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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
-------------
 
FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
 
For the Quarterly Period Ended June 30, 2004 - Commission File Number 1-11823
-------------
 
 
PAB BANKSHARES, INC.
(A Georgia Corporation)
IRS Employer Identification Number: 58-1473302
 
3250 North Valdosta Road, Valdosta, Georgia 31602
Telephone Number: (229) 241-2775
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]

The number of shares outstanding of the registrant’s common stock at July 30, 2004 was 9,488,760 shares.
 
 
     
 

TABLE OF CONTENTS


         
Page
 
PART I
      
 
Item 1.
      
       
3
       
4
       
5
       
6
       
7
       
9
 
Item 2.
      
       
12
 
Item 3.
    
20
 
Item 4.
    
21
           
 
PART II
      
 
Item 1.
    
None
 
Item 2.
    
22
 
Item 3.
    
None
 
Item 4.
    
22
 
Item 5.
    
None
 
Item 6.
    
23
           
       
23

 
  - 2 -  
 
 
PART I. FINANCIAL INFORMATION

PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
AS OF JUNE 30, 2004 AND DECEMBER 31, 2003
 

   
June 30,
December 31,
   
2004
2003
   
(Unaudited)
  
ASSETS
              
Cash and due from banks
  
$
20,789,330
 
$
22,920,218
 
Interest-bearing deposits in other banks
    
1,569,291
   
505,409
 
Federal funds sold
    
12,541,750
   
330,187
 
Investment securities
    
108,576,156
   
126,825,013
 
               
Loans
    
554,523,799
   
538,643,842
 
Allowance for loan losses
    
(9,609,087
)
  
(10,139,114
)
Net loans
    
544,914,712
   
528,504,728
 
               
Premises and equipment, net
    
19,489,713
   
20,047,375
 
Goodwill
    
5,984,604
   
5,984,604
 
Cash value of bank-owned life insurance policies
    
10,566,108
   
10,422,078
 
Foreclosed assets
    
4,298,433
   
4,577,824
 
Other assets
    
10,506,434
   
10,623,956
 
               
Total assets
  
$
739,236,531
 
$
730,741,392
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
              
Deposits:
              
Noninterest-bearing demand
  
$
96,554,164
 
$
94,882,871
 
Interest-bearing demand and savings
    
218,673,577
   
202,753,493
 
Time
    
250,385,508
   
259,280,172
 
Total deposits
    
565,613,249
   
556,916,536
 
               
Federal funds purchased and securities sold under agreements to repurchase
    
20,974,252
   
36,919,790
 
Advances from the Federal Home Loan Bank of Atlanta
    
59,321,386
   
44,714,043
 
Guaranteed preferred beneficial interests in debentures
    
10,310,000
   
10,000,000
 
Other liabilities
    
5,282,895
   
6,128,857
 
Total liabilities
    
661,501,782
   
654,679,226
 
               
Stockholders’ equity:
              
Preferred stock, no par value, 1,500,000 shares authorized, no shares issued
    
-
   
-
 
Common stock, no par value, 98,500,000 shares authorized,
              
9,496,360 and 9,484,660 shares issued and outstanding
    
1,217,065
   
1,217,065
 
Additional paid-in capital
    
29,285,477
   
29,314,700
 
Retained earnings
    
48,566,093
   
45,651,500
 
Accumulated other comprehensive loss
    
(1,333,886
)
  
(121,099
)
Total stockholders’ equity
    
77,734,749
   
76,062,166
 
               
Total liabilities and stockholders’ equity
  
$
739,236,531
 
$
730,741,392
 
 
See accompanying notes to consolidated financial statements.
 
  - 3 -  
 
 
PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
           
   
Three Months Ended
Six Months Ended
   
June 30,
June 30,
   
2004
2003
2004
2003
           
Interest income:
          
Interest and fees on loans
  
$
8,360,603
 
$
8,953,641
 
$
16,611,801
 
$
18,276,790
 
Interest and dividends on investment securities:
                          
Taxable
    
1,075,233
   
997,672
   
2,316,148
   
1,950,342
 
Nontaxable
    
84,147
   
88,245
   
171,530
   
172,414
 
Other interest income
    
31,893
   
35,086
   
39,681
   
91,735
 
Total interest income
    
9,551,876
   
10,074,644
   
19,139,160
   
20,491,281
 
                           
Interest expense:
                          
Interest on deposits
    
1,886,975
   
2,679,102
   
3,841,957
   
5,642,670
 
Interest on Federal Home Loan Bank advances
    
279,054
   
397,199
   
529,211
   
841,819
 
Interest on other borrowings
    
214,949
   
177,838
   
439,861
   
362,928
 
Total interest expense
    
2,380,978
   
3,254,139
   
4,811,029
   
6,847,417
 
                           
Net interest income
    
7,170,898
   
6,820,505
   
14,328,131
   
13,643,864
 
                           
Provision for loan losses
    
-
   
-
   
-
   
-
 
Net interest income after provision for loan losses
    
7,170,898
   
6,820,505
   
14,328,131
   
13,643,864
 
                           
Other income:
                          
Service charges on deposit accounts
    
1,094,276
   
1,287,588
   
2,160,171
   
2,534,039
 
Other fee income
    
289,099
   
453,579
   
669,509
   
965,471
 
Securities transactions, net
    
(1,020
)
  
107,199
   
576
   
357,774
 
Other noninterest income
    
107,766
   
38,311
   
465,775
   
190,753
 
Total other income
    
1,490,121
   
1,886,677
   
3,296,031
   
4,048,037
 
                           
Other expenses:
                          
Salaries and employee benefits
    
3,341,315
   
3,817,765
   
6,913,967
   
7,811,405
 
Occupancy expense of premises
    
459,525
   
442,816
   
901,539
   
877,906
 
Furniture and equipment expense
    
522,958
   
615,315
   
1,049,909
   
1,201,915
 
Other noninterest expense
    
1,289,372
   
1,348,663
   
2,473,284
   
2,638,672
 
Total other expenses
    
5,613,170
   
6,224,559
   
11,338,699
   
12,529,898
 
                           
Income before income tax expense
    
3,047,849
   
2,482,623
   
6,285,463
   
5,162,003
 
Income tax expense
    
928,060
   
750,972
   
2,039,393
   
1,605,507
 
                           
Net income
  
$
2,119,789
 
$
1,731,651
 
$
4,246,070
 
$
3,556,496
 
                           
Earnings per common share:
                          
Basic
  
$
0.23
 
$
0.19
 
$
0.45
 
$
0.38
 
Diluted
  
$
0.22
 
$
0.18
 
$
0.44
 
$
0.37
 
 
See accompanying notes to consolidated financial statements.

