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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission File Number: 000-21383
APPALACHIAN BANCSHARES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia 58-2242407
- ----------------------------------- ----------------------------------
(State of Incorporation) (IRS Employer Identification No.)
829 Industrial Boulevard
Ellijay, Georgia 30540
---------------------------------------
(Address of principal executive office)
(706) 276-8000
------------------------------------------------
(Issuer's telephone number, including area code)
No Change
(Former name, former address and former fiscal year, if changed since
last report)
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 past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act - Rule 12b-2). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 par value Outstanding at October 29, 2003: 3,658,713 Shares
Form 10-Q
APPALACHIAN BANCSHARES, INC.
September 30, 2003
TABLE OF CONTENTS
Page No.
Part I. Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Financial Condition as of September 30, 2003
and December 31, 2002............................................................................ 1
Consolidated Statements of Income For the Three Months and Nine Months
Ended September 30, 2003 and 2002................................................................ 2
Consolidated Statements of Comprehensive Income For the Three Months
and Nine Months Ended September 30, 2003 and 2002................................................ 3
Consolidated Statements of Cash Flows For the Nine Months Ended
September 30, 2003 and 2002...................................................................... 4
Notes to Consolidated Financial Statements......................................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................................ 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................... 18
Item 4. Controls and Procedures...................................................................... 21
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds.................................................... 22
Item 6. Exhibits and Reports on Form 8-K............................................................. 22
Signatures
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30,
2003 December 31,
(Unaudited) 2002
--------------- ----------------
Assets
Cash and due from banks...................................................... $ 8,411,613 $ 14,701,857
Interest bearing deposits with other banks................................... 625,656 8,398,840
Federal funds sold........................................................... 2,113,932 7,756,000
--------------- ----------------
Cash and Cash Equivalents............................................. 11,151,201 30,856,697
Securities available-for-sale................................................ 51,198,736 40,374,902
Loans, net of unearned income................................................ 323,928,915 298,063,055
Allowance for loan losses.................................................... (3,499,136) (3,237,898)
--------------- ----------------
Net Loans............................................................. 320,429,779 294,825,157
Premises and equipment, net.................................................. 8,668,622 8,771,352
Accrued interest............................................................. 2,230,786 2,240,920
Cash surrender value on life insurance....................................... 2,565,123 2,483,243
Intangibles, net............................................................. 2,186,558 2,081,264
Other assets................................................................. 2,489,509 2,390,550
--------------- ----------------
Total Assets.......................................................... $ 400,920,314 $ 384,024,085
=============== ================
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest-bearing..................................................... $ 23,033,715 $ 21,897,058
Interest-bearing........................................................ 296,737,203 294,385,698
--------------- ----------------
Total Deposits........................................................ 319,770,918 316,282,756
Short-term borrowings..................................................... 5,511,805 5,928,624
Accrued interest.......................................................... 636,707 976,156
Long-term debt............................................................ 37,714,286 34,735,714
Guaranteed preferred beneficial interest in the Company's
subordinated debentures................................................. 6,000,000 --
Other liabilities......................................................... 1,601,071 481,546
--------------- ----------------
Total Liabilities..................................................... 371,234,787 358,404,796
--------------- ----------------
Shareholders' Equity
Common stock, par value $0.01 per share, 20,000,000 shares authorized,
3,734,686 shares issued at September 30, 2003,
3,327,160 shares issued at December 31, 2002............................ 37,347 33,272
Paid-in capital........................................................... 22,500,672 16,428,767
Retained earnings......................................................... 7,571,864 10,495,901
Accumulated other comprehensive income: net unrealized holding
gains on securities available-for-sale, net of deferred income tax...... 275,440 449,050
Treasury stock, at cost (75,973 and 200,553 shares at September 30,
2003 and at December 31, 2002, respectively)............................ (699,796) (1,787,701)
--------------- ----------------
Total Shareholders' Equity............................................ 29,685,527 25,619,289
--------------- ----------------
Total Liabilities and Shareholders' Equity............................ $ 400,920,314 $ 384,024,085
=============== ================
See notes to consolidated financial statements
