ITEM 1. DESCRIPTION OF BUSINESS
The Company
General
Citizens Bancshares Corporation (the “Company”) was incorporated as a Georgia business corporation in 1972 and became a bank holding company by acquiring all of the common stock of Citizens Trust Bank (the “Bank”). The Company was organized to facilitate the Bank’s ability to serve its customers’ requirements for financial services. The holding company structure provides flexibility for expansion of the Company’s banking business through the possible acquisition of other financial service institutions and the provision of additional banking-related services that the traditional commercial bank may not provide under present laws. For example, banking regulations require that the Bank maintain a minimum ratio of capital to assets. In the event that the Bank’s growth is such that this minimum ratio is not maintained, the Company may borrow funds, subject to capital adequacy guidelines of the Federal Reserve, and contribute them to the capital of the Bank and otherwise raise capital in a manner that is unavailable to the Bank under existing banking regulations.
Over the years, the Company has completed several acquisitions. On January 30, 1998, the Company merged with First Southern Bancshares, Inc., whose banking subsidiary, First Southern Bank simultaneously merged into the Bank. On March 10, 2000, the Company acquired certain assets and all of the deposits of Mutual Federal Savings Bank, a failing minority bank, from the Federal Deposit Insurance Corporation. On February 28, 2003, the Company acquired CFS Bancshares, Inc., a minority-owned savings and loan holding company located in Birmingham, Alabama, whose banking subsidiary, Citizens Federal Savings Bank, simultaneously merged into the Bank. This acquisition has resulted in a significant expansion of the Company’s market area.
The Company may make additional acquisitions in the future in the event that such acquisitions are deemed to be in the best interests of the Company and its shareholders. Such acquisitions, if any, will be subject to certain regulatory approvals and requirements. See “Business-Bank Holding Company Regulations.”
Minority Control
A majority of the outstanding shares of the Company’s Common Stock is held by minority individuals. The Company thus views itself as having a social obligation to help members of the minority community. Accordingly, a majority of the Bank’s customers are from the minority communities.
The Bank
General
The Bank, a state bank headquartered in Atlanta, Georgia, was organized in 1921 and is a member of the Federal Reserve System.
The Bank’s home office is located at 75 Piedmont Avenue, N.E., Atlanta, Georgia 30303. Including its main branch, the Bank operates ten branch offices located in Atlanta, East Point, Lithonia, Decatur, Stone Mountain and Columbus, Georgia, and Birmingham and Eutaw, Alabama. The Bank conducts a general commercial banking business that serves Fulton, DeKalb and Muscogee Counties, Georgia, as well as Jefferson and Greene Counties, Alabama, acts as an issuing agent for U.S. savings bonds, travelers checks and cashiers checks, and offers collection teller services. The Bank has no subsidiaries.
The Bank does not engage in any line of business in addition to normal commercial banking activities. The Bank does not engage in any operations in foreign countries nor is a material portion of the Bank’s revenues derived from customers in foreign countries.
The Bank’s Primary Service Area
The Bank’s primary service area consists of Fulton and DeKalb Counties, along with certain portions of Rockdale County; through its branch in Columbus, the Bank also serves Muscogee County, Georgia, and now through its branches in Birmingham and Eutaw, it serves Jefferson and Greene Counties, Alabama. The primary focus of the Bank is the small business and commercial/service firms in the area plus individuals and households who reside in or commute to the area. The majority of the Bank’s customers are drawn from the described area.
Competition
The Bank must compete for both deposit and loan customers with other financial institutions with greater resources than are available to the Bank. Currently, there are numerous branches of regional and local banks, as well as other types of entities offering financial services, located in the Bank’s market area.
Deposits
The Bank offers a wide range of commercial and consumer deposit accounts, including non-interest bearing checking accounts, money market checking accounts (consumer and commercial), negotiable order of withdrawal (“NOW”) accounts, individual retirement accounts, time certificates of deposit, sweep accounts, and regular savings accounts. The sources of deposits typically are residents and businesses and their employees within the Bank’s market area, obtained through personal solicitation by the Bank’s officers and directors, direct mail solicitation and advertisements published in the local media. The Bank pays competitive interest rates on time and savings deposits and has a service charge fee schedule competitive with other financial institutions in the Bank’s market area, covering such matters as maintenance fees on checking accounts, per item processing fees on checking accounts, returned check charges and the like.
Loan Portfolio
The Bank engages in a full complement of lending activities, including consumer/installment loans, mortgage loans, home equity lines of credit, construction loans and commercial loans, with particular emphasis on small business loans. The Bank believes that the origination of short-term fixed rate loans and loans tied to floating interest rates is the most desirable method of conducting its lending activities.
Consumer Loans
The Bank’s consumer loans consist primarily of installment loans to individuals for personal, family and household purposes, including loans for automobiles, home improvements and investments. This category of loans also includes loans secured by second mortgages on the residences of borrowers.
Commercial Lending
Commercial lending is directed principally toward businesses whose demands for funds fall within the Bank’s legal lending limits and which are existing deposit customers of the Bank. This category of loans includes loans made to individual, partnership, or corporate borrowers and obtained for a variety of business purposes.
Investments
As of December 31, 2006, investment securities comprised approximately 24% of the Bank’s assets, with loans (net of loan loss reserves) comprising approximately 65% of assets. The Bank invests primarily in obligations of the United States, obligations guaranteed as to principal and interest by the United States, government-sponsored enterprises securities and other taxable securities.
Asset/Liability Management
It is the objective of the Bank to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established cash, loan, investment, borrowing and capital policies. Certain officers of the Bank are charged with the responsibility for developing and monitoring policies and procedures that are designed to ensure acceptable composition of the asset/liability mix. It is the overall philosophy of management to support asset growth primarily through the growth of core deposits, which include deposits of all categories made by individuals, partnerships and corporations. Management of the Bank seeks to invest the largest portion of the Bank’s assets in consumer/installment, commercial and construction loans.
The Bank’s asset/liability mix is monitored on a daily basis and a report reflecting the interest-sensitive assets and interest-sensitive liabilities is prepared and presented to the Bank’s Board of Directors on a monthly basis. The objective of this policy is to control interest-sensitive assets and liabilities so as to minimize the impact of substantial movements in interest rates on the Bank’s earnings.
Correspondent Banking
Correspondent banking involves the provision of services by one bank to another bank that cannot provide that service for itself from an economic or practical standpoint. The Bank purchases correspondent services offered by larger banks, including check collections, security safekeeping, investment services, wire transfer services, coin and currency supplies, overline and liquidity loan participation, and sales of loans to or participation with correspondent banks.
Employees
As of December 31, 2006, the Bank had 133 full-time equivalent employees (the Company has no employees who are not also employees of the Bank). The Bank is not a party to any collective bargaining agreement and, in the opinion of management, the Bank enjoys excellent relations with its employees.
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 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 rebuttably 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 Section 12 of the Securities Exchange Act of 1934. The regulations provide a procedure for challenge of the rebuttable control presumption.
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, the Financial Services Modernization Act of 1999, or the Gramm-Leach-Bliley Act, revised and expanded the provisions of the Bank Holding Company Act by permitting a bank holding company to qualify and elect to become a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. The following activities are considered 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.
On December 18, 2006, the SEC and the Federal Reserve issued joint proposed rules, which would implement the “broker” exception for banks under Section 3(a)(4) of the Exchange Act of 1934 and would be adopted as part of the Gramm-Leach-Bliley Act. The proposed rules would implement the statutory exceptions that allow a bank, subject to certain conditions, to continue to conduct securities transactions for the Bank’s customers as part of its trust and fiduciary, custodial and deposit “sweep” functions, and to refer customers to a securities broker-dealer pursuant to a networking arrangement with the broker-dealer.
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, we have 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
Since the Bank is a commercial bank chartered under the laws of the State of Georgia and is a Federal Reserve member bank, it is primarily subject to the supervision, examination and reporting requirements of the Georgia Department of Banking and Finance and the Federal Reserve Bank of Atlanta. The Georgia Department of Banking and Finance and the Federal Reserve Bank of Atlanta 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 the Company 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 the Company 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. The federal banking agencies have also specified by regulation the relevant capital levels for each of the other categories. As of December 31, 2006, the Bank qualified for the well-capitalized category.
Federal banking regulators are required to take some 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.
An institution in any of the undercapitalized categories 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 becomes 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’s 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 assesses higher rates on those institutions that pose greater risks to the Deposit Insurance Fund (the “DIF”). The FDIC places each institution in one of four risk categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment). Within the lower risk category, Risk Category I, rates will vary based on each institution’s CAMELS component ratings, certain financial ratios, and long-term debt issuer ratings.
Capital group assignments are made quarterly and an institution is assigned 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 banking 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 5 to 43 cents per $100 of deposits, depending on the institution’s capital group and supervisory subgroup. Institutions that are well capitalized will be charged a rate between 5 and 7 cents per $100 of deposits.
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 1.22 cents per $100 of deposits for the first quarter of 2007.
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. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.
Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Bank’s financial statements and regulatory reports. Because of its significance, the Bank has developed a system by which it develops, maintains and documents a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the bank’s stated policies and procedures, management’s best judgment and relevant supervisory guidance. Consistent with supervisory guidance, the Bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date. See “Management’s Discussion and Analysis-Critical Accounting Policies.”
Commercial Real Estate Lending. The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:
· total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or
· total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.
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 of more than 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;
· The 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;
· The Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
· The Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;
· The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
· The Servicemembers Civil Relief Act, which amended the Soldiers’ and Sailors’ Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service; and
· The rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
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;
· The Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which governs 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;
· Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts; and
· The rules and regulations of the various federal banking regulators charged with the responsibility of implementing these federal laws.
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 shareholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying 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 hybrid capital 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, 2006, our ratio of total capital to risk-weighted assets was 16% and our ratio of Tier 1 Capital to risk-weighted assets was 15%.
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, 2006, the Company’s leverage ratio was 11%. 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.
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 source of the Company’s cash flow, including cash flow to pay dividends to its shareholders, is dividends that the Bank pays to the Company, its sole shareholder. 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.
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 it cease and desist from its 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 is already 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.
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:
· loans or extensions of credit to affiliates;
· investment in affiliates;
· the purchase of assets 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
· any 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 an unaffiliated 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
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act imposed new requirements and limitations on specified financial transactions and account relationships, intended to guard against money laundering and terrorism. The Bank has established a customer identification program pursuant to the “Know your customer” rules contained in Section 326 of the USA PATRIOT Act. The Bank has implemented procedures and policies to comply with those rules prior to the effective date of each of those rules.
Federal Deposit Insurance Reform
On February 8, 2006, President Bush signed the Federal Deposit Insurance Reform Act of 2005 (FDIRA). The FDIC has now adopted rules implementing the various provisions of FDIRA.
Among other things, FDIRA changed the Federal deposit insurance system by:
· raising the coverage level for qualifying retirement accounts to $250,000, subject to future indexing;
· authorizing the FDIC and the National Credit Union Administration to index deposit insurance coverage for inflation, for standard accounts and qualifying retirement accounts, every five years beginning April 1, 2007;
· prohibiting undercapitalized financial institutions from accepting employee benefit plan deposits;
· merging the Bank Insurance Fund and Savings Association Insurance Fund into a new Deposit Insurance Fund (the DIF); and
· providing credits to financial institutions that capitalized the FDIC prior to 1996 to offset future assessment premiums.
FDIRA also authorizes the FDIC to revise the current risk-based assessment system, subject to notice and comment and caps the amount of the DIF at 1.50% of domestic deposits. The FDIC must issue cash dividends, awarded on a historical basis, for the amount of the DIF over the 1.50% ratio. Additionally, if the DIF exceeds 1.35% of domestic deposits at year-end, the FDIC must issue cash dividends, awarded on a historical basis, for half of the amount of the excess.