 
  - 4 -  
 

PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
   
Three Months Ended
Six Months Ended
   
June 30,
June 30,
   
2004
2003
2004
2003
           
Net income
  
$
2,119,789
 
$
1,731,651
 
$
4,246,070
 
$
3,556,496
 
                           
Other comprehensive income (loss):
                          
Unrealized holding gains (losses) arising during the
                          
period, net of tax (benefit) of ($1,088,490) and $402,719
                         
for the quarter and ($624,966) and $260,158
                         
for the year to date
    
(2,112,949
)
  
781,749
   
(1,212,407
)
  
505,014
 
Reclassification adjustment for (gains) losses
                          
included in net income, net of tax (benefit) of ($347)
                         
and $36,448 for the quarter and $196 and $121,643
                          
for the year to date
    
673
   
(70,751
)
  
(380
)
  
(236,131
)
     
(2,112,276
)
  
710,998
   
(1,212,787
)
  
268,883
 
                           
Comprehensive income
  
$
7,513
 
$
2,442,649
 
$
3,033,283
 
$
3,825,379
 

See accompanying notes to consolidated financial statements.

 
  - 5 -  
 

PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2004 AND YEAR ENDED DECEMBER 31, 2003
 

           
Accumulated
  
       
Additional
  
Other
  
   
Common Stock
Paid-in
Retained
Comprehensive
  
   
Shares
Par Value
Capital
Earnings
Income (Loss)
Total
               
Balance, December 31, 2002
    
9,430,413
 
$
1,217,065
 
$
28,785,476
 
$
40,228,327
 
$
1,033,870
 
$
71,264,738
 
Net income
    
-
   
-
   
-
   
7,125,518
   
-
   
7,125,518
 
Other comprehensive loss
    
-
   
-
   
-
   
-
   
(1,154,969
)
  
(1,154,969
)
Cash dividends declared,
                                     
$.18 per share
    
-
   
-
   
-
   
(1,702,345
)
  
-
   
(1,702,345
)
Stock options exercised
    
54,247
   
-
   
529,224
   
-
   
-
   
529,224
 
Balance, December 31, 2003
    
9,484,660
   
1,217,065
   
29,314,700
   
45,651,500
   
(121,099
)
  
76,062,166
 
Net income
    
-
   
-
   
-
   
4,246,070
   
-
   
4,246,070
 
Other comprehensive loss
    
-
   
-
   
-
   
-
   
(1,212,787
)
  
(1,212,787
)
Cash dividends declared,
                                     
$.14 per share
    
-
   
-
   
-
   
(1,331,477
)
  
-
   
(1,331,477
)
Stock acquired and cancelled
                                      
under stock repurchase plan
    
(20,000
)
  
-
   
(241,288
)
  
-
   
-
   
(241,288
)
Stock options exercised
    
31,700
   
-
   
212,065
   
-
   
-
   
212,065
 
Balance, June 30, 2004
    
9,496,360
 
$
1,217,065
 
$
29,285,477
 
$
48,566,093
 
$
(1,333,886
)
$
77,734,749
 
 
See accompanying notes to consolidated financial statements.
 
 
  - 6 -  
 
 
PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(Unaudited)
 
     
2004
 
  
2003
  
               
CASH FLOWS FROM OPERATING ACTIVITIES
              
Net income
  
$
4,246,070
 
$
3,556,496
 
Adjustments to reconcile net income to net cash
              
provided by operating activities:
              
Depreciation, amortization and accretion, net
    
1,329,073
   
1,731,596
  
Provision for loan losses
    
-
   
-
 
Net realized gain on securities transactions
    
(576
)
  
(357,774
)
Net gain (loss) on disposal of assets
    
(27,169
)
  
123,567
 
Increase in cash value of bank-owned life insurance
    
(144,030
)
  
(237,638
)
Increase (decrease) in deferred compensation accrual
    
(13,486
)
  
69,027
 
Decrease in retirement accruals
    
(196,541
)
  
(182,376
)
Decrease in taxes receivable
    
258,299
   
10,507
 
Decrease in interest receivable
    
316,945
   
521,910
 
Decrease in interest payable
    
(111,053
)
  
(223,852
)
Net increase in prepaid expenses and other assets
    
(329,955
)
  
(107,205
)
Net decrease in accrued expenses and other liabilities
    
(526,604
)
  
(481,082
)
Net cash provided by operating activities
    
4,800,973
   
4,423,176
 
               
CASH FLOWS FROM INVESTING ACTIVITIES
              
(Increase) decrease in interest-bearing deposits in other banks
    
(1,063,882
)
  
64,022
 
(Increase) decrease in Federal funds sold
    
(12,211,563
)
  
21,923,000
 
Purchase of securities available for sale
    
(6,255,684
)
  
(92,706,407
)
Proceeds from sales and calls of securities available for sale
    
12,362,355
   
36,659,399
 
Proceeds from maturities and paydowns of securities available for sale
    
10,660,983
   
14,800,721
 
Purchase of restricted and other equity investments
    
(723,400
)
  
(1,444,700
)
Redemption of restricted and other equity investments
    
600
   
543,800
 
Net (increase) decrease in loans
    
(16,891,104
)
  
23,076,594
 
Purchase of premises and equipment
    
(405,605
)
  
(665,149
)
Proceeds from disposal of assets
    
1,595,899
   
740,135
 
Net cash provided by (used in) investing activities
    
(12,931,401
)
  
2,991,415
 
               
CASH FLOWS FROM FINANCING ACTIVITIES
              
Net increase (decrease) in deposits
    
8,696,713
   
(33,500,171
)
Net increase (decrease) in Federal funds purchased and
              
securities sold under repurchase agreements
    
(15,945,538
)
  
7,500,848
 
Advances from Federal Home Loan Bank
    
14,848,400
   
36,000,000
 
Payments on Federal Home Loan Bank advances
    
(241,057
)
  
(12,653,221
)
Dividends paid
    
(1,329,755
)
  
(287,313
)
Proceeds from the exercise of stock options
    
212,065
   
41,935
 
Acquisition of stock under stock repurchase plan
    
(241,288
)
  
-
 
Repurchase of preferred stock in REIT subsidiaries
    
-
   
(3,000
)
Net cash provided by (used in) financing activities
    
5,999,540
   
(2,900,922
)

 
  - 7 -  
 

PAB BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(Unaudited)

   
2004
2003
       
Net increase (decrease) in cash and due from banks
  
$
(2,130,888
)
$
4,513,669
 
               
Cash and due from banks at beginning of period
    
22,920,218
   
25,199,278
 
               
Cash and due from banks at end of period
  
$
20,789,330
 
$
29,712,947
 
               
               
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
              
Cash paid during the period for:
              
Interest
  
$
4,922,082
 
$
7,071,269
 
Taxes
  
$
1,781,094
 
$
1,595,000
 
               
               
NONCASH INVESTING AND FINANCING TRANSACTIONS
              
Increase (decrease) in unrealized gains on securities available for sale
  
$
(1,837,556
)
$
407,399
 
Transfer of premises and equipment to other assets
  
$
-
 
$
551,269
 

See accompanying notes to consolidated financial statements.