1
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------------
2003 2002 2003 2002
------------- ------------- -------------- ----------------
Interest Income
Interest and fees on loans............. $ 5,355,002 $ 5,326,071 $ 15,839,753 $ 15,151,710
Interest on investment securities:
Taxable securities................... 182,740 391,758 707,463 1,325,110
Nontaxable securities................ 182,017 216,747 539,051 592,353
Interest on deposit in other banks..... 104 1,207 28,816 3,600
Interest on federal funds sold......... 5,261 12,382 34,384 49,603
------------- ------------- -------------- ----------------
Total Interest Income.............. 5,725,124 5,948,165 17,149,467 17,122,376
Interest Expense
Interest on deposits................... 1,572,091 2,358,675 5,516,094 7,090,744
Interest on federal funds purchased and
securities sold under agreements
to repurchase........................ 20,443 20,755 64,338 56,183
Interest expense on long-term debt..... 283,254 447,976 945,209 1,395,640
Interest on subordinated debentures.... 21,300 -- 21,300 --
------------- ------------- -------------- ----------------
Total Interest Expense............. 1,897,088 2,827,406 6,546,941 8,542,567
Net Interest Income....................... 3,828,036 3,120,759 10,602,526 8,579,809
Provision for loan losses................. 385,000 306,000 1,105,000 668,000
Net Interest Income After Provision for
Loan Losses............................ 3,443,036 2,814,759 9,497,526 7,911,809
Noninterest Income
Customer service fees.................. 207,362 252,568 598,120 798,655
Insurance commissions.................. 8,507 36,215 55,219 79,631
Mortgage origination fees.............. 358,585 289,203 1,060,205 701,393
Other operating income................. 149,993 237,836 450,431 453,857
Investment securities gains (losses)... -- 1,082 (16,978) 28,666
------------- ------------- -------------- ----------------
Total Noninterest Income........... 724,447 816,904 2,146,997 2,062,202
Noninterest Expenses
Salaries and employee benefits......... 1,432,870 1,242,699 4,058,598 3,541,145
Occupancy expense...................... 149,708 147,749 464,317 431,506
Furniture and equipment expense........ 236,636 275,477 724,569 700,100
Other operating expenses............... 1,186,416 939,389 3,415,056 2,621,920
------------- ------------- -------------- ----------------
Total Noninterest Expenses......... 3,005,630 2,605,314 8,662,540 7,294,671
Income before income taxes................ 1,161,853 1,026,349 2,981,983 2,679,340
Income tax expense........................ 365,000 350,798 912,000 890,860
------------- ------------- -------------- ----------------
Net Income................................ $ 796,853 $ 675,551 $ 2,069,983 $ 1,788,480
============= ============= ============== ================
Earnings Per Common Share
Basic.................................. $ 0.22 $ 0.21 $ 0.58 $ 0.55
Diluted................................ 0.21 0.19 0.55 0.52
Weighted Average Shares Outstanding
Basic.................................. 3,660,485 3,294,797 3,599,384 3,254,820
Diluted................................ 3,822,959 3,537,214 3,771,632 3,466,481
See notes to consolidated financial statements
2
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------------
2003 2002 2003 2002
------------- ------------- -------------- ----------------
Net Income.................................. $ 796,853 $ 675,551 $ 2,069,983 $ 1,788,480
Other comprehensive, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period............ (779,005) 689,515 (280,024) 1,273,728
Reclassification adjustments for (gains)
losses included in net income........ -- (1,082) 16,978 (28,666)
------------- ------------- -------------- ----------------
Net unrealized gains (losses)........ (779,005) 688,433 (263,046) 1,245,062
Income tax expense related to
items of other comprehensive income.... 264,862 (234,068) 89,436 (423,322)
------------- ------------- -------------- ----------------
Other comprehensive income.................. (514,143) 454,365 (173,610) 821,740
------------- ------------- -------------- ----------------
Comprehensive Income........................ $ 282,710 $ 1,129,916 $ 1,896,373 $ 2,610,220
============= ============= ============== ================
See notes to consolidated financial statements
3
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
2003 2002
--------------- ----------------
Operating Activities
Net income................................................................ $ 2,069,983 $ 1,788,480
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses............................................... 1,105,000 668,000
Net depreciation and amortization....................................... 638,095 529,715
Realized investment security (gains) losses............................. 16,978 (28,666)
Deferred tax benefit.................................................... -- (82,000)
Decrease in accrued interest receivable................................. 10,134 168,612
Increase in cash surrender value of life insurance...................... (81,880) (95,894)
Decrease in accrued interest payable.................................... (339,449) (220,581)
Other................................................................... 1,309,976 652,897
--------------- ----------------
Net Cash Provided by Operating Activities............................. 4,728,837 3,380,563
--------------- ----------------
Investing Activities
Net increase of securities available-for-sale............................. (11,103,857) (4,077,890)
Net increase in loans to customers........................................ (27,777,409) (44,696,258)
Capital expenditures, net................................................. (470,659) (2,107,127)
Proceeds from the disposition of foreclosed real estate................... 698,113 369,936
--------------- ----------------
Net Cash Used in Investing Activities................................. (38,653,812) (50,511,339)
--------------- ----------------