Financial Services Regulatory Relief Act
President Bush signed the Financial Services Regulatory Relief Act of 2006 (“Regulatory Relief Act”) into law on October 13, 2006. The Regulatory Relief Act repeals certain reporting requirements regarding loans to bank executive officers and principal shareholders. These changes have eliminated the statutory requirements for (1) the report to the Board of Directors when an executive officer becomes indebted to another institution in an aggregate amount that is greater than the officer would receive from his or her own institution; (2) the report filed by the institution that listed all credits made to executive officers since the previous report of condition; and (3) the report to the Board of Directors that is required when an executive officer or a principal shareholder become indebted to a correspondent bank.
The Regulatory Relief Act increased the size of a bank eligible for 18-month (rather than annual) examinations from $250 million to $500 million. The Regulatory Relief Act amends the privacy rules of Gramm-Leach-Bliley to clarify that CPA’s are not required to notify their customers of privacy and disclosure policies as long as they are subject to state law restraints on disclosure of non-public personal information without customer approval. Finally, the Regulatory Relief Act requires that the federal banking regulators develop model privacy notice forms, and banks adopting the model forms will be afforded a regulatory safe harbor under the disclosure requirements of Gramm-Leach-Bliley.
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 financial institutions operating or 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.
SELECTED STATISTICAL INFORMATION
The following statistical information is provided for the Company for the years ended December 31, 2006, 2005 and 2004. The data is presented using daily average balances. The data should be read in conjunction with the financial statements appearing elsewhere in this Annual Report on Form 10-K. Some of the financial information provided has been rounded in order to simplify its presentation. However, the ratios and percentages provided below are calculated using the detailed financial information contained in the Financial Statements, the Notes thereto and the other financial data included elsewhere in this Annual Report (amounts in thousands).
(a) Average loans are shown net of unearned income, discounts and the allowance for loan losses. Nonperforming loans are also included.
(b) Includes dividend income.
(c) Reflects taxable equivalent adjustments using a tax rate of 34% to adjust interest on tax-exempt investment securities to a fully taxable basis, including the impact of the disallowed interest expense related to carrying such tax-exempt securities.
(d) Includes both voting and non-voting common stock.
Average Balance Sheets, Interest Rate, and Interest Differential (Continued)
The following table sets forth, for the year ended December 31, 2006, a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates (amounts in thousands):
(a) The change in interest due to both rate and volume has been allocated proportionately to the volume and rate components.
(b) Included in interest earned on loans are fees of approximately $1,008,000 in 2006 and $1,189,000 in 2005. Includes interest income recognized on nonaccrual loans during 2006 and 2005.
(c) Includes dividend income.
(d) Reflects taxable equivalent adjustments using a tax rate of 34% to adjust interest on tax-exempt investment securities to a fully taxable basis, including the impact of the disallowed interest expense related to carrying such tax-exempt securities.
Average Balance Sheets, Interest Rate, and Interest Differential (Continued)
The following table sets forth, for the year ended December 31, 2005, a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates (amounts in thousands):
(a) The change in interest due to both rate and volume has been allocated proportionately to the volume and rate components.
(b) Included in interest earned on loans are fees of approximately $1,189,000 in 2005 and $1,068,000 in 2004. Includes interest income recognized on nonaccrual loans during 2005 and 2004.
(c) Includes dividend income.
(d) Reflects taxable equivalent adjustments using a tax rate of 34% to adjust interest on tax-exempt investment securities to a fully taxable basis, including the impact of the disallowed interest expense related to carrying such tax-exempt securities.
Investment Securities
The carrying values of investment securities held to maturity and investment securities available for sale at the indicated dates are presented below:
The following table shows the contractual maturities of all investment securities, presented at carrying value, at December 31, 2006 and the weighted average yields (on a fully taxable basis assuming a 34 percent tax rate) of such securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties (amounts in thousands, except yields):
(a) Mortgage-backed securities have been categorized at their average life according to their projected speed of repayment. Principal repayments will occur at varying dates throughout the terms of the mortgages.
The Company did not have any investments with a single issuer which exceeded 10% of the Company’s stockholders’ equity at December 31, 2006, except for government-sponsored enterprises and mortgage-backed securities as shown in the table above.
Loans
The amounts of loans outstanding at the indicated dates are shown in the following table according to the type of loan:
Certain loans were reclassified in 2003 and 2002 to conform to regulatory reporting requirements.
There were no securitizations of loans during 2006, 2005, 2004 or 2003. In 2002, the Company securitized a pool of loans with Fannie Mae. The net book value of the loans securitized was $4.7 million and was reclassified to investment securities available for sale. During 2003 these investments were sold. In 2004, the Company pooled and sold approximately 48 nonperforming mortgage loans, including servicing rights, with an unpaid book balance of $2.3 million.
The Company does not have any concentrations of loans exceeding 10% of total loans of which management is aware and which are not otherwise disclosed as a category of loans in the table above or in other sections of this Annual Report on Form 10-K. A substantial portion of the Company’s loan portfolio is secured by real estate in metropolitan Atlanta.
The Company’s loans to area churches were approximately $38 million at December 31, 2006 and 2005, respectively, which are generally secured by real estate. The Company also has approximately $13 million and $21 million in loans to area convenience stores at December 31, 2006 and 2005, respectively. The balance of churches and convenience stores loans represents the accounting loss the Company could incur if any party to these loans failed completely to perform according to the terms of the contract and the collateral proved to be of no value.
The following table sets forth certain information at December 31, 2006, regarding the contractual maturities and interest rate sensitivity of certain categories of the Company’s loans (amounts in thousands):
Actual repayments of loans may differ from the contractual maturities reflected above because borrowers may have the right to prepay obligations with or without prepayment penalties. Additionally, the refinancing of such loans or the potential delinquency of such loans could also cause differences between the contractual maturities reflected above and the actual repayments of such loans.
Nonperforming Assets
Nonperforming assets include nonperforming loans and real estate acquired through foreclosure. Nonperforming loans consist of loans which are past due with respect to principal or interest more than 90 days (“past-due loans”) or have been placed on nonaccrual of interest status (“nonaccrual loans”). Generally, past-due loans and nonaccrual loans which are delinquent more than 90 days will be charged off against the Company’s allowance for possible loan losses unless management determines that the loan has sufficient collateral to allow for the recovery of unpaid principal and interest or reasonable prospects for the resumption of principal and interest payments.
Accrual of interest on loans is discontinued when reasonable doubt exists as to the full, timely collection of interest or principal or when loans become contractually in default for 90 days or more as to either interest or principal unless the loan is well secured and in the process of collection. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is charged-off against interest income on loans unless management believes that the accrued interest is recoverable through the liquidation of collateral.
Nonperforming loans and real estate acquired through foreclosure decreased by $425,000 and $440,000, respectively at December 31, 2006 from the previous year. Nonperforming loans declined to $3,718,000 from $4,143,000 and real estate acquired through foreclosure declined to $130,000 from $570,000 at December 31, 2005. Nonperforming loans represent 1.74% of loans net of unearned income, discounts and real estate acquired through foreclosure at December 31, 2006, as compared to 2.15% at December 31, 2005. The improvement in nonperforming assets in 2006 resulted from improved oversight of this non-earning asset and tightened credit standards
At December 31, 2006 and 2005, the recorded investment in loans rated substandard, doubtful and loss was $11,804,000 and $9,875,000, respectively. The related allowance for loan losses for these loans was $2,006,000 and $1,968,000 at December 31, 2006 and 2005, respectively. The average investment in loans rated substandard, doubtful and loss during 2006 and 2005 was approximately $9,767,000 and $10,213,000,
respectively. Interest income recognized on these loans was approximately $1,080,000, $939,000, and $1,038,000 in 2006, 2005, and 2004, respectively. Interest income recognized on a cash basis was approximately $205,000, $119,000, and $73,000 in 2006, 2005, and 2004, respectively.
With the exception of the loans included within nonperforming assets in the table below, management is not aware of any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed which: (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (2) represent material credits about which management is aware of any information which causes management to have serious doubts as to the abilities of such borrower to comply with the loan repayment terms.
The table below presents a summary of the Company’s nonperforming assets at December 31, as follows (amounts in thousands, except financial ratios):
Interest income on nonaccrual loans, which would have been reported, is summarized as follows:
Allowance for Loan Losses
The following table summarizes loans at the end of each year and average loans during the year, changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category, and additions to the allowance which have been charged to expense:
The allowance for loan losses is primarily available to absorb losses inherent in the loan portfolio. Credit exposures deemed uncorrectable are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.
The Company provides for estimated losses on loans receivable when any significant and permanent decline in value occurs. These estimates for losses are based on individual assets and their cash flow forecasts, sales values, independent appraisals, the volatility of certain real estate markets, and concern for disposing of real estate in distressed markets. For loans that are pooled for purposes of determining necessary provisions, estimates are based on loan types, history of charge-offs, and other delinquency analyses. Therefore, the value used to determine the provision for losses is subject to the reasonableness of
these estimates. The adequacy of the allowance for loan losses is reviewed on a monthly basis by management and the Board of Directors. On a quarterly basis a comprehensive review of the adequacy of allowance for loan losses is performed. This assessment is made in the context of historical losses as well as existing economic conditions, performance trends within specific portfolio segments, and individual concentrations of credit.
Loans are charged against the allowance when, in the opinion of management, such loans are deemed to be uncollectible and subsequent recoveries are added to the allowance. For the year ended 2006, provisions for loan losses totaled $30,000 compared to $288,000 in 2005. The reduction in the provision for loan losses in 2006 resulted from improvement in the quality of the loan portfolio as well as improved oversight of the Company’s classified assets.
The allowance for loan losses at year ended December 31, 2006 was approximately $3,109,000, representing 1.41% of total loans, net of unearned income and discounts compared to approximately $3,327,000 at December 31, 2005, which represented 1.52% of total loans, net of unearned income and discounts.
Management believes 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, particularly in the metropolitan Atlanta area. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Allocation of Allowance for Loan Losses
The Company has allocated the allowance for loan losses according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the categories of loans set forth in the table below. This allocation is based on management’s evaluation of the loan portfolio under current economic conditions, past loan loss experience, adequacy and nature of collateral, and such other factors that, in the judgment of management, deserve recognition in estimating loan losses. Regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and the Company’s valuation of real estate acquired through foreclosure. Such agencies may require the Company to recognize additions to the allowance or adjustments to the valuations based on their judgments about information available to them at the time of their examination. Because the allocation is based on estimates and subjective judgment, it is not necessarily indicative of the specific amounts or loan categories in which charge-offs may occur. The amount of such components of the allowance for loan losses and the ratio of each loan category to total loans outstanding are presented below (amounts in thousands, except financial ratios):
Deposits
The average amount of and average rate paid on deposits by category for the last three years are presented below in thousands:
The maturities of time deposits of $100,000 or more are presented below in thousands as of December 31, 2006:
Short Term Borrowings
There were no short-term borrowings for which the average balance outstanding during the period was more than 30% of stockholders’ equity for each of the years ended December 31, 2006, 2005, and 2004.
Interest Rate Sensitivity Management
Interest rate sensitivity management involves managing the potential impact of interest rate movements on net interest income within acceptable levels of risk. The Company seeks to accomplish this by structuring the balance sheet so that repricing opportunities exist for both assets and liabilities in equivalent amounts and time intervals. Imbalances in these repricing opportunities at any point in time constitute a financial institution’s interest rate risk. The Company’s ability to reprice assets and liabilities in the same dollar amounts and at the same time minimizes interest rate risk.
One method of measuring the impact of interest rate sensitivity is the cumulative gap analysis. The difference between interest rate sensitive assets and interest rate sensitive liabilities at various time intervals is referred to as the gap. The Company is liability sensitive on a short-term basis as reflected in the following table. Generally, a net liability sensitive position indicates that there would be a negative impact on net interest income in an increasing rate environment. However, interest rate sensitivity gap does not necessarily indicate the impact of general interest rate movements on the net interest margin, since all interest rates and yields do not adjust at the same velocity and the repricing of various categories of assets and liabilities is subject to competitive pressures and the needs of the Company’s customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within such period and at different rates. For conservative purposes, the Company has included demand deposits such as NOW, money market and savings accounts in the three month category. However, the actual repricing of these accounts may lag beyond twelve months. The interest rate sensitivity gap is only a general indicator of potential effects of interest rate changes on net interest income.