 
  - 8 -  
 
 
PAB BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
NOTE 1. NATURE OF BUSINESS
 
PAB Bankshares, Inc, (the Company) is a bank holding company whose business is primarily conducted by its wholly-owned commercial bank subsidiary, The Park Avenue Bank (the Bank). The Bank is a state-chartered, member bank of the Federal Reserve System that was originally founded in 1956 in Valdosta, Lowndes County, Georgia. Through the Bank, the Company offers a broad range of commercial and consumer banking products and services to customers located primarily in the local market areas listed below. The Company and the Bank are subject to the regulations of certain federal and state agencies and are periodically examined by those regulatory agencies.


Banking Locations
  
Number of Offices
South Georgia Market:
    
Valdosta, Lowndes County, Georgia
  
3 (including the main office)
Lake Park, Lowndes County, Georgia
  
1
Adel, Cook County, Georgia
  
1
Bainbridge, Decatur County, Georgia
  
3
Cairo, Grady County, Georgia
  
1
Statesboro, Bulloch County, Georgia
  
2
Baxley, Appling County, Georgia
  
1
Hazlehurst, Jeff Davis County, Georgia
  
1
North Georgia Market:
    
McDonough, Henry County, Georgia
  
1
Stockbridge, Henry County, Georgia
  
1 (opened July 1, 2004)
Oakwood, Hall County, Georgia
  
1
Athens, Clarke County, Georgia
  
1 (loan production office)
Florida Market:
    
Ocala, Marion County, Florida
  
1
St. Augustine, St. Johns County, Florida
  
1 (loan production office)
 
The Company also owns PAB Bankshares Capital Trust I, a Delaware statutory business trust. This non-operating subsidiary was created in 2001 for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debt issued by the Company. During the first quarter of 2004, the Company adopted FASB Interpretation No. 46R (Revised December 2003), "Consolidation of Variable Interest Entities". This interpretation addresses consolidation by business entities of variable interest entities and when such entities are subject to consolidation under the provisions of this Interpretation. The Company has determined that the revised provisions required deconsolidation of the subsidiary trust which issued the trust preferred securities. The Interpretation did not have a material effect on the Co mpany’s financial condition or results of operations.

The Company has two real estate investment trusts (REIT’s) and two intermediate REIT holding companies as subsidiaries of the Bank. The REIT’s were established to realize state income tax benefits and to provide the Bank with ready access to capital markets if additional capital were needed. The REIT holding companies were established to provide assistance in managing the Company’s investment in the REIT’s. To comply with Federal tax law, a minority interest in the non-voting, cumulative preferred stock of the REIT’s was issued to certain directors, officers and employees of the Company. The $500 par value preferred stock pays an 8% annual dividend. The total minority interest of the REIT’s included in other liabilities was $117,000 as of June 30, 2004 and December 31, 2003.
 
 
 - 9 -  
 
 
PAB BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
NOTE 2.  BASIS OF PRESENTATION
 
The accompanying consolidated financial information of the Company is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations. The results of operations for the three months and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the full year. These statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.
 
The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany transactions and balances are eliminated in consolidation.
 
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of goodwill, the valuation of foreclosed assets and deferred taxes.
 
NOTE 3.  EARNINGS PER SHARE
 
The following table sets forth the computation of basic and diluted earnings per share:

 
 
Three Months Ended
Six Months Ended
 
 
June 30,
June 30,
 
 
2004
2003
2004
2003
Basic earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
2,119,789
 
$
1,731,651
 
$
4,246,070
 
$
3,556,496
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
9,515,438
 
 
9,431,644
 
 
9,507,735
 
 
9,431,032
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share
 
$
0.23
 
$
0.19
 
$
0.45
 
$
0.38
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
2,119,789
 
$
1,731,651
 
$
4,246,070
 
$
3,556,496
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
9,515,438
 
 
9,431,644
 
 
9,507,735
 
 
9,431,032
 
Effect of dilutive stock options
 
 
125,399
 
 
122,701
 
 
158,022
 
 
76,516
 
Weighted average diluted common
 
 
 
 
 
 
 
 
 
 
 
 
 
shares outstanding
 
 
9,640,837
 
 
9,554,345
 
 
9,665,757
 
 
9,507,548
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share
 
$
0.22
 
$
0.18
 
$
0.44
 
$
0.37
 

 
 - 10 -  
 
 
PAB BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 4.  STOCK-BASED EMPLOYEE COMPENSATION
 
The Company accounts for stock options under its stock option plans based on the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. The following table illustrates the effect on net income and earnings per share for the three months and six months ended June 30, 2004 and 2003 if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.


   
Three Months Ended
Six Months Ended
   
June 30,
June 30,
   
2004
2003
2004
2003
           
Net income, as reported
  
$
2,119,789
 
$
1,731,651
 
$
4,246,070
 
$
3,556,496
 
Deduct:
                          
Total stock-based employee compensation expense
                          
determined under fair value based method for all
                         
awards, net of related tax effects
    
(54,269
)
  
(59,047
)
  
(108,689
)
  
(115,484
)
Pro forma net income
  
$
2,065,520
 
$
1,672,604
 
$
4,137,381
 
$
3,441,012
 
                           
Earnings per share:
                          
Basic - as reported
  
$
0.23
 
$
0.19
 
$
0.45
 
$
0.38
 
Basic - pro forma
  
$
0.22
 
$
0.18
 
$
0.44
 
$
0.36
 
Diluted - as reported
  
$
0.22
 
$
0.18
 
$
0.44
 
$
0.37
 
Diluted - pro forma
  
$
0.21
 
$
0.18
 
$
0.43
 
$
0.36
 
 
  - 11 -  
 
 
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
 
Some of the statements in this Report, including, without limitation, matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operation", as well as oral statements made by PAB Bankshares, Inc. ("PAB", and also referred to in this Report as either "the Company", "we", "us", or "our") or the officers, directors, or employees of PAB may constitute "forward-looking statements" under federal securities laws. Forward-looking statements include statements about the competitiveness of the banking industry, potential regulatory obligations, potential share repurchases, our entrance and expansion into higher growth markets, our other business strategies and other statements that are not historical facts. When we use words like "anticipate", "believe", "intend", "plan ", "expect", "estimate", "could", "should", "will" and similar expressions, you should consider them as identifying forward-looking statements. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions, and on the information available to us at the time that these disclosures were prepared. Factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements include, among others, the following possibilities: (1) competitive pressures among depository and other financial institutions may increase significantly; (2) changes in the interest rate environment may reduce margins; (3) general economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and/or a reduction in demand for credit; (4) legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which we are engaged; (5) competi tors may have greater financial resources and develop products that enable such competitors to compete more successfully than us; (6) adverse changes may occur in the bond and equity markets; (7) war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets; and (8) restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals. Many of such factors are beyond our ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. We disclaim any obligation to update or revise any forward-looking statements contained in this Report, whether as a result of new information, future events or otherwise.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
 
The following discussion and analysis of the consolidated financial condition and results of operations of the Company should be read in conjunction with the Annual Consolidated Financial Statements and related Notes included in the Company’s 2003 Annual Report on Form 10-K, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2003 Annual Report on Form 10-K, and is qualified in its entirety by the foregoing and other more detailed financial information appearing elsewhere. Historical results of operations and the percentage relationships among any amounts included, and any trends which may appear to be inferred, should not be taken as being necessarily indicative of trends in operations or results of operations for any future periods.
 