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts.................................................... 7,008,132 33,969,643
Net increase (decrease) in certificates of deposit........................ (3,519,970) 5,041,600
Net increase (decrease) in short-term borrowings.......................... (416,819) 4,374,940
Proceeds from issuance of common stock.................................... 302,800 456,801
Proceeds (repayments)from long-term debt, net............................. 8,978,572 9,595,238
Payments to repurchase common stock....................................... (54,900) --
Proceeds from the sale of treasury stock.................................. 1,923,595 --
Cash paid in lieu of fractional shares on stock dividend.................. (1,931) --
--------------- ----------------
Net Cash Provided by Financing Activities............................. 14,219,479 53,438,222
--------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents......................... (19,705,496) 6,307,446
Cash and Cash Equivalents at Beginning of Period............................. 30,856,697 7,558,258
--------------- ----------------
Cash and Cash Equivalents at End of Period................................... $ 11,151,201 $ 13,865,704
=============== ================
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest.................................................................. $ 6,886,390 $ 8,763,148
Income taxes.............................................................. 230,000 925,345
See notes to consolidated financial statements
4
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note A - Basis of Presentation
The consolidated financial statements include the accounts of Appalachian
Bancshares, Inc., a Georgia corporation (the "Company"), and its wholly-owned
subsidiaries: Appalachian Community Bank (the "Bank"), Appalachian Information
Management, Inc. ("AIM") and Appalachian Capital Trust I (the "Trust"). The Bank
is a product of the 2001 merger of the two wholly-owned bank subsidiaries of the
Company at the time, Gilmer County Bank and Appalachian Community Bank (formerly
known as First National Bank of Union County). Gilmer County Bank, as the
surviving bank, changed its name to Appalachian Community Bank simultaneously
with the execution of the merger. AIM was formed as a wholly-owned subsidiary of
the Bank to provide in-house data services to the Bank and to offer data
processing services to other institutions; however, AIM's operations ceased on
November 12, 2002. All significant inter-company transactions and balances have
been eliminated in consolidation. Unless otherwise indicated herein, the
financial results of the Company refer to the Company, the Bank and the Trust on
a consolidated basis. The Bank provides a full range of banking services to
individual and corporate customers in northern Georgia. The accompanying
unaudited consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the nine-month period ended September 30, 2003, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003.
The consolidated statement of financial condition at December 31, 2002, has
been derived from the audited consolidated financial statements at that date,
but does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements for
Appalachian Bancshares, Inc. for the year ended December 31, 2002, and footnotes
thereto, included in the Company's Form 10-K, filed with the Securities and
Exchange Commission on March 31, 2003.
Note B - Critical Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements, as well as the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
The determination of the adequacy of the allowance for loan losses is based
on estimates that are particularly susceptible to significant changes in the
economic environment and market conditions. In connection with the determination
of the estimated losses on loans, management obtains independent appraisals for
significant collateral. While management uses available information to recognize
losses on loans, further reductions in the carrying amounts of loans may be
necessary based on changes in local
5
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note B - Critical Accounting Policies - Continued
economic conditions. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the estimated losses on loans.
Such agencies may require the Bank to recognize additional losses based on their
judgments about information available to them at the time of their examination.
Because of these factors, it is reasonably possible that the estimated losses on
loans may change materially in the near term. However, the amount of the change
that is reasonably possible cannot be estimated.
Note C - Income Taxes
The effective tax rates of approximately 30.6 percent and 33.2 percent for
the nine months ended September 30, 2003 and September 30, 2002, respectively,
are less than the applicable statutory rate due primarily to the effects of
tax-exempt income and general business credits.
Note D - Investment Securities
The Company applies the accounting and reporting requirements of Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. This pronouncement requires that all
investments in debt securities be classified as either "held-to-maturity"
securities, which are reported at amortized cost; "trading" securities, which
are reported at fair value, with unrealized gains and losses included in
earnings; or "available-for-sale" securities, which are reported at fair value,
with unrealized gains and losses excluded from earnings and reported in a
separate component of shareholders' equity (net of deferred tax effect).
At September 30, 2003, the Company had net unrealized gains of $417,334 in
available-for-sale securities, which are reflected in the presented assets and
resulted in an increase in shareholders' equity of $275,440, net of deferred tax
benefit. There were no trading securities. The net decrease in shareholders'
equity as a result of the SFAS No. 115 adjustment from December 31, 2002 to
September 30, 2003, was $173,610.