The following table sets forth the distribution of the repricing of the Company’s interest rate sensitive assets and interest rate sensitive liabilities over a one year horizon as of December 31, 2006.
(a) Savings, NOW, and money market deposits totaling $100,951 are included in the maturing in 3 months classification.
ITEM 1A.
ITEM 1A. RISK FACTORS
As a community bank, we have different lending risks than larger banks. We provide services to our local communities. Our ability to diversify our economic risks is limited by our own local markets and economies. We lend primarily to small to medium-sized businesses, and, to a lesser extent, individuals which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses often with longer operating histories.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding our borrowers, the economies in which we and our borrowers operate, as well as the judgment of our regulators. Our loan loss reserves may not be sufficient to absorb future loan losses or prevent a material adverse effect on our business, financial condition, or results of operations.
We could suffer loan losses from a decline in credit quality. We could sustain losses if borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for credit losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.
Our profitability is vulnerable to interest rate fluctuations. Our profitability depends substantially upon our net interest income. Net interest income is the difference between the interest earned on assets, such as loans and investment securities, and the interest paid for liabilities, such as savings and time deposits and out-of-market certificates of deposit. Market interest rates for loans, investments and deposits are highly sensitive to many factors beyond our control. Recently, interest rate spreads have generally narrowed due to changing market conditions, policies of various government and regulatory authorities and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow even further. This narrowing of interest rate spreads could adversely affect our financial condition and results of operations. In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.
An economic downturn, especially one affecting our market areas, could adversely affect our financial condition, results of operations or cash flows. Our success depends upon the growth in population, income levels, deposits and housing starts in our primary market areas. If the communities in which we operate do not grow, or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Unpredictable economic conditions may have an adverse effect on the quality of our loan portfolio and our financial performance. Economic recession over a prolonged period or other economic problems in our market areas could have a material adverse impact on the quality of the loan portfolio and the demand for our products and services. Future adverse changes in the economies in our market areas may have a material adverse effect on our financial condition, results of operations or cash flows. Further, the banking industry in Georgia is affected by general economic conditions such as inflation, recession, unemployment and other factors beyond our control. As a community bank, we are less able to spread the risk of unfavorable local economic conditions than larger or more regional banks. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas even if they do occur.
Changes in monetary policies may have an adverse effect on our business, financial condition and results of operations. Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve Board. Actions by monetary and fiscal authorities, including the Federal Reserve Board, could have an adverse effect on our deposit levels, loan demand or business and earnings.
Competition from other financial institutions may adversely affect our profitability. The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other financial institutions, which operate in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established and much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our markets, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.
Although we compete by concentrating our marketing efforts in our primary market areas with local advertisements, personal contacts and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability. As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Our subsidiary bank, as a Federal Reserve member, is primarily regulated by the Federal Reserve Board and the Georgia Department of Banking and Finance. Our compliance with Federal Reserve Board and Department of Banking and Finance regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements of our regulators.
The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.
The Sarbanes-Oxley Act of 2002, the related rules and regulations promulgated by the SEC that currently apply to us and the related exchange rules and regulations, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. As a result, we may experience greater compliance costs.
If the value of real estate in our core market were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our business, financial condition and results of operations. With most of our loans concentrated in the Atlanta and Columbus, Georgia and the Birmingham and Eutaw, Alabama areas, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse.
In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2006, approximately 87% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value
during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.
If we fail to retain our key employees, our growth and profitability could be adversely affected. Our success is, and is expected to remain highly dependent on our executive management team, consisting of James E. Young, Cynthia N. Day, Samuel J. Cox and Roger Botwin. This is particularly true because, as a community bank, we depend on our management team’s ties to the community to generate business for us. The loss of any such person’s services may have an adverse effect upon our growth and profitability.
Lack of seasoning of our loan portfolio may increase the risk of credit defaults in the future. A portion of the loans in our loan portfolio and our lending relationships are of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer loan portfolio. Because a portion of our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.
Additional growth may require us to raise additional capital in the future, but that capital may not be available when it is needed, which could adversely affect our financial condition and results of operations. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate our capital resources following this offering will satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired.
Our ability to pay dividends is limited and we cannot assure payment of future dividends. As a result, capital appreciation, if any, of our common stock may be your sole opportunity for gains on your investment for the foreseeable future. We make no assurances that we will pay any dividends in the future. Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that our Board of Directors may deem relevant. The holders of our common stock are entitled to receive dividends when, and if declared by our Board of Directors out of funds legally available for that purpose. As part of our consideration to pay cash dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business. In addition, our ability to pay dividends is restricted by federal policies and regulations. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. Further, our principal source of funds to pay dividends is cash dividends that we receive from the bank.
Our business strategy includes the continuation of growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively. We intend to continue pursuing a growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies pursuing such a strategy. We cannot assure you we will be able to expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage
our growth effectively could have a material adverse effect on our business, financial condition, results of operations, or future prospects, and could adversely affect our ability to successfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our results of operations could be materially adversely affected.
Our ability to grow successfully will depend on a variety of factors including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. While we believe we have the management resources and internal systems in place to manage our future growth, there can be no assurance that growth opportunities will be available or growth will be managed successfully.
Our plans for future expansion depend, in some instances, on factors beyond our control, and an unsuccessful attempt to achieve growth could have a material adverse effect on our business, financial condition, results of operations and future prospects. We expect to engage in strategic new branch expansion in the future. We may also seek to acquire other financial institutions, or parts of those institutions, though we have no present plans in that regard. Expansion involves a number of risks, including:
· the time and costs of evaluating new markets, hiring experienced local management and opening new offices;
· the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
· we may not be able to finance an acquisition without diluting the interests of our existing shareholders;
· the diversion of our management’s attention to the negotiation of a transaction may detract from their business productivity;
· we may enter into new markets where we lack experience; and
· we may introduce new products and services with which we have no prior experience into our business.
Our recent results may not be indicative of our future results, and may not provide guidance to assess the risk of an investment in our common stock. We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In the future, we may not have the benefit of several recently favorable factors, such as a generally increasing interest rate environment, a strong residential mortgage market or the ability to find suitable expansion opportunities. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected.
Reputational Risk. Negative public opinion could damage our reputation and adversely impact our earnings.
Potential Litigation. Adverse decisions in litigation involving the banking industry or us specifically could have a negative impact on our earnings.
Holders of our junior subordinated debentures have rights that are senior to those of our common stockholders. We have supported our continued growth by issuing trust preferred securities from a special purpose trust and accompanying junior subordinated debentures. At December 31, 2006, we had outstanding trust preferred securities totaling $5,000,000. We unconditionally guaranteed the payment of principal and interest on the trust preferred securities. Also, the junior debentures we issued to the special purpose trust that relate to those trust preferred securities are senior to our common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our
common stock. In the event of our bankruptcy, dissolution or liquidation, holders of our junior subordinated debentures must be satisfied before any distributions can be made on our common stock.
Environmental liability associated with lending activities could result in losses. In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
There are no written comments from the Commission staff regarding our periodic reports or current reports under the Act which remain unresolved.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTIES
The Bank’s main office building is located at 75 Piedmont Avenue, N.E., Atlanta, , Georgia. In addition to its main branch, the Bank also operates nine other branch offices: the office located at 2727 Panola Road, Lithonia, Georgia, which is owned by the Bank; the office located at 965 M.L. King Jr. Drive, Atlanta, Georgia, which is owned by the bank; the office located at 2840 East Point Street, East Point, Georgia, which is owned by the bank; the office located at 2592 S. Hairston Road, Decatur, Georgia, which is owned by the bank; the office located at Rockbridge Plaza, 5771 Rockbridge Road, Stone Mountain, Georgia, which is owned by the Bank; the office located at 3705 Cascade Road, Atlanta, Georgia, which is owned by the bank; the office located at 6 Eleventh Street, Columbus, Georgia, is leased on a month-to-month basis as the Company is seeking larger accommodations in this market; the office located at 1700 Third Avenue North, Birmingham, Alabama, which is owned by the Bank; and the office located at 213 Main Street, Eutaw, Alabama, which is owned by the Bank. In the opinion of management, all of these properties are adequately insured.
Other than normal commercial lending activities of the Bank, the Company generally does not invest in real estate, interests in real estate, real estate mortgages, or securities of or interests in entities primarily engaged in real estate activities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party or of which any of its properties are subject; nor are there material proceedings known to the Company to be contemplated by any governmental authority; nor are there material proceedings known to the Company, pending or contemplated, in which any director, officer or affiliate or any principal security holder of the Company, or any associate of any of the foregoing, is a party or has an interest adverse to the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock, $1.00 par value (“Common Stock”), is traded on the Nasdaq Bulletin Board, but there is limited trading. The following table sets forth high and low bid information for the Common Stock for each of the quarters in which trading has occurred since January 1, 2005. The prices set forth below reflect only information that has come to management’s attention and do not include retail mark-ups, markdowns or commissions and may not represent actual transactions.
As of March 15, 2007, there were approximately 1,464 holders of record of Common Stock. The Company also has outstanding 90,000 shares of Non-Voting Common Stock, all of which is held by one shareholder.
The Company paid an annual cash dividend of $0.17 per share in 2006 and $0.15 per share in 2005. The Company’s dividend policy in the future will depend on the Bank’s earnings, capital requirements, financial condition, and other factors considered relevant by the Board of Directors of the Company. See “Description of Business-Bank Regulation.”
The Company issued 5,704 shares of unregistered common stock from treasury stock to the Company’s Employee Stock Purchase Plan during 2006 at a price ranging from $7.80 per share to $8.17 per share.
The Company repurchased 6,968 shares of its common stock during 2006 at a price ranging from $10.25 per share to $11.69 per share.
PERFORMANCE GRAPH
The following performance graph compares the yearly percentage change in the cumulative total shareholder return on the Company’s common stock to the cumulative total return on the OTC Bulletin Board since December 31, 2001.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is included herein in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 under Part I, Item 1, “Description of Business.”
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company
Citizens Bancshares Corporation and subsidiaries (the “Company”) is a holding company that provides a full range of commercial banking and mortgage brokerage services to individual and corporate customers through its wholly owned subsidiary, Citizens Trust Bank (the “Bank”). The Bank operates under a state charter and serves its customers through its home office and six full-service branches in metropolitan Atlanta, one full-service branch in Columbus, Georgia, one full-service branch in Birmingham, Alabama, and one full-service branch in Eutaw, Alabama. The Company also owns and operates a wholly owned subsidiary grantor trust, Citizens (GA) Statutory Trust I (the “Trust”) through the issuance of pooled trust preferred securities. All significant intercompany accounts and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the Trust has not been consolidated in the financial statements.
The following discussions of the Company’s financial condition and results of operations should be read in conjunction with the Company’s consolidated financial statements and related notes, appearing in other sections of this Annual Report.
Forward Looking Statements
In addition to historical information, this Annual Report on Form 10-K may contain forward-looking statements. For this purpose, any statements contained herein, including documents incorporated by reference, that are not statements of historical fact may be deemed to be forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks and uncertainties. Without limiting the foregoing, the words “intend,” “seek,” “estimate,” “believe,” “anticipates,” “plan,” expects,” and similar expressions are intended to identify forward-looking statements.
Forward-looking statements are based on current management expectations and, by their nature, are subject to risk and uncertainties because of the possibility of changes in underlying factors and assumptions. Actual conditions, events or results could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons, including: sharp and/or rapid changes in interest rates; significant changes in the economic scenario from the current anticipated scenario which could materially change anticipated credit quality trends and the ability to generate loans and gather deposits; significant delay in or inability to execute strategic initiatives designed to grow revenues and/or control expenses; unanticipated issues during the integration of acquisitions; and significant changes in accounting, tax or regulatory practices or requirements. The Company undertakes no obligation to, nor does it intend to, update forward-looking statements to reflect circumstances or events that occur after the date hereof or to reflect the occurrence of unanticipated events. All written or oral forward-looking statements attributable to the Company are expressly qualified in the entirety by these cautionary statements.