We generally group our offices into three geographic regions for discussion purposes due to the varying demographics of each market. Our offices in Lowndes, Cook, Decatur, Grady, Bulloch, Appling and Jeff Davis counties are collectively referred to as our "South Georgia" market. Our offices in Henry, Hall, and Clarke counties are referred to collectively as our "North Georgia" market in this Report. Our offices in Marion and St. Johns counties are collectively referred to as our "Florida" market. In addition, we hold our corporate assets, correspondent account balances, investment portfolio, out-of-market participation loans, insider loans and deposits, etc. at the corporate level, in the "Treasury".
 
FINANCIAL CONDITION
 
During the six months ended June 30, 2004, total assets grew $8.5 million, or 1.2%, from $730.7 million as of the end of 2003 to $739.2 million at the end of the second quarter. Total loans increased $15.9 million, or 3.0%, and total deposits increased $8.7 million, or 1.6%, during the same period. Of the $8.7 million in net deposit growth for the year, $8.0 million was deposited into the Bank during the quarter by a local public funds account. We used $14.8 million in new advances from the Federal Home Loan Bank of Atlanta (the "FHLB"), cash flows from our investment portfolio, and the deposit growth to fund the increase in loans during the six months ended June 30, 2004. The balance of the investment cash flows and deposit growth has been temporarily invested in Fed Funds and will be used to meet liquidity needs, pay of f debt, or reinvested in loans or securities.

 
  - 12 -  
 

Our loan portfolio continues to grow at a modest pace. Loans in North Georgia have increased $18.5 million (10.3%) since year end with the majority of the growth being construction and development loans. Loans in South Georgia have decreased $4.4 million (1.5%) since year end, and loans in Florida have increased $5.4 million (12.9%) since year end. Broken down by market, the loan portfolio consists of $198.3 million (35.8%) in North Georgia, $282.0 million (50.9%) in South Georgia, $47.4 million (8.5%) in Florida, and $26.8 million (4.8%) in the Treasury.
 
The following table highlights the changes in the composition of the loan portfolio over the past six months.

As of Quarter End
  
Jun-04
% of Total
Dec-03
% of Total
   
(Dollars In Thousands)
Commercial and financial
  
$
50,151
   
9.0
%
$
53,849
   
10.0
%
Agricultural (including loans secured by farmland)
    
27,005
   
4.9
%
  
24,071
   
4.5
%
Real estate - construction
    
114,794
   
20.7
%
  
100,150
   
18.6
%
Real estate - mortgage (commercial and residential)
    
340,081
   
61.3
%
  
332,004
   
61.6
%
Installment loans to individuals and other loans
    
23,193
   
4.2
%
  
29,366
   
5.5
%
     
555,224
   
100.1
%
  
539,440
   
100.1
%
Unearned income, net
    
(700
)
  
-0.1
%
  
(796
)
  
-0.1
%
     
554,524
   
100.0
%
  
538,644
   
100.0
%
Allowance for loan losses
    
(9,609
)
  
-1.7
%
  
(10,139
)
  
-1.9
%
 
  
$
544,915
   
98.3
%
$
528,505
   
98.1
%
 
Stockholders’ equity was 10.5% of total assets at quarter end. Total equity has increased $1.7 million, or 2.2%, since year end. This increase is primarily the net result of $4.2 million in earnings, less $1.3 million in dividends and a $1.2 million decrease in the market value of our securities portfolio. We declared a second quarter 2004 dividend of $0.07 per common share payable to stockholders of record on June 30, 2004. We announced a 400,000 share stock buyback plan during the second quarter of 2004, and we repurchased and cancelled 20,000 shares of our common stock under the plan during the quarter.
 
RESULTS OF OPERATIONS
 
Net income for the three months ended June 30, 2004 was $2.1 million, or $0.22 per diluted share, as compared to $1.7 million, or $0.18 per diluted share, during the same period in 2003. The $388,000 increase in net income is the net result of a $350,000 increase in net interest income (or $348,000 on a taxable-equivalent basis), a $397,000 decrease in other income, a $612,000 decrease in other expenses, and a $177,000 increase in income tax expense.
 
Net income for the six months ended June 30, 2004 was $4.2 million, or $0.44 per diluted share, as compared to $3.6 million, or $0.37 per diluted share, during the same period in 2003. The $690,000 increase in net income is the net result of a $684,000 increase in net interest income (or $683,000 on a taxable-equivalent basis), a $752,000 decrease in other income, a $1,191,000 decrease in other expenses, and a $433,000 increase in income tax expense.
 
The reasons for these changes are discussed in more detail below.
 
Net Interest Income
The primary component of a financial institution’s profitability is net interest income, or the difference between the interest income earned on assets, primarily loans and investments, and interest paid on liabilities, primarily deposits and other borrowed funds. For the three months ended June 30, 2004, our net interest income on a taxable-equivalent basis was $7.2 million, a 5.1% increase over the $6.9 million in net interest income for the second quarter of 2003. For the six months ended June 30, 2004, net interest income on a taxable-equivalent basis was $14.4 million, a 5.0% increase over the $13.7 million in net interest income for the same period in 2003. The improvement in net interest income for the quarter and year to date is primarily the result of our aggressive management of our interest expense. With t he majority of our earning assets repricing downward, we had to lower our deposit rates and refinance our other borrowings at lower rates to offset the decrease in interest income.

 
  - 13 -  
 
 
For the second quarter of 2004, total interest income on a taxable-equivalent basis was $9.6 million, a 5.2% decrease compared to $10.1 million earned during the same period in 2003. The decrease in interest income was due primarily to a 38 basis point decrease in the average yield earned on those earning assets between the periods. Total interest expense was $2.4 million, a 26.8% decrease compared to $3.3 million paid during the same period in 2003. The decrease in interest expense was due primarily to a 60 basis point decrease in the average rate paid on those interest-bearing liabilities between the periods.
 