Note E - Segment Information
All of the Company's offices offer similar products and services, are
located in the same geographic region, and serve the same customer segments of
the market. As a result, management considers all units as one operating segment
and therefore feels that the basic financial statements and related footnotes
provide details related to segment reporting.
6
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note F - Goodwill
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. The statement requires that goodwill and other intangible assets with
indefinite useful lives no longer be amortized, but instead an entity must
perform an assessment of whether these assets are impaired as of the date of
adoption and test for impairment at least annually in accordance with the
provisions of the statement. The statement also required that intangible assets
with determinable lives be amortized. The Company adopted SFAS No. 142 on
January 1, 2002. The initial assessment of the Company's intangible assets as of
January 1, 2002, indicated that no impairment of values existed at that date.
Acquired goodwill and other intangible assets at September 30, 2003, are
detailed as follows:
As of September 30, 2003
-------------------------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------------- --------------- --------------
Identifiable amortizing assets................................. $ 335,000 $ 140,333 $ 194,667
Nonamortizing goodwill......................................... 2,335,858 343,967 1,991,891
-------------- --------------- --------------
Total acquired intangible asset................................ $ 2,670,858 $ 484,300 $ 2,186,558
============== =============== ==============
Aggregate amortization expense for the nine months ended September 30,
2003, was $64,709. Aggregate annual amortization expense estimated for the years
ending December 31, 2003 and 2004 is $93,836 and $40,883, respectively.
Note G - Stock Based Compensation
The Company has long-term incentive stock option plans and an employee
stock purchase plan. The Company accounts for those plans under the recognition
and measurement principles of APB Opinion 25, Accounting for Stock Issued to
Employees, and related interpretations using the intrinsic value based method,
as permitted by SFAS No. 123, Accounting for Stock-based Compensation. In
December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This statement amends SFAS No. 123 to
provide alternative methods of transition for an entity that voluntarily changes
to the fair value based method of accounting for stock-based employee
compensation. It amends the disclosure provisions of that Statement to require
prominent disclosure about the effects on reported net income of an entity's
accounting policy decisions with respect to stock-based employee compensation.
This Statement also amends APB Opinion No. 28 to require disclosure about those
effects in interim financial information. This Statement is effective for
financial statements for fiscal years ending after December 15, 2002, and for
financial reports containing condensed financial statements for interim periods
beginning after December 15, 2002. No stock-based employee compensation cost is
reflected in net income for these plans.
7
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note G - Stock Based Compensation - Continued
Pro forma information regarding net income and earnings per share is
presented as if the Company had accounted for its employee stock options under
the fair value method, as prescribed by SFAS No. 123. The fair value for these
options was estimated at the dates of grant using the Black-Scholes
option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The Company has issued incentive stock options to certain key employees of
which options 137,000 are outstanding at September 30, 2003, at exercise prices
ranging from $4.00 to $15.00 (the fair market values on the grant dates). These
options vest over a five-year time period at 20% on each anniversary of the
grant date and expire ten years from the grant date.
The Company has also issued nonqualified stock options primarily to
directors of the Company, of which options 250,400 are outstanding at September
30, 2003, at an exercise price of $4.00 to $6.00 (the fair market value on the
grant dates). These options vest over a five-year time period at 20% on each
anniversary of the grant date and expire ten years from the grant date.
The Company's actual and pro forma information follows:
Nine Months Ended September 30, Three Months September 30,
------------------------------------- --------------------------------------
2003 2002 2003 2002
----------------- ----------------- ------------------- -----------------
Net Income
As Reported......................... $ 2,069,983 $ 1,788,480 $ 796,853 $ 675,551
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of tax........... (45,182) (89,064) (14,540) (18,338)
----------------- ----------------- ------------------- -----------------
Pro forma net income................ $ 2,024,801 $ 1,699,416 $ 782,313 $ 657,213
================= ================= =================== =================
8
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note G - Stock Options - Continued
Nine Months Ended Three Months Ended
September 30, September 30,
------------------------------------- --------------------------------------
2003 2002 2003 2002
----------------- ----------------- ------------------- ------------------
Basic earnings per share:
As Reported......................... $ 0.58 $ 0.55 $ 0.22 $ 0.21
================ ================ =================== =================
Pro forma........................... $ 0.56 $ 0.52 $ 0.21 $ 0.20
================ ================ =================== =================
Diluted earnings per share:
As Reported......................... $ 0.55 $ 0.52 $ 0.21 $ 0.19
================ ================ =================== =================
Pro forma........................... $ 0.54 $ 0.49 $ 0.20 $ 0.19
================ ================ =================== =================
Note H - Recently Passed Legislation
Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 (the "Sarbanes-Oxley Act") was adopted, in order to address corporate and
accounting fraud. The Sarbanes-Oxley Act establishes a new accounting oversight
board that will enforce auditing standards and restricts the scope of services
that accounting firms may provide to their public company audit clients. Among
other things, it also (i) requires chief executive officers and chief financial
officers to certify to the accuracy of periodic reports filed with the
Securities and Exchange Commission (the "SEC"); (ii) imposes new disclosure
requirements regarding internal controls, off-balance-sheet transactions, and
pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting
of insider transactions and periodic disclosures by certain public companies;
and (iv) requires companies to disclose whether or not they have adopted a code
of ethics for senior financial officers and whether the audit committee includes
at least one "audit committee financial expert."