Critical Accounting Policies
The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), which often require the judgment of management in the selection and application of certain accounting principles and methods. Management believes the quality and reasonableness of its most critical policies enable the fair presentation of its financial position and results of operations.
In response to the Securities and Exchange Commission’s (“SEC”) Release No. 33-8040, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, the Company has identified the
following as the most critical accounting policies upon which its financial status depends. The critical policies were determined by considering accounting policies that involve the most complex or subjective decisions or assessments by the Company’s management. The Company’s most critical accounting policies are:
Investment Securities-The Company classifies investments in one of three categories based on management’s intent upon purchase: held to maturity securities which are reported at amortized cost, trading securities which are reported at fair value with unrealized holding gains and losses included in earnings, and available for sale securities which are recorded at fair value with unrealized holding gains and losses included as a component of accumulated other comprehensive income. The Company had no investment securities classified as trading securities during 2006, 2005 or 2004.
Premiums and discounts on available for sale and held to maturity securities are amortized or accreted using a method which approximates a level yield. Amortization and accretion of premiums and discounts is presented within investment securities interest income on the Consolidated Statements of Income. Gains and losses on sales of investment securities are recognized upon disposition, based on the adjusted cost of the specific security. A decline in market value of any security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.
Loans-Loans are reported at principal amounts outstanding less unearned income, discounts and the allowance for loan losses. Interest income on loans is recognized on a level yield basis. Loan fees and certain direct origination costs are deferred and amortized over the estimated terms of the loans using the level-yield method. Discounts on loans purchased are accreted using the level yield method over the estimated remaining life of the loan purchased. The accretion and amortization of loan fees, origination costs, and premiums and discounts are presented as a component of loan interest income on the Consolidated Statements of Income.
Allowance for Loan Losses-The Company provides for estimated losses on loans receivable when any significant and permanent decline in value occurs. These estimates for losses are based on individual assets and their related cash flow forecasts, sales values, independent appraisals, the volatility of certain real estate markets, and concern for disposing of real estate in distressed markets. For loans that are pooled for purposes of determining necessary provisions, estimates are based on loan types, history of charge-offs, and other delinquency analyses. Therefore, the value used to determine the provision for losses is subject to the reasonableness of these estimates. The adequacy of the allowance for loan losses is reviewed on a monthly basis by management and the Board of Directors. On a quarterly basis a comprehensive review of the adequacy of allowance for loan losses is performed. This assessment is made in the context of historical losses as well as existing economic conditions, performance trends within specific portfolio segments, and individual concentrations of credit. Loans are charged against the allowance when, in the opinion of management, such loans are deemed to be uncollectible and subsequent recoveries are added to the allowance.
A description of the Company’s other accounting policies are summarized in Note 1, Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements.
Selected Financial Data
The following selected financial data for Citizens Bancshares Corporation and subsidiaries should be read in conjunction with the Consolidated Financial Statements and related Notes appearing in another section of this Annual Report.
In 2006, the Company reported net income of $3,003,000, a 28 percent increase over net income of $2,343,000 in 2005, which represented a 2 percent increase over 2004. Basic and diluted earnings per share were $1.44 and $1.12 for 2006 and 2005, respectively. Pretax income for 2006 increased by $1,066,000 or 40 percent compared to 2005, while income tax expense increased by $406,000 or 116 percent over the same periods. The year over year increase in income tax expense is primarily due to the reduction of certain valuation allowance for state income tax loss carryforwards taken in 2005.
Average interest earning assets increased by $4,092,000 in 2006. This increase is primarily due to an increase in average loans, net outstanding for the year, which grew by $6,321,000 in 2006, partially offset by a decrease of $2,487,000 in average interest bearing deposits with other banks. The average earning asset mix in 2006 remained consistent with the previous year, with loans, net at 73 percent and 72 percent in 2006 and 2005, respectively, and total investment securities at 27 percent in both 2006 and 2005. The 3 percent increase in average loans, net compared to a 63 percent decrease in interest-bearing deposits aided the Company’s yield on earning assets. The annual yield on loans, net in 2006 was 8.40 percent compared to an annual yield of 4.61 percent on interest-bearing deposits. Management on a continuous basis monitors the mix of earning assets in order to place the Company in a position to react to interest rate movements and to maximize the return on earning assets.
The ratio of average stockholders’ equity to average assets is one measure used to determine capital strength. The Company has a strong capital position as its ratio of average stockholders’ equity to average
assets for 2006, 2005 and 2004 was 8.6 percent, 8.1 percent and 7.3 percent, respectively. Another key capital ratio, the Company’s net income to average stockholders’ equity (return on equity), was 10.7 percent, 8.9 percent and 9.3 percent in 2006, 2005 and 2004, respectively.
Financial Condition
At December 31, 2006, the Company’s total assets increased by $7 million or 2 percent to $335,185,000.
Interest bearing deposits with banks increased by $4,191,000 and total investment securities increased by $3,346,000 compared to the same period in 2005. These increases were partially offset by a $3 million decrease in cash and due from banks, a non-earning asset, due to a strategy implemented to reduce this asset category and shift these funds into interest earning assets.
Premises and equipment registered a small increase of $225,000 or 3 percent during 2006 as compared to December 31, 2005. This increase is attributed to a new VoIP (voice over internet protocol) telephone system and Call Center installed to improve communications between our banking customers and our financial centers.
Cash value of life insurance, a comprehensive compensation program for directors and certain senior managers of the Company, increased $259,000 or 3 percent at December 31, 2006. The increase is due to additional premiums paid and earnings on such premiums throughout the year.
Foreclosed real estate, net, decreased $440,000 or 77 percent as the Company liquidated properties throughout the year and reinvested the funds into interest earning assets. The Company realized a net gain of $2,000 from these transactions during 2006.
Investment Portfolio
The composition of the Company’s investment securities portfolio reflects the Company’s investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of the Company’s investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling the Company’s interest rate sensitivity position, while at the same time producing adequate levels of interest income.
At December 31, 2006 and 2005, investment securities comprised approximately 24 percent of the Company’s assets. The investment portfolio had a fair market value of $78,505,000 and an amortized cost of $79,337,000, resulting in a net unrealized loss of $832,000 at December 31, 2006. For the same period in 2005, the investment portfolio had a fair market value of $75,135,000 and an amortized cost of $76,370,000, resulting in a net unrealized loss of $1,235,000.
Investments classified as held-to-maturity at December 31, 2006 had an amortized cost of $8,175,000 ($8,157,000 estimated fair value), compared to an amortized cost of $9,411,000 ($9,369,000 estimated fair value) at December 31, 2005. Total investments classified as available-for-sale had a fair value of $70,348,000 ($71,162,000 amortized cost) at December 31, 2006, compared to a fair value of $65,767,000 ($66,960,000 amortized cost) at December 31, 2005.
The following table shows the contractual maturities of all investment securities at December 31, 2006 and the weighted average yields (on a fully taxable basis assuming a 34 percent tax rate) of such securities. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties (amounts in thousands, except yields):
(a) Mortgage-backed securities have been categorized at their average life according to their projected speed of repayment. Principal repayments will occur at varying dates throughout the terms of the mortgages.
Provision and Allowance for Loan Losses
The allowance for loan losses is based on management’s evaluation of the loan portfolio under current economic conditions, historical loan loss experience, adequacy of collateral, and such other factors, which, in management’s judgment, deserve recognition in estimating loan losses. The Company’s process for determining an appropriate allowance for loan losses includes management’s judgment and use of estimates.
Reviews of nonperforming loans, designed to identify potential charges to the reserve for possible loan losses, as well as to determine the adequacy of the reserve, are made on a continuous basis during the year. These reviews are conducted by the responsible lending officers, a separate independent review process, and the internal audit division. They consider such factors as trends in portfolio volume, quality, maturity and composition; industry concentrations; lending policies; new products; adequacy of collateral; historical loss experience; the status and amount of non-performing and past-due loans; specific known risks; and current, as well as anticipated specific and general economic factors that may affect certain borrowers. The conclusions are reviewed and approved by senior management. When a loan, or a portion thereof, is considered by management to be uncollectible, it is charged against the reserve. Any recoveries on loans previously charged off are added to the reserve.
The provision for loan losses is the periodic cost of increasing the allowance or reserve for the estimated losses on loans in the portfolio. A charge against operating earnings is necessary to maintain the allowance for loan losses at an adequate level as determined by management. The provision is determined based on growth of the loan portfolio, the amount of net loans charged-off, and management’s estimation of potential future loan losses based on an evaluation of loan portfolio risks, adequacy of underlying collateral, and economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. In 2006, the provision for loan losses charged against operating earnings were $30,000 compared to $288,000 in 2005, and is reflective of the improvements in the quality of the Company’s loan portfolio.
The Company’s allowance for loan losses was approximately $3,109,000 or 1.41 percent of loans receivable, net of unearned income and discounts at December 31, 2006, and $3,327,000 or 1.52 percent of loans receivable, net of unearned income and discounts at December 31, 2005. Management believes that the allowance for loan losses at December 31, 2006 is adequate to provide for potential loan losses given past experience and the underlying strength of the loan portfolio.
Deposits
Deposits remain the Company’s primary source for funding loan growth. Total deposits at December 31, 2006 increased by $14,351,000 or 6 percent to $269,020,000 compared to the previous year balance of $254,669,000. At December 31, 2006, noninterest-bearing deposits remained consistent with same period in 2005, increasing by $176,000 to $60,263,000. Interest-bearing deposits increased by $14,175,000 or 7 percent. The Company has Corporate and Governmental customers that have significant interest-bearing deposits with the Company; and their deposit and withdrawal activities can impact the Company’s deposit balances significantly.
The Company’s average interest-bearing deposits increased by only $437,000 during 2006 to $205,924,000 at December 31, 2006; however, interest expense on deposits increased by $1,734,000 or 44 percent due to repricing of funds in a higher rate environment and competition for deposits. For additional information about deposit maturities and composition, see Note 5, Deposits, in the Notes to Consolidated Financial Statements.
Other Borrowed Funds
While the Company continues to emphasize funding earning asset growth through deposits, it relies on other borrowings as a supplemental funding source and to manage its interest rate sensitivity. During 2006, the Company’s average borrowed funds decreased by $2,722,000 to $26,984,000 when compared to 2005. The average interest rate on other borrowings was 6 percent in 2006 and 5 percent in 2005. Other borrowings primarily consist of Federal Home Loan Bank (the “FHLB”) advances, notes payable and junior subordinated debentures. The Bank had an average outstanding advance from the FHLB of $21,454,000 in 2006 and $23,923,000 in 2005. These advances are collateralized by FHLB stock, a blanket lien on the Bank’s 1-4 family mortgages, commercial real estate loans and home equity loans.
In 2002, the Company issued $5,000,000 of pooled trust preferred securities to increase its capital position to purchase CFS Bancshares, Inc., a bank holding company which wholly owned Citizens Federal Savings Bank of Birmingham, Alabama. The Company completed the purchase of CFS Bancshares, Inc. on February 28, 2003. The outstanding pooled trust preferred securities at December 31, 2006 and 2005 was $5,000,000. These securities are reported in the Company’s consolidated balance sheet as Junior Subordinated Debentures, which includes a wholly owned subsidiary grantor trust amount of $155,000 in accordance with FASB interpretation No. 46 (FIN 46R) “Consolidation of Variable Interest Entities”-an interpretation of ARB 51 (revised December 2003).” For additional information regarding the Company’s other borrowings, see Note 6, Other Borrowings, in the Notes to Consolidated Financial Statements.
Disclosure about Contractual Obligations and Commitments
The following tables identify the Company’s aggregated information about contractual obligations and loan commitments at December 31, 2006.
Liquidity Management
Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. Additionally, the Company requires cash for various operating needs including: dividends to shareholders; business combinations; capital injections to its subsidiaries; the servicing of debt; and the payment of general corporate expenses. The Company has access to various capital markets. However, the primary source of liquidity for the Company is dividends from its bank subsidiary. The Georgia Department of Banking and Finance regulates the dividend payments and must approve dividend payments that exceed 50 percent of the Bank’s prior year net income. The payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The amount of dividends available from the Bank without prior approval from the regulators for payment in 2007 is approximately $1,731,000. The Company does not anticipate any liquidity requirements in the near future that it will not be able to meet.