For the first half of 2004, total interest income on a taxable-equivalent basis was $19.2 million, a 6.2% decrease compared to $20.5 million earned during the same period in 2003. The decrease in interest income was due primarily to a 45 basis point decrease in the average yield earned on those earning assets between the periods. Total interest expense was $4.8 million, a 29.7% decrease compared to $6.8 million paid during the same period in 2003. The decrease in interest expense was due primarily to a 71 basis point decrease in the average rate paid on those interest-bearing liabilities between the periods.
 
The net interest margin is net interest income expressed as a percentage of average earning assets. Our net interest margin for the second quarter of 2004 was 4.28%, 15 basis points higher than our net interest margin of 4.13% during the same period in 2003. For the six months ended June 30, 2004, our net interest margin was 4.31%, 17 basis points higher than our net interest margin of 4.14% for the same period in 2003. Both of these improved margins are primarily the result of a lower cost of funds compared to the three and six months periods ending June 30, 2003.
 
The following tables detail the average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned and paid, and the average yields and rates for the three months and six months ended June 30, 2004 and 2003. Federally tax-exempt income is presented on a taxable-equivalent basis assuming a 34% Federal tax rate. Loan average balances include loans on nonaccrual status.

For the Quarter Ended June 30,
  
 
  
2004
  
 
  
 
  
2003
  
 
  
       
Interest
  
Average
      
Interest
  
Average
  
   
Average
  
Income/
  
Yield/
  
Average
  
Income/
  
Yield/
  
 
  
Balance
  
Expense
  
Rate
  
Balance
  
Expense
  
Rate
  
   
(Dollars In Thousands)
  
Interest-earning assets:
                          
Loans
  
$
551,675
 
$
8,361
   
6.10
%
$
541,836
 
$
8,954
   
6.63
%
Investment securities:
                                      
Taxable
    
103,222
   
1,075
   
4.19
%
  
105,155
   
998
   
3.81
%
Nontaxable
    
8,611
   
127
   
5.96
%
  
8,578
   
133
   
6.25
%
Other short-term investments
    
14,019
   
32
   
0.92
%
  
11,893
   
35
   
1.18
%
Total interest-earning assets
  
$
677,527
 
$
9,595
   
5.70
%
$
667,462
 
$
10,120
   
6.08
%
Interest-bearing liabilities:
                                      
Demand deposits
  
$
169,654
 
$
256
   
0.61
%
$
165,803
 
$
378
   
0.92
%
Savings deposits
    
42,448
   
56
   
0.53
%
  
39,438
   
76
   
0.77
%
Time deposits
    
253,012
   
1,575
   
2.50
%
  
285,368
   
2,225
   
3.13
%
FHLB advances
    
55,614
   
279
   
2.02
%
  
45,102
   
397
   
3.53
%
Notes payable
    
10,310
   
140
   
5.45
%
  
10,000
   
128
   
5.13
%
Other short-term borrowings
    
26,483
   
75
   
1.14
%
  
16,010
   
50
   
1.25
%
Total interest-bearing liabilities
  
$
557,521
 
$
2,381
   
1.72
%
$
561,721
 
$
3,254
   
2.32
%
                                       
Interest rate spread
                
3.98
%
              
3.76
%
Net interest income
        
$
7,214
             
$
6,866
       
Net interest margin
                
4.28
%
              
4.13
%
 
 
  - 14 -  
 
 
For the Six Months Ended June 30,
  
 
  
2004
  
 
  
 
  
2003
  
 
  
       
Interest
  
Average
      
Interest
  
Average
  
   
Average 
 
  
Income/
    
Yield/
    
Average
    
Income/
    
Yield/
  
   
Balance 
    
Expense
    
Rate
    
Balance
    
Expense
    
Rate
  
 
(Dollars In Thousands) 
Interest-earning assets:
                                      
Loans
  
$
546,612
 
$
16,612
   
6.11
%
$
548,202
 
$
18,277
   
6.72
%
Investment securities:
                                      
Taxable
    
108,340
   
2,316
   
4.30
%
  
97,513
   
1,950
   
4.03
%
Nontaxable
    
8,706
   
260
   
6.00
%
  
8,307
   
261
   
6.34
%
Other short-term investments
    
8,863
   
39
   
0.90
%
  
15,461
   
92
   
1.20
%
Total interest-earning assets
  
$
672,521
 
$
19,227
   
5.75
%
$
669,483
 
$
20,580
   
6.20
%
Interest-bearing liabilities:
                                      
Demand deposits
  
$
167,453
 
$
510
   
0.61
%
$
168,576
 
$
828
   
0.99
%
Savings deposits
    
41,561
   
112
   
0.54
%
  
38,913
   
157
   
0.81
%
Time deposits
    
254,102
   
3,220
   
2.55
%
  
290,564
   
4,658
   
3.23
%
FHLB advances
    
50,743
   
529
   
2.10
%
  
39,743
   
842
   
4.27
%
Notes payable
    
10,310
   
266
   
5.19
%
  
10,000
   
258
   
5.22
%
Other short-term borrowings
    
30,516
   
174
   
1.14
%
  
16,402
   
104
   
1.28
%
Total interest-bearing liabilities
  
$
554,685
 
$
4,811
   
1.74
%
$
564,198
 
$
6,847
   
2.45
%
                                       
Interest rate spread
                
4.01
%
              
3.75
%
Net interest income
        
$
14,416
             
$
13,733
       
Net interest margin
                
4.31
%
              
4.14
%
 
Provision for Loan Losses
For the three and six months ended June 30, 2004 and June 30, 2003, there were no provisions for loan losses recorded. Based on our monthly assessments of the allowance for loan losses during the quarter, no provisions were needed. As an integral part of our credit risk management process, we regularly review loans in our portfolio for credit quality and documentation of collateral. As outlined below, our levels of nonperforming loans and loan losses have improved over recent years. In addition, our loans past due 30 days or more was down to 0.72% of total loans at June 30, 2004, a significant improvement compared to our ratios in the three to four percent range from two years ago. The economy is growing and commercial loan demand is improving. However, we continue to be concerned with the levels of consumer debt a nd the high level of consumer bankruptcies in our markets. We recognize the potential risk that rising interest rates and inflation could have a negative impact on both our consumer and commercial borrowers. We also recognize the potential risks associated with the growing concentration of construction and development loans in our loan portfolio, and we have made adjustments for those environmental factors in our determination of the adequacy of the allowance for loan losses at June 30, 2004.