The Sarbanes-Oxley Act requires the SEC, based on certain enumerated
factors, to regularly and systematically review corporate filings. To deter
wrongdoing, the Sarbanes-Oxley Act (i) subjects bonuses issued to top executives
to disgorgement if a restatement of a company's financial statements was due to
corporate misconduct; (ii) prohibits an officer or director misleading or
coercing an auditor; (iii) prohibits insider trades during pension fund
"blackout periods"; (iv) imposes new criminal penalties for fraud and other
wrongful acts; and (v) extends the period during which certain securities fraud
lawsuits can be brought against a company or its officers.
9
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
September 30, 2003
Note I - Commitments and Contingencies
Standby letters of credit are commitments issued by the Company to
guarantee the performance of a customer to a third party. These guarantees are
primarily issued to support public and private borrowing arrangements, including
commercial paper, bond financing and similar transactions, and expire in
decreasing amounts with terms ranging from one to four years. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.
The following represents the Company's commitments to extend credit and
standby letters of credit as of September 30, 2003 and December 31, 2002:
Period Ended
-----------------------------------
September 30, December 31,
2003 2002
---------------- -----------------
Commitments to extend credit................................................. $ 46,055,000 $ 35,890,000
Standby and commercial letters of credit..................................... 981,000 1,320,000
---------------- -----------------
Total commitments and contingencies.......................................... $ 47,036,000 $ 37,210,000
================ =================
Note J - Stock Dividends
On July 1, 2003, the Company issued 332,826 shares of common stock in
conjunction with a 10% stock dividend. Weighted average shares and earnings per
share data have been retroactively restated to reflect the stock dividend.
Note K - Guaranteed Preferred Beneficial Interest in the Company's Subordinated
Debentures
On August 28, 2003, Appalachian Capital Trust I ("the Trust"), a Delaware
statutory trust established by the Company, received $6,000,000 in proceeds in
exchange for the $6,000,000 principal amount of the Trust's floating rate
cumulative trust preferred securities (the "Trust Preferred Securities") in a
trust preferred private placement. The proceeds of that transaction were then
used by the Trust to purchase an equal amount of floating rate subordinated
debentures (the "Subordinated Debentures") of the Company. The Company has fully
and unconditionally guaranteed all obligations of the Trust on a subordinated
basis with respect to the Trust Preferred Securities. The Company accounts for
the Trust Preferred Securities as a minority interest. Subject to certain
limitations, the Trust Preferred Securities qualify as Tier 1 capital and are
presented in the consolidated statements of financial condition as "Guaranteed
preferred beneficial interest in the Company's subordinated debentures."
The sole asset of the Trust is the Subordinated Debentures issued by the
Company. Both the Trust Preferred Securities and the Subordinated Debentures
have approximately 30-year lives. However, both the Company and the Trust have
options to call their respective securities after five years, subject to
regulatory capital requirements.
10
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Certain of the statements made in this Report, including matters discussed
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations," as well as oral statements made by the Company or
its officers, directors or employees, may constitute forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Such forward-looking statements are based on
Management's beliefs, current expectations, estimates and projections about the
financial services industry, the economy and about the Company and the Bank in
general. The words "expect," "anticipate," "intend," "plan," "believe," "seek,"
"estimate" and similar expressions are intended to identify such forward-looking
statements; however, this Report also contains other forward-looking statements
in addition to historical information. Such forward-looking statements are not
guarantees of future performance and are subject to risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
the Company to differ materially from historical results or from any results
expressed or implied by such forward-looking statements. Such factors include,
without limitation, (i) increased competition with other financial institutions,
(ii) lack of sustained growth in the economy in Gilmer, Fannin, and Union
Counties, (iii) rapid fluctuations in interest rates, (iv) the inability of the
Bank (as defined herein) to maintain regulatory capital standards, and (v)
changes in the legislative and regulatory environment. Many of these factors are
beyond the Company's ability to control or predict, and readers are cautioned
not to put undue reliance on such forward-looking statements. The Company
disclaims 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.