Asset and liability management functions not only serve to assure adequate liquidity in order to meet the needs of the Company’s customers, but also to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that the Company can earn a return that meets the investment requirements of its shareholders. Daily monitoring of the sources and uses of funds is necessary to maintain an acceptable cash position that meets both requirements.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities and, to a lesser extent, sales of investment securities available for sale and trading account securities. Other short-term investments such as federal funds sold, securities purchased under agreements to resell and maturing interest bearing deposits with other banks, are additional sources of liquidity funding.
The liability portion of the balance sheet provides liquidity through various customers’ interest bearing and noninterest bearing deposit accounts. Federal funds purchased, securities sold under
agreements to repurchase and other short-term borrowings are additional sources of liquidity and, basically, represent the Company’s incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet short-term liquidity needs.
Capital Resources
Stockholders’ equity increased by $2,935,000 or 11 percent during 2006. This increase is largely due to the growth in retained earnings of $2,647,000 as a result of net earnings in 2006 of $3,003,000 and a decrease in accumulated other comprehensive losses of $249,000.
Dividends of $356,000 were paid on the Company’s common stock in 2006, representing a 14 percent increase over the amount paid in 2005. The annual dividend payout rate was $0.17 per common share in 2006 compared to $0.15 per common share paid in 2005. The dividend payout ratio was 12 percent and 13 percent for 2006 and 2005 respectively. The Company intends to continue a dividend payout ratio that is competitive in the banking industry while maintaining an adequate level of retained earnings to support continued growth.
A strong capital position, which is vital to the continued profitability of the Company, also promotes depositor and investor confidence and provides a solid foundation for the future growth of the organization. The Company has satisfied its capital requirements principally through the retention of earnings. In 2002, the Company raised $5 million through the single issuance of a trust preferred security to increase its capital position to purchase CFS Bancshares, Inc., an Alabama bank holding company, on February 28, 2003. The trust preferred security qualifies as Tier 1 capital under Federal Reserve Board guidelines. The ratio of average shareholders’ equity as a percentage of total average assets is one measure used to determine capital strength. The Company has a strong capital position as the ratio of average stockholders’ equity to average assets for 2006 was 8.60 percent compared with 8.05 percent in 2005.
In addition to the capital ratios mentioned above, banking industry regulators have defined minimum regulatory capital ratios that the Company and the Bank are required to maintain. These risk-based capital guidelines take into consideration risk factors, as defined by the regulators, associated with various categories of assets, both on and off of the balance sheet. The minimum guideline for the ratio of total capital to risk-weighted assets is 8 percent. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common shareholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying 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 percent of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock and hybrid capital and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100 percent of Tier 1 Capital. Also, 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 percent 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, including the Company, generally are required to maintain a leverage ratio of at least 4 percent.
At December 31, 2006 our ratio of total capital to risk-weighted assets was 16 percent, our ratio of Tier 1 Capital to risk-weighted assets was 15 percent and our leverage ratio was 11 percent.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is the principal component of a financial institution’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.
Net interest income, on a fully tax-equivalent basis, accounted for 75 percent of net interest income and noninterest income before provision for loan losses in 2006, 74 percent in 2005 and 72 percent in 2004. The level of such income is influenced primarily by changes in volume and mix of earning assets, sources of noninterest income and sources of funding, market rates of interest, and income tax rates. The Company’s Asset/Liability Management Committee (“ALCO”) is responsible for managing changes in net interest income and net worth resulting from changes in interest rates based on acceptable limits established by the Board of Directors. The ALCO reviews economic conditions, interest rate forecasts, the demand for loans, the availability of deposits, current operating results, liquidity, capital, and interest rate exposures. Based on such reviews, the ALCO formulates a strategy that is intended to implement objectives set forth in the asset/liability management policy.
The following table represents the Company’s net interest income on a tax-equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets. Interest income on tax-exempt investment securities was adjusted to reflect the income on a tax-equivalent basis (considering the effect of the disallowed interest expense related to carrying these tax-exempt investment securities) using a nominal tax rate of 34 percent for 2006, 2005, 2004.
Net interest income on a tax-equivalent basis for 2006 was consistent with 2005, decreasing slightly by $21,000 compared to a decrease of $894,000 or 6 percent in 2005. In line with most financial institutions in 2006, our net interest margin has experienced pressure from flattening loan rates and higher interest rates associated with gathering and maintaining deposits. In 2006, the average rate earned by the Company on its interest earning assets increased by 54 basis points to 7.46 percent; however, the average rate paid on interest-bearing liabilities increased by 84 basis points to 3.15 percent. This continues a trend experienced in 2005, when the average rate earned by the Company on its interest earning assets increased by 48 basis points to 6.92 percent, but the average rate paid on interest-bearing liabilities increased by 69 basis points to 2.31 percent. Despite this pressure, the Company maintained a net interest yield on earning assets in 2006, 2005 and 2004 of 4.98 percent, 5.06 percent, and 5.12 percent on a tax equivalent basis, respectively.
Total interest income on a tax equivalent basis increased $1,876,000 or 9 percent for the period ended December 31, 2006 compared to the same period in 2005. Similarly, total interest income on a tax equivalent basis increased by $489,000 or 2 percent in 2005 compared to the same period in 2004. These increases were primarily due to changes in rates and volume of average earning assets. In 2006, rate accounted for $1,391,000 of the increase in total interest income on a tax equivalent basis and $1,069,000, partially offset by a decrease in volume of $580,000 in 2005.
Total interest expense on a tax equivalent basis increased $1,897,000 or 35 percent in 2006 due to the repricing of interest-bearing liabilities in a higher rate environment and competition for deposits. As a result, the average rate paid on interest-bearing liabilities increased by 84 basis points in 2006 and 69 basis points in 2005.
Noninterest Income
Noninterest income consists of revenues generated from a broad range of financial services and activities, including deposit and service fees, gains and losses realized from the sale of securities and assets, as well as various other components that comprise other noninterest income. Noninterest income totaled $4,864,000 in 2006, a decrease of $243,000 or 5 percent compared to 2005. Noninterest income was $5,107,000 in 2005, representing a decrease of $857,000 or 14 percent compared to 2004.
Fee income from service charges on deposit accounts, the major component of noninterest income, decreased 12 percent in 2006 and 10 percent in 2005. A large component of the Company’s service charges on deposit accounts is related to insufficient funds, returned check charges, and other customer service fees. The volume of insufficient funds and returned check charges, due to their nature, fluctuates monthly and impacts the amount of revenues earned on deposit accounts. Also, customers have embraced the Company’s free checking account product implemented to compete with local financial institutions offering similar products in the Company’s target market area. Management is reviewing several strategies to increase fees it earns on deposit accounts.
In 2005, in accordance with the guidance in SFAS No. 115 and SAB Topic 5: M, the Company’s management concluded that an other-than-temporary impairment has incurred in its agency preferred securities, and that a writedown of the securities to market value was appropriate. The Company realized a $346,000 loss on the writedown for other-than-temporary impairment in its Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) perpetual preferred stocks.
Gains on sales of securities were $154,000, $75,000 and $58,000 in 2006, 2005 and 2004, respectively. During 2006 and 2005, the bank sold investments in order to restructure its investment portfolio to take advantage of the rising interest rate environment. The Company experienced a gain of $2,000 in 2006, a loss of $8,000 in 2005 and a gain of $308,000 in 2004 on the sale of assets. The loss in 2005 is due to the sale of foreclosed properties. The gain in 2004 represents the sale of an unused building from the Company’s fixed asset portfolio as well as gains realized from the sale of foreclosed properties.
Other operating income decreased by $276,000 in 2006 or 14 percent due to an event which increased the 2005 balance by $250,000. In 2005 we reversed a $250,000 accrual related to a jury verdict the Company won on appeal. As a result of the reversal, other operating income increased $165,000 or 9 percent in 2005.
Noninterest Expense
Continuing a trend started last year, noninterest expense decreased by $1,117,000 or 7 percent to $15,351,000 in 2006, compared to $16,468,000 in the previous year as most components in this category decreased in 2006. In 2005 noninterest expense decreased $914,000 or 5 percent compared to 2004 as the Company consolidated and closed two branches, and reduced its average full-time employee base. These
and other cost reduction measures was taking to combat the increasing pressures on the Company’s net interest margin brought about by the continuing rise in interest rates and the flat yield curve.
Salaries and employee benefits expense decreased $619,000 or 8 percent in 2006 and $97,000 or 1 percent in 2005 due to a decrease in the Company’s full-time employees (FTE). The Company’s ongoing organizational changes have reduced its FTE to 133 at the end of December 31, 2006 from 147 in 2005, representing a 10 percent reduction in staff. The Company also reduced it staff count by 10 percent in 2005, reducing its FTE to 147 from 164 in 2004. In 2006 to combat the increased cost of providing healthcare, the Company increased the medical deductibles to its employees, enacted certain preventive care and, consequently, has experienced a reduction in the amount of medical claims filed compared to the same period last year.
Net occupancy and equipment expense includes depreciation expense and repairs and maintenance costs relating to the Company’s premises and equipment. Net occupancy and equipment expense decreased $281,000 or 11 percent in 2006, after decreasing $69,000 or 3 percent in 2005. Last year, the Company consolidated its two Birmingham branches and closed its Stonecrest Mall branch.
Other operating expenses decreased by $217,000 or 4 percent in 2006 to $5,478,000 from $5,695,000 in 2005, and by $748,000 or 12 percent from $6,443,000 in 2004 due to expense control. Professional, legal and other services decreased $183,000, other losses decreased $94,000 and other miscellaneous expenses decreased $279,000, partially offset by an increase in marketing expense of $326,000 in 2006. Professional, legal and other services decreased $449,000, stationary and supplies cost decreased $104,000, and advertising expenses decreased $175,000 in 2005 compared to the previous year.
Income Taxes
Income tax expense increased $406,000 or 116 percent to $756,000 for the year ended December 31, 2006 compared to a decrease of $300,000 or 46 percent in 2005. The effective tax rate as a percentage of pretax income was 20 percent in 2006, 13 percent in 2005 and 22 percent in 2004. The statutory federal rate was 34 percent during 2006, 2005 and 2004. The increase in the effective tax rate in 2006 and 2004 is due to a 40 percent and 67 percent increase in pretax income, respectively. The decrease in the effective tax rate in 2005 is due to the reduction of a certain valuation allowance established for net operating loss carryforwards of approximately $7 million for state income tax purposes. For further information concerning the provision for income taxes, refer to Note 7, Income Taxes, in the Notes to Consolidated Financial Statements.
Quarterly Financial Data (Unaudited)
The following table presents the Company’s quarterly financial data for the years ended December 31, 2006 and 2005 (amounts in thousands, except per share amounts):
Stock Based Compensation
On January 1, 2006, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) SFAS No. 123(R), “Accounting for Stock-Based Compensation”, to account for compensation costs under its stock option plan. The Company previously utilized the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees (as amended)” (“APB 25”). Under the intrinsic value method prescribed by APB 25, no compensation costs were recognized for the Company’s stock options and warrants because the option and warrant exercise price in its plan equaled the market price on the date of grant. Prior to January 1, 2006, the Company only disclosed the pro forma effects on net income and earnings per share as if the fair value recognition provisions of SFAS 123(R) had been utilized.
In adopting SFAS No. 123(R), the Company elected to use the modified prospective method to account for the transition from the intrinsic value method to the fair value recognition method. Under the modified prospective method, compensation cost is recognized from the adoption date forward for all new stock options granted and for any outstanding unvested awards as if the fair value method had been applied to those awards as of the date of grant. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period.