At June 30, 2004, the allowance for loan losses as a percent of total loans was 1.73%, compared to 1.88% at December 31, 2003. We consider the current level of the allowance for loan losses adequate to absorb losses from loans in the portfolio. We have a comprehensive methodology for determining the adequacy of our allowance for loan losses. This methodology includes an assessment for specific valuations on larger loan lines and nonperforming loans, and an assessment based on environmental factors applied to other homogenous groups of otherwise performing loans. The environmental factors considered in developing our loss measurements include:

· levels of and trends in delinquencies and impaired loans;
· levels of and trends in charge-offs and recoveries;
· trends in volume and terms of loans;
· effects of any changes in risk selection and underwriting standards and other changes in lending policies, procedures, and practices;
· experience, ability, and depth of lending management and other relevant staff;
· national and local economic trends and conditions;
· industry conditions;
· and effects of changes in credit concentrations.
 
 
  - 15 -  
 
 
This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. While we use the best information available to make the evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or other environmental factors. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The table below summarizes our levels of nonperforming loans over the past five quarters.

As of Quarter End
  
Jun-04
Mar-04
Dec-03
Sep-03
Jun-03
     
(Dollars in Thousands)
Loans accounted for on a nonaccrual basis
  
$
4,484
 
$
4,868
 
$
7,048
 
$
7,230
 
$
9,842
 
Accruing loans which are contractually past due
                                
90 days or more as to principal or interest payments
    
9
   
-
   
-
   
-
   
-
 
Troubled debt restructurings not included above
    
2,179
   
2,188
   
1,168
   
1,176
   
1,188
 
Total nonperforming loans
  
$
6,672
 
$
7,056
 
$
8,216
 
$
8,406
 
$
11,030
 
                                 
Total nonperforming loans as a percentage of
                                
total loans
    
1.20
%
  
1.28
%
  
1.53
%
  
1.58
%
  
2.08
%

For the six month period ended June 30, 2004, we recorded $1,057,000 in loan losses and we recovered $527,000 in previously charged-off loans, for a net loss of $530,000, or 0.19% of average loans on an annualized basis. This is an improvement in both the levels of charge-offs and recoveries over the same period in 2003. For the six month period ended June 30, 2003, we recorded $1,677,000 in loan losses and we recovered $308,000 in previously charged-off loans, for a net loss of $1,369,000, or 0.50% of average loans on an annualized basis.


Other Income
A summary of noninterest income follows:

   
Second Quarter
  
Year To Date
  
 
  
2004
2003
Pct. Chg.
2004
2003
Pct. Chg.
   
(Dollars in Thousands)
Noninterest income:
              
Service charges on deposit account
  
$
1,094
 
$
1,288
   
-15.0
%
$
2,160
 
$
2,534
   
-14.8
%
Mortgage origination fees
    
133
   
201
   
-33.7
%
  
236
   
431
   
-45.3
%
Securities transactions, net
    
(1
)
  
107
   
-100.9
%
  
1
   
358
   
-99.7
%
Gain on sale of financial services operation
    
-
   
-
   
-
   
200
   
-
   
-
 
Earnings on bank-owned life insurance
    
46
   
156
   
-70.5
%
  
144
   
238
   
-39.5
%
Gain (loss) on disposal of assets
    
10
   
(189
)
  
105.3
%
  
20
   
(194
)
  
110.3
%
Other noninterest income
    
208
   
324
   
-35.9
%
  
535
   
681
   
-21.5
%
Total noninterest income
  
$
1,490
 
$
1,887
   
-21.0
%
$
3,296
 
$
4,048
   
-18.6
%

Service charges on deposit accounts decreased due to a decrease in volume of overdraft and non-sufficient funds charges. Mortgage origination fees decreased due to a decline in the volume of mortgage originations and refinancings as mortgage rates have risen. Earnings on bank-owned life insurance decreased primarily as a result of decreased earnings on these policies compared to 2003. Gains on disposal of assets improved from a net loss in 2003 to a net gain in 2004 due to a decrease in the volume of foreclosed asset transactions and the subsequent recording of losses associated with their disposition. The decrease in other noninterest income is primarily due to the disposal of our financial services operation during the first quarter of 2004 and the corresponding absence of brokerage fees earned.
 
 
  - 16 -  
 

Other Expenses

A summary of noninterest expense follows:

   
Second Quarter
  
Year To Date
  
 
  
2004
2003
Pct. Chg.
2004
2003
Pct. Chg.
   
(Dollars in Thousands)
Noninterest expenses:
              
Salaries and wages
  
$
2,821
 
$
3,137
   
-10.1
%
$
5,709
 
$
6,338
   
-9.9
%
Deferred loan cost
    
(185
)
  
(98
)
  
88.8
%
  
(355
)
  
(217
)
  
63.6
%
Employee benefits
    
705
   
779
   
-9.5
%
  
1,560
   
1,690
   
-7.7
%
Net occupancy expense of premises
    
460
   
443
   
3.8
%
  
902
   
878
   
2.7
%
Furniture and equipment expense
    
523
   
615
   
-15.0
%
  
1,050
   
1,202
   
-12.6
%
Advertising and business development
    
104
   
102
   
2.0
%
  
212
   
201
   
5.5
%
Supplies and printing
    
99
   
148
   
-33.1
%
  
220
   
300
   
-26.7
%
Telephone and internet charges
    
89
   
115
   
-22.6
%
  
167
   
257
   
-35.0
%
Postage and courier
    
140
   
141
   
-0.7
%
  
282
   
281
   
0.4
%
Legal and accounting fees
    
105
   
171
   
-38.6
%
  
165
   
281
   
-41.3
%
Other noninterest expense
    
752
   
672
   
11.9
%
  
1,427
   
1,319
   
8.2
%
Total noninterest expense
  
$
5,613
 
$
6,225
   
-9.8
%
$
11,339
 
$
12,530
   
-9.5
%

Salaries and wages expense and employee benefits were down due primarily to a 6% decline in the number of employees from 295 (full-time equivalents) as of June 30, 2003 to 277 as of June 30, 2004. Deferred loan cost, a credit against salaries and wages, increased and resulted in a decrease in expense reported during the period. The increase in the deferral of direct loan costs is due to an increase in loan volume experienced during 2004 compared to the same period in 2003. Furniture and equipment expense decreased primarily as a result of decreased depreciation expense. Occupancy costs are up primarily as a result of increases in insurance, maintenance costs, and property taxes. Supplies and printing costs decreased as a result of tighter cost control measures and centralized purchasing. Telephone and internet char ges have decreased as a result of technological investments. Legal and accounting fees decreased from the higher expenses incurred in 2003 on the collection and recovery of problem loans and regulatory matters.


Income Tax Expense
As a percentage of net income before taxes, income tax expense was 32.4% and 31.1% for the six months ending June 30, 2004 and June 30, 2003, respectively. The increase in income tax expense for 2004 compared to the same periods in 2003 are a direct result of an increase in income before income tax expense.