Discussion
This discussion is intended to assist in an understanding of the Company's
financial condition and results of operations. This analysis should be read in
conjunction with the financial statements and related notes appearing in Item 1
of this Report on Form 10-Q and Management's Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
2002, appearing in the Company's Form 10-K filed with the Securities and
Exchange Commission on March 31, 2003.
The Company's operations are primarily conducted through the Bank.
Management continuously monitors the financial condition of the Bank in order to
protect depositors, increase retained earnings and protect current and future
earnings. Significant items affecting the Company's financial condition and
results of operations are discussed in detail below.
In August 2002, management decided to discontinue operations of AIM, which
operations ceased on November 12, 2002. Accordingly, the Bank entered into a
data processing agreement with Fiserv Solutions, Inc., whereby the Bank
outsourced those data services previously provided in-house by AIM. AIM has
ceased offering data processing services to other institutions. Management
anticipates that the discontinuance of AIM's operations will not have a material
effect on the Company's operations or financial condition.
11
APPALACHIAN BANCSHARES, INC.
September 30, 2003
FINANCIAL CONDITION
September 30, 2003 compared to December 31, 2002
Loans
Loans comprised the largest single category of the Company's earning assets
on September 30, 2003. Loans, net of unearned income and allowance for loan
losses, were 79.9 percent of total assets at September 30, 2003. Total net loans
were $320,429,779 at September 30, 2003, representing an 8.68% increase from
$294,825,157 at December 31, 2002. This increase reflects the continued increase
in loan demand for the Bank's respective market areas coupled with an increase
in the Bank's market share for their respective areas.
Investment Securities and Other Earning Assets
Investment securities at September 30, 2003, were $51,198,736 compared with
$40,374,902 at December 31, 2002, reflecting a 22.11% increase of $10,823,834.
Federal funds sold were $2,113,932 at September 30, 2003, compared to the
December 31, 2002, total of $7,756,000, a 72.7% decrease. The investment
securities portfolio is used to make various term investments, to provide a
source of liquidity and to serve as collateral to secure certain government
deposits. Federal funds sold are maintained, as a tool in managing the daily
cash needs of the Bank. The decrease is federal funds sold was the result of
Managements decision to increase the investment security portfolio.
Asset Quality
Asset quality is measured by three key ratios: the ratio of the allowance
for loan losses to total nonperforming assets, the ratio of total nonperforming
assets to total assets and the ratio of nonperforming loans to total loans. The
ratio of the allowance for loan losses to total nonperforming assets (defined as
nonaccrual loans, loans past due 90 days or greater, restructured loans,
nonaccruing securities, and other real estate) increased from 0.53% at December
31, 2002 to 1.13% at September 30, 2003. Total non-performing assets at
September 30, 2003, were $3.1 million, which consisted of $118,000 in consumer
loans, $189,000 in commercial and industrial loans, $1.4 million in loans
secured by real estate and $1.4 million of foreclosed real estate. Nonperforming
assets at December 31, 2002, were $6.1 million. The ratio of total nonperforming
assets to total assets decreased from 1.60% at December 31, 2002 to 0.77% at
September 30, 2003, and the ratio of nonperforming loans to total loans
decreased from 1.73% at December 31, 2002 to 0.55% at September 30, 2003. The
decrease in nonperforming assets is due to two commercial relationships that
were identified during 2002 and were resolved by management. Management is
closely monitoring the loan portfolio to identify any potential loan quality
issues.
Deposits
Total deposits at September 30, 2003, were $319,770,918, an increase of
$3,488,162 or 1.1 % over total deposits of $316,282,756 at year-end 2002.
Deposits are the Company's primary source of funds with which to support its
earning assets. Noninterest-bearing deposits increased $1,136,657 or 5.19% from
year-end 2002 to $23,033,715 at September 30, 2003, and interest-bearing
deposits increased $2,351,505 or 0.80% during the same period to $296,737,203.
The Company is focusing on the local markets for deposits, but it is also
monitoring alternative funding sources to maximize the return to its
shareholders.