The following table presents the Company’s as reported and pro forma information, including stock-based compensation expense, as if the fair-value based method had been applied, for the years ended December 31:
The fair value of the 2006 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 1.48%; expected volatility of 32%; risk free interest rate of 5.14% and an expected life of six years. The fair value of the 2006 Option grant was approximately $38,000. Similarly, the fair values of the options granted in 2005 and 2004 were estimated on the date of grant using the Black-Scholes option-pricing model. The assumptions for the 2005 Option grant were dividend yield of 1.36%; expected volatility of 39%; risk free interest rate of 4.26% and an expected life of six years. The fair value of the 2005 Option grant was approximately $62,000. The assumptions for the 2004 Option grant were dividend yield of 1.40%; expected volatility of 42%; risk free interest rate of 4.05% and an expected life of six years. The fair value of the 2004 Option grant was approximately $67,000.
Recently Issued Accounting Standards
In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140.” This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This Statement resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not believe that the adoption of SFAS No. 155 will have a material impact on its financial position, results of operations and cash flows.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140.” This Statement amends FASB No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. An entity should adopt SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15, 2006. The Company does not believe the adoption of SFAS No. 156 will have a material impact on its financial position, results of operations and cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises’ financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48 its financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 is effective for the Company on January 1, 2008 and is not expected to have a significant impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, the date at which the benefit obligation and plan assets are measured, is required to be the company’s fiscal year end. SFAS 158 is effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan. Therefore, SFAS 158 will not impact the Company’s financial conditions or results of operations.
In September, 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4 “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. EITF 06-4 addresses
employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion-1967”. EITF 06-4 is effective for fiscal years beginning after December 15, 2006. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company is currently analyzing the effect of adoption of EITF 06-4 on its financial position, results of operations and cash flows.
In September 2006, the FASB ratified the consensus reached related to EITF 06-5, “Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2007. The Company is currently analyzing the effect of adoption of EITF 06-5 on its financial position, results of operations and cash flows.
In September 2006, the SEC issued Staff Accounting Bulleting No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS 115, available-for-sale and held-to-maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS 159 is effective for the Company on January 1, 2008. Earlier adoption is permitted in 2007 if the Company also elects to apply the provisions of SFAS 157, “Fair Value Measurement.” The Company is currently analyzing the fair value option provided under SFAS 159.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.
Impact of Inflation and Changing Prices
A bank’s asset and liability structure is substantially different from that of an industrial company in that virtually all assets and liabilities of a bank are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company’s ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of other goods and services. Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.
The Company has adopted an asset/liability management program to monitor the Company’s interest rate sensitivity and to ensure the Company is competitive in the loans and deposit market. Secondly, the Company performs periodic reviews to ensure its banking services and products are priced appropriately. Various information shown elsewhere in the Company’s 10-K and in the Notes to Consolidated Financial Statements, should be considered in the understanding of how well the Company is positioned to react to changing interest rates and inflationary trends.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company has adopted an asset liability management program to monitor the Company’s interest rate sensitivity risk and to ensure that the Company is competitive in the lending and deposit markets. Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. During the three year period ended December 31, 2006, the Company did not enter into any derivative financial instruments such as futures, forwards, swaps or options. Additionally, refer to our interest sensitive management and liquidity disclosures included in the Company’s Annual Report to Shareholders for the year ended December 31, 2006 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The following table presents the effect of a 100 basis points positive and negative interest rate fluctuation on the Company’s interest-rate sensitive assets and liabilities at December 31, 2006 (in thousands):
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements, notes thereon, and independent auditors report are included herein beginning on page:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes or disagreements with the Company’s accountants in the last two fiscal years.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by 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 and material weaknesses.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The responses to this Item are included in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2007, under the headings “Election of Directors,” “Executive Officers,” “Beneficial Ownership of Common Stock” and “Compliance With Section 16(a) of the Securities Exchange Act of 1934” and are incorporated herein by reference.
The Company has adopted a Code of Business Conduct and Ethics that applies to its principal executive, financial and accounting officers. A copy may also be obtained, without charge, upon written request addressed to Citizens Bancshares Corporation, 75 Piedmont Avenue, N.E., Atlanta, Georgia 30303, Attention: Corporate Secretary. The request may also be delivered by fax to the Corporate Secretary at (404) 575-8311.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The responses to this Item are included in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2007 under the heading “Executive Compensation” and are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The responses to this item are included in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2007 under the heading “Beneficial Ownership of Common Stock” and are incorporated herein by reference.
The following table sets forth information regarding our equity compensation plans under which shares of our common stock are authorized for issuance. All data is presented as of December 31, 2006.
Equity Compensation Plan Table
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The responses to this Item are included in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2007 under the heading, “Certain Transactions” and “Director Independence” and are incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information relating to the fees paid to the Company’s independent accountants is set forth in the Company’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 23, 2007 under the heading “Accounting Matters” and are incorporated herein by reference.
citizens bancshares corporation and subsidiaries
Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the Years Ended December 31, 2006, 2005, and 2004
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the Years Ended December 31, 2006, 2005, and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and
-7
Notes to Consolidated Financial Statements
-33
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Citizens Bancshares Corporation
Atlanta, Georgia
We have audited the accompanying consolidated balance sheets of Citizens Bancshares Corporation and its subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three year period then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and the 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 present fairly, in all material respects, the consolidated financial position of Citizens Bancshares Corporation and its subsidiaries as of December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for the years in the three year period then ended, in conformity with accounting principles generally accepted in the United States of America.
Elliott Davis, LLC
Columbia, South Carolina
March 7, 2007
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
The accompanying notes are an integral part of these consolidated financial statements.
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
The accompanying notes are an integral part of these consolidated financial statements.
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
The accompanying notes are an integral part of these consolidated financial statements.
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
The accompanying notes are an integral part of these consolidated financial statements.
CITIZENS BANCSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005, AND 2004
(concluded)
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2006 AND 2005 AND FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business-Citizens Bancshares Corporation and subsidiaries (the “Company”) is a holding company that provides a full range of commercial banking and mortgage brokerage services to individual and corporate customers in metropolitan Atlanta and Columbus, Georgia, through its wholly owned subsidiary, Citizens Trust Bank (the “Bank”). The Bank operates under a state charter and serves its customers through seven full-service branches in metropolitan Atlanta, one full-service branch in Columbus, Georgia, one full-service branch in Birmingham, Alabama, and one full-service branch in Eutaw, Alabama. The Company also owns and operates a wholly owned subsidiary grantor trust, Citizens (GA) Statutory Trust I (the “Trust”) through the issuance of junior subordinated debentures. All significant intercompany accounts and transactions have been eliminated in consolidation. In accordance with current accounting guidance, the Trust has not been consolidated in the financial statements.
Basis of Presentation-The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with general practices within the banking industry. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts in the consolidated 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 are the allowance for loan losses, the valuation of allowances associated with the recognition of deferred tax assets and the value of foreclosed real estate and goodwill.
Cash and Cash Equivalents-Cash and cash equivalents includes cash on hand and amounts due from banks and federal funds sold. The Federal Reserve Bank (the “FRB”) requires the Company to maintain a required cash reserve balance on deposit with the FRB, based on the Company’s daily average balance with the FRB. This reserve requirement represents 3% of the Company’s daily average demand deposit balance between $7.8 million and $40.5 million and 10% of the Company’s daily average demand deposit balance above $40.5 million.
Investment Securities-The Company classifies investments in one of three categories based on management’s intent upon purchase: held to maturity securities which are reported at amortized cost, trading securities which are reported at fair value with unrealized holding gains and losses included in earnings, and available for sale securities which are recorded at fair value with unrealized holding gains and losses included as a component of accumulated other comprehensive income. The Company had no investment securities classified as trading securities during 2006, 2005, or 2004.
Premiums and discounts on available for sale and held to maturity securities are amortized or accreted using a method which approximates a level yield. Amortization and accretion of premiums and discounts is presented within investment securities interest income on the Consolidated Statements of Income.
Gains and losses on sales of investment securities are recognized upon disposition, based on the adjusted cost of the specific security. A decline in market value of any security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security. The determination of whether an other-than-temporary impairment has occurred involves significant assumptions, estimates, changes in economic conditions and judgment by management. In 2005, the Company realized a $346,000 loss related to the writedown on its investments in Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FHLMC) perpetual
preferred stocks as a result of other-than-temporary impairment. In 2006, these securities recovered some of the value written-off in 2005 and the Company was able to sell the perpetual preferred stocks for a gain of $124,000. There was no other-than-temporary impairment for securities recorded during 2006 or in 2004.
Other Investments-Other investments consist of Federal Home Loan Bank stock and Federal Reserve Bank stock which are restricted and have no readily determinable market value. These investments are carried at cost.
Loans Receivable and Allowance for Loan Losses-Loans are reported at principal amounts outstanding less unearned income and the allowance for loan losses. Interest income on loans is recognized on a level yield basis. Loan fees and certain direct origination costs are deferred and amortized over the estimated terms of the loans using the level yield method. Premiums and discounts on loans purchased are amortized and accreted using the level yield method over the estimated remaining life of the loan purchased. The accretion and amortization of loan fees, origination costs, and premiums and discounts are presented as a component of loan interest income on the Consolidated Statements of Income.
Management considers a loan to be impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan 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 if the loan is collateral dependent.
Loans are generally placed on nonaccrual status when the full and timely collection of principal or interest becomes uncertain or the loan becomes contractually in default for 90 days or more as to either principal or interest, unless the loan is well collateralized and in the process of collection. When a loan is placed on nonaccrual status, current period accrued and uncollected interest is charged-off against interest income on loans unless management believes the accrued interest is recoverable through the liquidation of collateral. Interest income, if any, on impaired loans is recognized on the cash basis.
The Company provides for estimated losses on loans receivable when any significant and permanent decline in value occurs. These estimates for losses are based on individual assets and their related cash flow forecasts, sales values, independent appraisals, the volatility of certain real estate markets, and concern for disposing of real estate in distressed markets. For loans that are pooled for purposes of determining necessary provisions, estimates are based on loan types, history of charge-offs, and other delinquency analyses. Therefore, the value used to determine the provision for losses is subject to the reasonableness of these estimates. The adequacy of the allowance for loan losses is reviewed on a monthly basis by management and the Board of Directors. This assessment is made in the context of historical losses as well as existing economic conditions, performance trends within specific portfolio segments, and individual concentrations of credit.
Loans are charged-off against the allowance when, in the opinion of management, such loans are deemed to be uncollectible and subsequent recoveries are added to the allowance.
Mortgage Servicing Rights-The Company allocates the total cost of a whole mortgage loan originated or purchased to mortgage servicing rights and loans based on relative fair values. Amounts capitalized as mortgage servicing rights are amortized over the period of, and in proportion to, estimated future net servicing income. The Company assesses its capitalized mortgage servicing rights for impairment based on independent appraisals of the market values of those rights. Impairments are recognized as a valuation allowance. The independent appraisals value such rights in consideration of prevailing interest rates, prepayment and default rates, and other relevant factors as appropriate. At December 31, 2006 and 2005, the fair values of mortgage servicing rights were $93,344 and $82,900, respectively, and are presented as a component of other assets in the consolidated balance sheets.
Premises and Equipment-Premises and equipment are stated at cost less accumulated depreciation which is computed using the straight-line method over the estimated useful lives of the related assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in earnings for the period. The costs of maintenance and repairs, which do not improve or extend the useful life of the respective assets, are charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment is as follows:
Foreclosed Real Estate-Foreclosed real estate is reported at the lower of cost or fair value less estimated disposal costs, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. Any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is treated as a charge-off against the allowance for loan losses. Any subsequent declines in value are charged to earnings.
Intangible Assets-Finite lived intangible assets of the Company represent deposit assumption premiums recorded upon the purchase of certain assets and liabilities from other financial institutions. Deposit assumption premiums are amortized over seven years, the estimated average lives of the deposits acquired, using the straight-line method and are included within other assets on the Consolidated Balance Sheets.
The Company reviews the carrying value of goodwill on an annual basis and on an interim basis if certain events or circumstances indicate that an impairment loss may have been incurred. An impairment charge is recognized if the carrying value of the reporting unit’s goodwill exceeds its implied fair value.