LIQUIDITY AND CAPITAL RESOURCES

Liquidity is an important factor in our financial condition and affects our ability to meet the borrowing needs and deposit withdrawal requirements of our customers. Assets, consisting primarily of loans and investment securities, are funded by customer deposits, borrowed funds, and retained earnings. Maturities in the investment and loan portfolios also provide a steady flow of funds for reinvestment. In addition, our liquidity continues to be enhanced by a relatively stable core deposit base and the availability of additional funding sources.

At June 30, 2004, our ratio of liquid assets (defined as the sum of cash and due from bank balances, interest-bearing deposits in other banks, Fed Funds sold, and investment securities) to total assets was 18.74%, compared to 19.90% at December 31, 2003. It is our policy to maintain a ratio of liquid assets to total assets of at least 15%.

The Company opened a new branch office in Stockbridge, Henry County, Georgia on July 1, 2004. We are leasing the office and will invest approximately $110,000 in leasehold improvements, furniture, fixtures and equipment. We are funding these expenditures with cash provided from operations in 2004. There are no additional binding commitments for material cash expenditures outstanding at this time.
 
 
  - 17 -  
 

Contractual Obligations
Summarized below are our contractual obligations as of June 30, 2004.

     
Less than
1 to 3
3 to 5
More than
Contractual Obligations
  
Total
1 year
years
years
5 years
   
(Dollars in Thousands)
FHLB Advances
  
$
59,321
 
$
2,930
 
$
15,731
 
$
10,341
 
$
30,319
 
Operating Lease Obligations
    
671
   
162
   
288
   
221
   
-
 
Guaranteed Preferred Beneficial Interests
                                
in Debentures
    
10,310
   
-
   
-
   
-
   
10,310
 
   
$
70,302
 
$
3,092
 
$
16,019
 
$
10,562
 
$
40,629
 
 
Off Balance Sheet Arrangements
Our financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of business. These off-balance sheet financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are included in the financial statements when funds are distributed or the instruments become payable. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and credit card commitments is represented by the contractual amount of those instruments. We use the same credit policies in making commitments as we do for on-balance sheet instruments. Although these amounts do not necessarily represent future cash requirements, a summary of our c ommitments as of June 30, 2004 and December 31, 2003 are as follows:

   
Jun-04
Dec-03
   
(Dollars in Thousands)
Commitments to extend credit
  
$
99,257
 
$
84,533
 
Standby letters of credit
  
$
3,075
 
$
2,755
 
 
Stockholders’ Equity
The Company maintains a ratio of stockholders’ equity to total assets that is considered adequate according to regulatory standards. The Company and the Bank are required to comply with capital adequacy standards established by banking regulators. At June 30, 2004, the Company and the Bank were in compliance with those standards. There are no conditions or events since quarter end that we believe have changed our capital ratings.

The following table summarizes the regulatory capital ratios of the Company and the Bank at June 30, 2004.

     
Minimum
 
Company
  
Regulatory
 
Consolidated
Bank
Requirement
Total Capital to Risk Weighted Assets
15.2%
14.5%
8.0%
Tier 1 Capital to Risk Weighted Assets
14.0%
13.3%
4.0%
Tier 1 Capital to Average Assets (Leverage Ratio)
11.4%
10.8%
4.0%
 
On May 25, 2004, the Company announced a plan to repurchase up to 400,000 shares of the Company’s common stock over the next twelve-month period. The Company plans to use cash on hand to repurchase its shares on the open market. At June 30, 2004, the Company had $5.52 million cash on hand. As of June 30, 2004, 20,000 shares had been purchased for an average price of $12.06. The expiration date for this plan is May 25, 2005.    
 
 
  - 18 -  
 
 
CRITICAL ACCOUNTING ESTIMATES   
 
The preparation of financial statements and the related disclosures in conformity with accounting principles generally accepted in the United States requires that management make estimates and assumptions which affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that our determination of the allowance for loan losses and the fair value of assets, including the impairment of goodwill, affect our most significant judgments and estimates used in the preparation of our consolidated financial statements. The Company’s accounting policies are described in detail in Note 1 of our Consolidated F inancial Statements provided in Item 8 of our 2003 Annual Report on Form 10-K. The following is a brief description of the Company’s critical accounting estimates involving significant management valuation judgment.
 
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on management’s assessment of several factors including, but not limited to, reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on segments of the loan portfolio, historical loan loss experiences and the level of classified and nonperforming loans.
 
Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses assumptions (e.g., discount rate) and methodologies (e.g., comparison to the recent selling price of similar assets) consistent with those that would be utilized by unrelated third parties.
 
Management’s assessment is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Changes in various internal and external environmental factors including, but not limited to, the financial condition of individual borrowers, economic conditions, historical loss experience, or the condition of the various markets in which collateral may be sold may affect the required level of the allowance for loan losses and the associated provision for loan losses. Should these environmental factors change, a different amount may be reported for the allowance for loan losses and the associated provision for loan losses.
 
Estimates of Fair Value
The estimation of fair value is significant to a number of the Company’s assets, including, but not limited to, investment securities, goodwill, other real estate owned, and other repossessed assets. These are all recorded at either fair value or at the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, discount rates, or market interest rates. Our estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
 
Fair values for most investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments. The fair values of other real estate owned are typically determined based on appraisals by third parties, less estimated costs to sell.
 
Estimates of fair value are also required in performing an impairment analysis of goodwill. The Company reviews goodwill for impairment on at least an annual basis and whenever events or circumstances indicate the carrying value may not be recoverable. An impairment would be indicated if the carrying value exceeds the fair value of a reporting unit.
 
Recent Accounting Pronouncements
 
In management’s opinion, there are no recent accounting pronouncements that have had or will have had a material impact on our earnings or financial position as of or for the quarter and the six months ended June 30, 2004.
 
 
  - 19 -  
 
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are subject to exposure to U.S. dollar interest rate changes and accordingly, we manage our exposure by considering the possible changes in the net interest margin. We do not engage in trading activity nor do we classify any portion of the investment portfolio as held for trading. We do not engage in any hedging activities or enter into any derivative instruments with a higher degree of risk than mortgage-backed securities, which are commonly-held pass through securities. Finally, we have no material direct exposure to foreign currency exchange rate risk, commodity price risk, and other market risks.
 
Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as "interest rate risk." The repricing of interest earning assets and interest-bearing liabilities can influence the changes in net interest income. As part of our asset/liability management program, the timing of repriced assets and liabilities is referred to as gap management. It is our policy to maintain a gap ratio in the one-year time horizon between 0.80 and 1.20. However, with interest rates at historic lows and the steep shape of the interest rate curve, the Company has exceeded policy limits by adjusting the balance sheet to a more asset-sensitive position. At June 30, 2004, our one-year management-adjusted gap ratio of 1.43 was outside of our policy guidelines, however, this exception to policy was part of our strategy to position our balance sheet to benefit from an increase in interest rates.
 