12
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Securities Sold Under Agreements To Repurchase
Securities sold under agreements to repurchase totaled $5,511,805 at
September 30, 2003, a $416,819 decrease from the December 31, 2002, total of
$5,928,624. The total of securities sold under agreements to repurchase is
associated with the cash flow needs of the Bank's corporate customers that
participate in repurchase agreements.
Shareholders' Equity
Shareholders' equity increased $4,066,238 from $25,619,289 at December 31,
2002, to $29,685,527 at September 30, 2003. This increase was mainly
attributable to net income of $2,069,983 and the sale of 128,241 shares of
treasury stock for a total of $1,923,595.
Liquidity Management
Liquidity is defined as the ability of a company to convert assets into
cash or cash equivalents without significant loss. Liquidity management involves
maintaining the Bank'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 Bank would not be able to perform its primary function as a
financial intermediary and would, therefore, not be able to meet the production
and growth needs of the communities it serves.
The objective of assets and liabilities management is not only to assure
adequate liquidity in order for the Bank to meet the needs of its customer base,
but also to maintain an appropriate balance between interest-sensitive assets
and interest-sensitive liabilities so that the Bank can meet the investment
objectives of the Company's shareholders. Daily monitoring of the sources and
uses of funds is necessary to maintain an acceptable cash position that meets
both requirements. In the banking environment, both assets and liabilities are
considered sources of liquidity funding and both are, therefore, monitored on a
daily basis.
The asset portion of the balance sheet provides liquidity primarily through
loan principal repayments or sales of investment and trading account securities.
Loans that mature in one year or less equaled approximately $210 million or
64.8% of the total loan portfolio at September 30, 2003, while there were no
investment securities maturing in one year or less. Other sources of liquidity
include short-term investments such as federal funds sold.
The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
September 30, 2003, funds were also available through the purchase of federal
funds from correspondent commercial banks, from available lines of credit of up
to an aggregate of $18 million. Liquidity management involves the daily
monitoring of the sources and uses of funds to maintain an acceptable cash
position.
To maintain and improve its liquidity position, the Bank is a member of the
Federal Home Loan Bank of Atlanta. As a member of the Federal Home Loan Bank,
the Bank is able to improve its ability to manage liquidity and reduce interest
rate risk by having a funding source to match longer-term loans. The Bank's
credit line was approximately $59 million as of September 30, 2003. At September
30, 2003, the outstanding balance of Appalachian Community Bank's credit line
was $37,714,286.
13
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Capital Resources
A strong capital position is vital to the continued profitability of the
Company because it promotes depositor and investor confidence and provides a
solid foundation for future growth of the organization.
Term Loan. On April 3, 2002, the Company obtained a $4.6 million term loan
under a Loan and Stock Pledge Agreement and a Promissory Note (collectively, the
"Term Loan") with Crescent Bank and Trust Company. The Company used $4.6 million
of the proceeds of the Term Loan to repay that certain loan and stock pledge
agreement, dated April 3, 2000, previously entered into by and between the
Company and Crescent Bank and Trust Company. At June 30, 2003, the balance on
the Term Loan was $3,943,000. Interest on the outstanding amounts under the Term
Loan was payable quarterly, commencing July 1, 2002, at the prime rate (as
defined in the Promissory Note) less twenty-five (25) basis points, and
principal repayment was due in seven equal annual installments, each in the
amount of $657,000, beginning on April 1, 2003. The entire outstanding balance
of the Term Loan, together with all accrued and unpaid interest, was due and
payable in a final installment on March 31, 2010. On September 9, 2003, the
Company repaid in full the outstanding principal of and the accrued interest on
the Term Loan, in the amount of $4,009,634, from the proceeds of the issuance
and sale by the Company, on August 28, 2003, of $6,000,000 of variable-rate
trust preferred securities (the "Trust Preferred Securities").
Trust Preferred Securities. The Trust Preferred Securities have a maturity
date of August 28, 2033, with quarterly interest payable on the 8th day of each
February, May, August and November at the rate of 3% over the three-month London
Interbank Offered Rate, as reported at the end of the preceding calendar
quarter. The Company, in addition to the repayment of the Term Loan in the
amount of $4,009,634 on September 9, 2003, also contributed $500,000 to the
capital of the Bank on September 29, 2003, retaining the remaining balance of
$1,490,366 for operating expenses and as a future source of capital for the
Bank.