The following table presents information about our intangible assets:
The following table presents information about aggregate amortization expense for each of the four succeeding fiscal years as follows:
Income Taxes-Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. 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 the Company’s assets and liabilities result 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 for the portion of a deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.
Net Income Per Share-Basic net income per common share (“EPS”) is computed based on net income divided by the weighted average number of common shares outstanding. Diluted EPS is computed based on net income divided by the weighted average number of common and potential common shares. The only potential common share equivalents are those related to stock options. Stock options which are anti-dilutive are excluded from the calculation of diluted EPS.
Stock Based Compensation-On January 1, 2006, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) SFAS No. 123(R), “Accounting for Stock-Based Compensation”, to account for compensation costs under its stock option plan. The Company previously utilized the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees (as amended)” (“APB 25”). Under the intrinsic value method prescribed by APB 25, no compensation costs were recognized for the Company’s stock options and warrants because the option and warrant exercise price in its plan equaled the market price on the date of grant. Prior to January 1, 2006, the Company only disclosed the pro forma effects on net income and earnings per share as if the fair value recognition provisions of SFAS 123(R) had been utilized.
In adopting SFAS No. 123(R), the Company elected to use the modified prospective method to account for the transition from the intrinsic value method to the fair value recognition method. Under the modified prospective method, compensation cost is recognized from the adoption date forward for all new stock options granted and for any outstanding unvested awards as if the fair value method had been applied to those awards as of the date of grant. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period.
The following table presents the Company’s as reported and pro forma information, including stock-based compensation expense, as if the fair-value based method had been applied, for the years ended December 31:
The fair value of the 2006 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 1.48%; expected volatility of 32%; risk free interest rate of 5.14% and an expected life of six years. The fair value of the 2006 Option grant was approximately $38,000. Similarly, the fair values of the options granted in 2005 and 2004 were estimated on the date of grant using the Black-Scholes option-pricing model. The assumptions for the 2005 Option grant were dividend yield of 1.36%; expected volatility of 39%; risk free interest rate of 4.26% and an expected life of six years. The fair value of the 2005 Option grant was approximately $62,000. The assumptions for the 2004 Option grant were dividend yield of 1.40%; expected volatility of 42%; risk free interest rate of 4.05% and an expected life of six years. The fair value of the 2004 Option grant was approximately $67,000.
Recently Issued Accounting Standards-In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140.” This Statement amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” This Statement resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not believe that the adoption of SFAS No. 155 will have a material impact on its financial position, results of operations and cash flows.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140.” This Statement amends FASB No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. An entity should adopt SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15, 2006. The Company does not believe the adoption of SFAS No. 156 will have a material impact on its financial position, results of operations and cash flows.
In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises’ financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48 its financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 is effective for the Company on January 1, 2008 and is not expected to have a significant impact on the Company’s financial statements.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date, the date at which the benefit obligation and plan assets are measured, is required to be the company’s fiscal year end. SFAS 158 is effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan. Therefore, SFAS 158 will not impact the Company’s financial conditions or results of operations.
In September, 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4 “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. EITF 06-4 addresses
employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion-1967”. EITF 06-4 is effective for fiscal years beginning after December 15, 2006. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company is currently analyzing the effect of adoption of EITF 06-4 on its financial position, results of operations and cash flows.
In September 2006, the FASB ratified the consensus reached related to EITF 06-5, “Accounting for Purchases of Life Insurance-Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2007. The Company is currently analyzing the effect of adoption of EITF 06-5 on its financial position, results of operations and cash flows.
In September 2006, the SEC issued Staff Accounting Bulleting No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value. With respect to SFAS 115, available-for-sale and held-to-maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS 159 is effective for the Company on January 1, 2008. Earlier adoption is permitted in 2007 if the Company also elects to apply the provisions of SFAS 157, “Fair Value Measurement.” The Company is currently analyzing the fair value option provided under SFAS 159.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.
Reclassifications-Certain 2005 and 2004 amounts have been reclassified to conform to the 2006 presentation.
2. INVESTMENT SECURITIES
Investment securities available for sale are summarized as follows:
Investment securities held to maturity are summarized as follows:
The amortized costs and fair values of investment securities at December 31, 2006, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with and without call or prepayment penalties.
Gross realized gains on securities were $154,847, $74,854, and $138,218 in 2006, 2005, and 2004, respectively. Gross realized losses on securities were $1,200 and $79,754 in 2006 and 2004, respectively. There were no gross realized losses on securities in 2005. However, during 2005 the Company realized a $346,000 loss related to the writedown of its investments in equity portfolio as a result of other-than-temporary impairment. There was no other-than-temporary impairment for securities recorded during 2006 or in 2004.
Investment securities with carrying values of approximately $58,719,000, $53,856,000 and $77,443,000 at December 31, 2006, 2005 and 2004, respectively, were pledged to secure public funds on deposit and for other purposes as required by law.
Those investment securities held to maturity and available for sale which have an unrealized loss position at December 31, 2006 are detailed below:
Securties Held to Maturity
Securities Available for Sale
Securities classified as available-for-sale are recorded at fair market value and held-to-maturity securities are recorded at amortized cost. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary.
The Company’s investment portfolio consists principally of obligations of the United States, its agencies or its corporations and general obligation municipal securities. In the opinion of management, there is no concentration of credit risk in its investment portfolio. The company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.
3. LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans outstanding, by classification, are summarized as follows:
Concentrations-The Company’s concentrations of credit risk are as follows:
· A substantial portion of the Company’s loan portfolio is collateralized by real estate in metropolitan Atlanta. Accordingly, the ultimate collectibility of a substantial portion of the Company’s loan portfolio is susceptible to changes in market conditions in the metropolitan Atlanta area.
· The Company’s loans to area churches were approximately $37.7 million and $37.6 million at December 31, 2006 and 2005, respectively, which are generally secured by real estate.
· The Company’s loans to area convenience stores were approximately $13.4 million and $20.9 million at December 31, 2006 and 2005, respectively. Loans to convenience stores are generally secured by real estate.
Allowance for Loan Losses-Activity in the allowance for loan losses is summarized as follows:
Nonaccrual loans amounted to $3,718,000 and $4,143,000 at December 31, 2006 and 2005, respectively.
At December 31, 2006 and 2005, the recorded investment in loans considered to be impaired was $11,804,000 and $9,875,000, respectively. The related allowance for loan losses for these loans was $2,006,000 and $1,968,000 at December 31, 2006 and 2005, respectively. The average investment in impaired loans during 2006 and 2005 was approximately $9,767,000 and $10,213,000, respectively. Interest income recognized on impaired loans was approximately $1,080,000, $939,000, and $1,038,000 in 2006, 2005, and 2004, respectively. Interest income recognized on a cash basis was approximately $205,000, $119,000, and $73,000 in 2006, 2005, and 2004, respectively.
4. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
5. DEPOSITS
The following is a summary of interest-bearing deposits:
At December 31, 2006, maturities of time deposits are approximately as follows:
6. OTHER BORROWINGS
Federal Funds Purchased-Federal funds purchased represent unsecured borrowings from other banks and generally mature daily. At December 31, 2006 and 2005, the Company had no amounts outstanding.
Notes Payable-At December 31, 2006 and 2005, the unsecured note payable had an outstanding principal balance of $339,647 and $439,647, respectively. The note bore interest at a rate of 7.75% at
December 31, 2006 and 6.75% at December 31, 2005 (50 basis points below the lender’s prime rate) and is payable quarterly. The principal balance is due in full on June 30, 2007.
Junior Subordinated Debentures-During 2002, Citizens Bancshares Corporation issued $5 million of pooled trust preferred securities through one issuance by a wholly owned subsidiary grantor trust, Citizens (GA) Statutory Trust I (the “Trust”). The trust preferred securities accrue and pay distributions periodically at an annual rate as provided in the indentures of the London Interbank Offered Rate plus 3.45%. The Trust used the net proceeds from the offering to purchase a like amount of Junior Subordinated Debentures (the “Debentures”) of the Company. These securities are reported on our consolidated balance sheet as Junior Subordinated Debentures. The trust preferred securities are mandatorily redeemable upon the maturity of the Debentures on June 26, 2032, or upon earlier redemption as provided in the indentures beginning June 26, 2007. The Company has the right to redeem the Debentures in whole or in part or after specific dates, at a redemption price specified in the indentures plus any accrued but unpaid interest to the redemption date. At December 31, 2006, the interest rate on the Junior Subordinated Debentures was 8.82%.
Federal Home Loan Bank Advances-The Company has outstanding a $10 million convertible advance at December 31, 2006 and 2005 bearing interest at a fixed rate of 5.82% due April 5, 2010. The convertible advance is callable by the lender at the end of each fiscal quarter. If called, the advance will convert into a flat three month LIBOR based floating rate advance. At December 31, 2006 and 2005, the Company has variable rate advances of approximately $16.4 million and $27.7 million outstanding with a weighted average interest rate of 5.50% and 4.44%, respectively. The variable rate advances outstanding fluctuates daily depending on the liquidity needs of the Company. In August 2006, the Company received an AHP Award in the amount of $400,000. The AHP is a principal reducing credit with an interest rate of zero, and at December 31, 2006 had a remaining balance of $395,923. All of these advances are collateralized by FHLB stock, a blanket lien on the Bank’s 1-4 family mortgages and commercial real estate loans. As of December 31, 2006 and 2005, total loans pledged as collateral was $49,000,000 and $54,000,000, respectively. As of December 31, 2006 and 2005, maturities of the Company’s Federal Home Loan Bank Advances are approximately as follows:
(1) Represents an Affordable Housing Program (AHP) award used to subsidized loans for homeownership or rental initiatives. The AHP is a principal reducing credit, scheduled to mature on August 17, 2026 with an interest rate of zero.
7. INCOME TAXES
The components of income tax expense consist of:
Income tax expense for the years ended December 31, 2006, 2005, and 2004 differed from the amounts computed by applying the statutory federal income tax rate of 34% to earnings before income taxes as follows:
The tax effects of temporary differences that give rise to significant amounts of deferred tax assets and deferred tax liabilities are presented below:
The Company has, at December 31, 2006, net operating loss carryforwards of approximately $3,944,000 for state income tax purposes, which expire in years 2007 through 2022. The Company also has certain state income tax credits of $385,000 at December 31, 2006 which expires in years 2007 through 2011. Due to the uncertainty relating to the realizability of all the carryforwards and credits, management currently considers it more likely than not that all related deferred tax assets will not be realized; thus, a $129,000 valuation allowance has been provided against state tax carryforwards totaling $3,247,000.
8. EMPLOYEE BENEFITS
Defined Contribution Plan-The Company sponsors a defined contribution 401(k) plan covering substantially all full-time employees. Employee contributions are voluntary. The Company matches 50% of the employee contributions up to a maximum of 6% of compensation. During the years ended December 31, 2006, 2005, and 2004, the Company recognized $90,000, $113,000, and $126,000, respectively, in expenses related to this plan.
Other Postretirement Benefits-In addition to the Company’s defined contribution plan, the Company sponsors postretirement medical and life insurance benefit plans for full-time employees who meet certain minimum age and service requirements. The plans contain cost sharing features with retirees and the Company funds benefit payments in the period incurred.
The following table presents the plans’ changes in accumulated benefit obligation for the years ended December 31, 2006 and 2005:
Changes in the plan assets include the following components:
The following table presents the plans’ funded status reconciled with amounts recognized in the consolidated balance sheets at December 31, 2006 and 2005:
Net periodic postretirement benefit cost includes the following components:
The Company used the following actuarial assumptions to determine our benefit obligations at December 31, 2006, 2005 and 2004, and our net periodic benefit cost for the years ended December 31, 2006, 2005 and 2004, as measured at December 31:
(1) The healthcare cost trend rate is assumed to decrease gradually to 5%. As a result of the Company’s curtailment of its postretirement medical plan during 2003, an assumed healthcare cost trend rate was not considered for the years ending December 31, 2006 and 2005. At December 31, 2006, the Company continued to pay life insurance premiums for 12 retirees totaling $318 under the curtailed plan.