The table below has two measures of gap; regulatory and management-adjusted. The regulatory gap considers only contractual maturities or repricings. The management-adjusted gap includes assumptions regarding prepayment speeds on certain rate sensitive assets, the repricing frequency of interest-bearing demand and savings accounts, and the stability of core deposit levels, all of which are adjusted periodically as market conditions change. We believe the management-adjusted gap is a more accurate reflection of the interest rate risk in our balance sheet. The management-adjusted gap indicates we are highly asset sensitive in relation to changes in market interest rates in the short-term. Being asset sensitive would result in net interest income increasing in a rising rate environment and decreasing in a declining rate envir onment.
 
Cumulative Repricing Gap Analysis
    
 
  
3-Month
6-Month
1-Year
   
(Dollars in thousands)
Regulatory Defined
                    
Rate Sensitive Assets (RSA)
  
$
380,049
 
$
403,739
 
$
449,770
 
Rate Sensitive Liabilities (RSL)
    
315,763
   
357,252
   
461,503
 
RSA minus RSL (Gap)
  
$
64,286
 
$
46,487
 
$
(11,733
)
                     
Gap Ratio (RSA/RSL)
    
1.20
   
1.13
   
0.97
 
 
                    
Management-Adjusted
                    
Rate Sensitive Assets (RSA)
  
$
390,669
 
$
424,774
 
$
490,799
 
Rate Sensitive Liabilities (RSL)
    
118,596
   
160,085
   
343,402
 
RSA minus RSL (Gap)
  
$
272,073
 
$
264,689
 
$
147,397
 
                     
Gap Ratio (RSA/RSL)
    
3.29
   
2.65
   
1.43
 

We use simulation analysis to monitor changes in net interest income due to changes in market interest rates. The simulation of rising, declining, and flat interest rate scenarios allows us to monitor and adjust interest rate sensitivity to minimize the impact of market interest rate swings. The analysis of the impact on net interest income over a twelve-month period is subjected to increases or decreases in market rates on net interest income and is monitored on a quarterly basis. As of quarter end, the simulation model projected net interest income would increase 4.5% over the next year if market rates immediately rose by 200 basis points. On the other hand, the model projected net interest

 
  - 20 -  
 

income to decrease 20.9% over the next year if market rates immediately fell by 200 basis points. The high volatility in our results is due primarily to our asset-sensitive balance sheet mix and our behavioral assumptions for repricing and prepayment speeds. Our policy states that net interest income cannot be reduced by more than 10% using this analysis, and technically, we were outside of policy guidelines at quarter end. However, this exception needs to be considered in conjunction with the fact that a further 200 basis point drop was not realistic given that the federal funds rate stood at 1.25%. If market rates immediately fell by 100 basis points, a more possible but still unlikely scenario, our model projected net interest income to decrease 9.7% over the next year. On June 30, 2004, the federal funds rate w as raised to 1.25% from 1.00%. As our interest sensitivity analysis shows, we expect the rise in rates will help to increase our net interest income in future periods.

The following table shows the results of these projections for net interest income expressed as a percentage change over net interest income in a flat rate scenario for both a gradual change in market interest rates over a twelve-month period and an immediate change, or "shock", in market interest rates.
 
Market
Effect on Net Interest Income
Rate Change
  
Gradual
  
Immediate
+300 bps
  
5.29%
  
5.33%
+200 bps
  
4.52%
  
4.46%
+100 bps
  
2.63%
  
2.32%
-100 bps
  
-9.13%
  
-9.73%
 
ITEM 4. CONTROLS AND PROCEDURES
 
A review and evaluation was performed by the Company’s management, including the Company’s Chief Executive Officer (the "CEO") and Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on that review and evaluation, the CEO and CFO have concluded that the Company’s current disclosure controls and procedures, as designed and implemented, were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of their evaluation. There were no material weaknesses identified in the course of such review and evaluation and, therefore, no corrective measures were taken by the Company.
 
 
  - 21 -  
 
 
PART II. OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS
 
None
 
 
ITEM 2.  CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
 

Issuer Purchases of Equity Securities in the quarter ended June 30, 2004:
 
     
Total number of shares
purchased
    
Average price
paid per share 
    
Number of shares purchased as part of publicly announced plans or programs
  
Maximum number of shares that may yet be purchased under the plans or programs1
  
April
    
-
 
$
-
   
-
 

 -
 
  
May
    
-
   
-
   
-
 

 -
 
  
June
    
20,000
    
12.06
   
20,000
  

 380,000
 
  
Total
    
20,000
  
$
12.06
   
20,000
  
380,000
 
  

1 On May 25, 2004, the Board of Directors authorized the purchase of 400,000 sharesof the Company's common stock. The plan will expire May 25, 2005
 
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
None
 
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
At the annual meeting of stockholders held on May 25, 2004, one item was voted upon. The vote was for the appointment of four directors to hold office until the 2007 annual meeting of stockholders and until their successors are dully elected and qualified or until their earlier death, resignation, incapacity to serve, or removal:
 
Name
Votes For
Votes Against
Votes Abstained
       
Bill J. Jones
7,226,405
0
88,592
James B. Lanier, Jr.
7,227,994
0
87,003
F. Ferrell Scruggs, Sr.
7,221,141
0
93,856
John M. Simmons
7,227,860
0
87,137
 
The following directors will continue in office:
 
R. Bradford Burnette, Kennith D. McLeod, Paul E. Parker, James L. Dewar, Jr., Michael E. Ricketson,
Joe P. Singletary, Jr., Walter W. Carroll, II, and Michael H. Godwin
 
ITEM 5. OTHER INFORMATION
 
None
 
 
  - 22 -  
 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)   Exhibits.

31.1 Rule 13a-14(a) Certification of CEO

31.2 Rule 13a-14(a) Certification of CFO
 
32.1 Section 1350 Certification of CEO

32.2 Section 1350 Certification of CFO
 
(b)   Reports on Form 8-K.

1. Press Release dated May 3, 2004 Announcing First Quarter 2004 Earnings
 
2. Press Release dated May 25, 2004 Announcing Second Quarter 2004 Dividend and Stock Buyback Plan

 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

PAB BANKSHARES, INC.   
Registrant
     
 
 		  
 		  
 
Date:  August 9, 2004 By:   /s/ Michael E. Ricketson
 
 
Michael E. Ricketson,
President and Chief Executive Officer
     
 
 		  
 		  
 
Date:  August 9, 2004 By:   /s/ Donald J. Torbert, Jr.
 
 
Donald J. Torbert, Jr.
Executive Vice President and Chief Financial Officer 

 
  - 23 -