form 10-K/A for the fiscal year ended December 31, 1997)
10.16* Form of Deferred Compensation Plan by and between The Citizens Bank and individuals listed on exhibit cover page (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.17* Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated through March 30, 1998) (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.18* Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended through September 18, 1997) (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.19* First Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of March 15, 1999 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.20* Second Amendment to the Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of January 16, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.21* First Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of December 21, 1998 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.22* Second Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of October 25, 1999 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.23* Third Amendment to the Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated January 16, 2001 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
10.24* Third Amendment to Flag Financial Corporation 1994 Employees Stock Incentive Plan (as amended and restated as of March 30, 1998), dated as of February 19, 2002 (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2001).
10.25* Fourth Amendment to Flag Financial Corporation 1994 Directors Stock Incentive Plan (as amended and restated as of September 18, 1997), dated as of February 19, 2002 (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 2002)
22 Subsidiaries (incorporated by reference from exhibit of the same number to the Annual Report on Form 10-K for the fiscal year ended December 31, 2000)
23 Consent of Porter Keadle Moore, LLP
99.1 Certifications by Chief Executive Officer and Chief Financial Officer ____________________
* The indicated exhibit is a compensatory plan required to be filed as an exhibit to this Form 10-K.