The Company expects to contribute $318 to its postretirement medical plan from January 1, 2007 through December 31, 2007.
Benefit payments estimated to be paid in 2007 to 2015 are as follows:
The measurement dates for the net periodic postretirement benefit cost and net amount recognized was January 1 and December 31, respectively.
The Bank also has a postretirement benefit plan which provides retirement benefits to its key officers and Board members and provides death benefits for their designated beneficiaries. Under the plan, the Bank purchased whole life insurance contracts on the lives of certain key officers and Board members.
The increase in cash surrender value of the contracts, less the Bank’s premiums, constitutes the Bank’s 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, 2006 and 2005, the cash surrender value of these insurance contracts was $9,363,656 and $9,105,107, respectively.
9. COMMITMENTS AND CONTINGENCIES
Credit Commitments and Commercial Letters-The Company, in the normal course of business, is a party to financial instruments with off-balance-sheet risk used to meet the financing needs of its customers. These financial instruments include commitments to extend credit and commercial letters of credit.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and residential and commercial real estate. Commercial letters of credit are commitments issued by the Company to guarantee funding to a third party on behalf of a customer. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party of the financial instrument for commitments to extend credit and commercial letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations related to off-balance-sheet financial instruments as it does for the financial instruments recorded in the Consolidated Balance Sheets.
Mortgage-Backed Securities-In connection with servicing mortgage-backed securities guaranteed by Fannie Mae, the Company advances certain principal and interest payments to security holders prior to their collection from specific mortgagors. Additionally, the Company must remit certain payments of property taxes and insurance premiums in advance of collecting them from specific mortgagors and make certain payments of attorneys’ fees and other costs related to loans in foreclosure. These amounts are included as receivables within other assets in the consolidated balance sheets.
Leases-As of December 31, 2006, future minimum lease payments under all noncancelable lease agreements inclusive of sales tax and maintenance costs for the next five years and thereafter are as follows:
Rent expense in 2006, 2005, and 2004 was approximately $425,000, $437,000, and $411,000, respectively.
Legal-During 2006, a jury awarded a $100,000 judgment against the Company. The Company is appealing the ruling to have the jury award reversed and the accrual for this loss is reflected in the December 31, 2005 Consolidated Financial Statements. During 2003, a jury awarded a $250,000 judgment against the Company for lenders’ liability. The Company appealed and succeeded in having the jury award reversed in 2005. The reversal of the accrual for the $250,000 loss is reflected in the December 31, 2005 Consolidated Financial Statements. Other than that discussed above, the Company and the Bank are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based in part on the advice of counsel, the ultimate disposition of these matters will not have a material adverse impact on the Company’s consolidated financial statements.
10. STOCK OPTIONS
1998 Option-On January 30, 1998, the Company granted its president an option to purchase 17,500 shares of common stock of the Company at an exercise price of $9.88 per share (the “1998 Option”) as compared to trades of stock at $5.00 per share around the date of grant. The 1998 Option vests at a rate of 20% per year, commencing on January 30, 1999. The option’s term is ten years from the date of vesting, and at December 31, 2006, all options granted under the 1998 Option remained outstanding.
The fair value of the 1998 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 0.26%; expected volatility of 13%; risk free interest rate of 4% and an expected life of six years. The fair value of the 1998 Option grant was immaterial since the exercise price significantly exceeded the market price of the stock.
2002 Option-On January 16, 2002, the Company granted its president and certain senior officers options to purchase 21,100 shares of common stock of the Company at an exercise price of $7.00 per share (the “2002 Option”), which equaled the market price of the stock on the date of grant. The 2002 Option vests at a rate of 33.3% per year, commencing on January 16, 2003. The option’s term is ten years from the date of grant, and at December 31, 2006, 10,176 options to purchase shares under the 2002 Option remained outstanding.
The fair value of the 2002 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 2.37%; expected volatility of 46%; risk free interest rate of 4.88% and an expected life of four years. The fair value of the 2002 Option grant was approximately $52,000.
2004 Option-On January 21, 2004, the Company granted its president options to purchase 15,000 shares of common stock of the Company at an exercise price of $11.89 per share (the “2004 Option”), as compared to trades of stock at $11.20 per share on the date of grant. The 2004 Option vests at a rate of 33.3% per year, commencing on January 21, 2005. The option’s term is ten years from the date of grant, and at December 31, 2006, 15,000 options to purchase shares under the 2004 Option remained outstanding.
The fair value of the 2004 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 1.40%; expected volatility of 42%; risk free interest rate of 4.05% and an expected life of six years. The fair value of the 2006 Option grant was approximately $67,000.
2005 Option-On April 25, 2005, the Company granted its president and certain officers options to purchase 21,000 shares of common stock of the Company at an exercise price of $13.41 per share (the “2005 Option”), as compared to trades of stock at $13.00 per share on the date of grant. The 2005 Option vests at a rate of 33.3% per year, commencing on April 24, 2006. The option’s term is ten years from the date of grant, and at December 31, 2005, 14,500 options to purchase shares under the 2005 Option remained outstanding.
The fair value of the 2005 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 1.36%; expected volatility of 39%; risk free interest rate of 4.26% and an expected life of six years. The fair value of the 2005 Option grant was approximately $62,000.
2006 Option-On May 1, 2006, the Company granted its president and certain officers options to purchase 16,000 shares of common stock of the Company at an exercise price of $11.45 per share (the “2006 Option”), as compared to trades of stock at $11.40 per share on the date of grant. The 2006 Option vests at a rate of 33.3% per year, commencing on May 1, 2007. The option’s term is ten years from the date
of grant, and at September 30, 2006, 16,000 options to purchase shares under the 2006 Option remained outstanding.
The fair value of the 2006 Option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 1.48%; expected volatility of 32%; risk free interest rate of 5.14% and an expected life of six years. The fair value of the 2006 Option grant was approximately $38,000.
A summary of the status of the Company’s stock options as of December 31, 2006, 2005, and 2004, and changes during the years ended on those dates is presented below:
The following table summarizes information about stock options outstanding under the Company’s plan at December 31, 2006:
The total fair value of options vested during 2006, 2005 and 2004 was $46,177, $39,722 and $17,372, respectively.
11. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Basic and diluted net income per common and potential common share has been calculated based on the weighted average number of shares outstanding. The following schedule reconciles the numerators and denominator of the basic and diluted net income per common and potential common share for the years ended December 31, 2006, 2005, 2004.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
Following are disclosures of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the 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 the Company, but rather a good-faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.
Cash, Due From Banks, Federal Funds Sold, Interest-Bearing Deposits With Banks, and Certificates of Deposits-Carrying amount is a reasonable estimate of fair value due to the short-term nature of such items.
Investment Securities-Fair value of investment securities are based on quoted market prices.
Other Investments-The carrying amount of other investments approximates its fair value.
Loans Receivables-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-Cash values of life insurance policies are carried at the value for which such policies may be redeemed for cash.
Deposits-The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed rate certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
Notes Payable-Notes payable bear a variable interest rate and the carrying value approximates fair value.
Advances from Federal Home Loan Bank-The fair values of advances from the Federal Home Loan Bank are estimated by discounting the future cash flows using the rates currently available to the Bank for debt with similar remaining maturities and terms.
Junior Subordinated Debentures-The fair value of the issuance is estimated by discounting future cash flows using the rates currently available to the Bank for debt with similar remaining maturities and terms.
Commitments to Extend Credit and Commercial Letters of Credit-Because commitments to extend credit and commercial letters of credit are made using variable rates, or are recently executed, the contract value is a reasonable estimate of fair value.
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 the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’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; for example, premises and equipment. 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 values and estimated fair values of the Company’s financial instruments at December 31, 2006 and 2005 are as follows:
13. SHAREHOLDERS’ EQUITY
Capital Adequacy-The Company and the Bank are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, the Company meets all capital adequacy requirements to which it is subject.
As of December 31, 2006, the most recent notification from the various regulators categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution’s category.
The Company’s and the Bank’s actual capital amounts and ratios are also presented in the table below (in thousands):
Dividend Limitation-The amount of dividends paid by the Bank to the Company is limited by various banking regulatory agencies. Any such dividends will be subject to maintenance of required capital levels. The Georgia Department of Banking and Finance requires prior approval for a bank to pay dividends in excess of 50% of its prior year’s earnings. The amount of dividends available from the Bank without prior approval from the regulators for payment in 2007 is approximately $1,731,000.
14. RELATED-PARTY TRANSACTIONS
Certain of the Company’s directors, officers, principal shareholders, and their associates were customers of, or had transactions with, the Company or the Bank in the ordinary course of business during 2006. Some of the Company’s directors are directors, officers, trustees, or principal securities holders of corporations or other organizations that also were customers of, or had transactions with, the Company or the Bank in the ordinary course of business during 2006.
All outstanding loans and other transactions with the Company’s directors, officers, and principal shareholders were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, when made, did not involve more than the normal risk of collectibility or present other unfavorable features.
The following table summarizes the activity in these loans during 2006 and 2005:
Deposits by directors and executive officers of the Company and the Bank, and associates of such persons, totaled $2,099,000 and $1,908,000 at December 31, 2006 and 2005, respectively.
15. SUPPLEMENTARY INCOME STATEMENT INFORMATION
Components of other operating expenses in excess of 1% of total interest income and other income in any of the respective years are approximately as follows:
16. CONDENSED FINANCIAL INFORMATION OF CITIZENS BANCSHARES CORPORATION (PARENT ONLY)
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) The list of all 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
Number
Exhibit
3.1
The Articles of Incorporation.(1)
3.2
Bylaws.(2)
4.1
Instruments Defining the Rights of Security Holders.(3)
10.1*
Employment Agreement dated January 30, 1998 between James E. Young and the Company.(4)
10.2*
Citizens Bancshares Corporation Employee Stock Purchase Plan.(4)
10.3*
Citizens Bancshares Corporation 1999 Incentive Stock Option Plan.(4)
10.5
Stock Purchase Agreement by and between Citizens Bancshares Corporation and Fannie Mae dated September 10, 1999 and amended as of October 12, 1999.(5)
10.6
Stock Exchange Agreement between Citizens Bancshares Corporation and Fannie Mae dated November 10, 1999.(5)
10.7*
Change in Control Agreement by and between James E. Young and Citizens Bancshares Corporation(6)
10.8*
Change in Control Agreement by and between Cynthia Day and Citizens Bancshares Corporation(6)
10.9*
Change in Control Agreement by and between Samuel J. Cox and Citizens Bancshares Corporation(6)
10.10*
Change in Control Agreement by and between Robert E. Nesbitt and Citizens Bancshares Corporation(6)
10.11*
Change in Control Agreement by and between Roger Botwin and Citizens Bancshares Corporation(6)
21.1
List of subsidiaries.(5)
23.1
Consent of Elliott Davis, LLC.
31.1
Certification by Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification by Chief Operating Officer under Section 302 of the Sarbanes-Oxley Act of 2002
31.3
Certification by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certifications by Chief Executive Officer, Chief Operating Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002
* Compensatory plan or arrangement.
(1) Incorporated by reference to exhibit of same number in the Company’s Form 10-QSB for the quarter ending September 30, 2001.
(2) Incorporated by reference to exhibit of same number in the Company’s Registration Statement on Form 10, File No. 0-14535.
(3) See the Articles of Incorporation of the Company at Exhibit 3.1 hereto and the Bylaws of the Company at Exhibit 3.2 hereto.
(4) Incorporated by reference to exhibit of same number in the Company’s 2000 Form 10-KSB.
(5) Incorporated by reference to exhibit of same number in the Company’s Registration Statement on Form S-3, File No. 333-91003.
(6) Incorporated by reference to exhibit of same number in the Company’s Form 10-K for the year ended December 31, 2005.
(b) The Exhibits not incorporated herein by reference are submitted as a separate part of this report.
(c) Financial Statement 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 Report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears on the signature page to this Report constitutes and appoints James E. Young and Cynthia N. Day and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits hereto, and other documents in connection herewith with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
* Principal executive officer
** Principal operating officer
*** Principal accounting and financial officer