Capital Standards. Regulatory authorities are placing increased emphasis on
the maintenance of adequate capital. The Company and the Bank are subject to
guidelines mandating minimum risk-based capital requirements. The guidelines
take into consideration risk factors associated with various categories of
assets, both on and off the balance sheet. Under the guidelines, capital
strength is measured in two tiers, which are used in conjunction with
risk-adjusted assets to determine the risk-based capital ratios. The Company's
Tier 1 capital, which consists of common equity, paid-in capital, proceeds of
the Trust Preferred Securities and retained earnings (less intangible assets),
amounted to $33.2 million at September 30, 2003. Tier 2 capital components
include supplemental capital components such as qualifying allowance for loan
losses and qualifying subordinated debt. Tier 1 capital plus the Tier 2 capital
components is referred to as Total Capital and was $36.7 million at September
30, 2003. The Company's percentage ratios as calculated under regulatory
guidelines were 10.18% and 11.25% for Tier 1 and Total Capital, respectively, at
September 30, 2003, exceeding the minimum ratios of 4.0% and 8.0%, respectively.
Another important indicator of capital adequacy in the banking industry is
the leverage ratio. The leverage ratio is defined as the ratio which
shareholders' equity, minus intangibles bears to total assets minus intangibles.
At September 30, 2003, the Company's leverage ratio was 8.43% exceeding the
regulatory minimum requirement of 4%.
There have been no cash dividends during 2002 or 2003 paid by the Bank to
the Company.
14
APPALACHIAN BANCSHARES, INC.
September 30, 2003
The Company received approval from the Federal Reserve to issue
trust-preferred securities. The Company issued $6 million in floating rate
securities on August 28, 2003. The issuance of the securities made the Company
"well capitalized" according to regulatory guidelines. The specifics related to
the trust preferred issuance are included in the attached exhibits and in Note K
to the financial statements.
RESULTS OF OPERATIONS
Nine months and three months ended September 30, 2003 and September 30, 2002
Summary
Net earnings for the nine months ended September 30, 2003, were $2,069,983
compared to net earnings of $1,788,480 for the same period in 2002. This 15.7%
increase in net earnings is primarily attributable to the re-pricing of
longer-term high cost certificates of deposit and a focus on reducing the
Company's cost of funds. Net interest income increased $2,022,717 (23.6%) during
the first nine months of 2003 as compared to the same period in 2002;
noninterest expenses increased $1,367,869 (18.8%) during the same period, while
noninterest income increased by $84,795 (4.1%). Total interest expense decreased
$1,995,626 (23.4%) during the first nine months of 2003 as compared to the same
period in 2002.
Net earnings for the quarter ended September 30, 2003, were $796,853
compared to net earnings of $675,551 for the quarter ended September 30, 2002.
This represents an 18% increase as compared to the same period in 2002 and is a
result of the same causes noted for the nine months ended September 30, 2003 and
2002. Total interest expense decreased by $930,318 compared to the same period
in 2002. Net interest income increased $707,277 during the three months ended
September 30, 2003, as compared to the same period in 2002; noninterest expenses
increased $400,316 during the same period, while noninterest income decreased by
$92,457.
Net Interest Income
Net interest income, the difference between interest earned on assets and
the cost of interest-bearing liabilities, is the largest component of the
Company's net income. Revenue from earning assets of the Company during the nine
months ended September 30, 2003, increased $27,091 (0.16%) from the same period
in 2002. Interest expense for the nine months ended September 30, 2002,
decreased $1,995,626 or (23.4%) compared to the same period in 2002. The overall
increase in net interest income is a result of the Company's focus on reducing
its cost of funding.
Net interest income increased $707,277 or 22.7% during the quarter ended
September 30, 2003, as compared to the same period in 2002. A decrease of
$223,041 or 3.75% in revenue from earning assets coupled with a decrease in
total interest expense of $930,318 or 32.9% are the principal reasons for the
increase in net interest income for the quarter.
Provision for Loan Losses
The provision for loan losses represents the charge against current
earnings necessary to maintain the allowance for loan losses at a level which
management considers appropriate. This level is determined based upon
management's assessment of current economic conditions, the composition of the
loan portfolio and the levels of nonaccruing and past due loans. The provision
for loan losses was $1,105,000 for the nine months ended September 30, 2003,
compared to $668,000 for the same period of
15
APPALACHIAN BANCSHARES, INC.
September 30, 2003
2002. Charge-offs exceeded recoveries by $843,762 for the nine months ended
September 30, 2003. The allowance for loan losses as a percent of outstanding
loans, net of unearned income, was 1.08% at September 30, 2003, compared to 1.09
percent at year-end 2002.
The provision for loan losses was $385,000 for the three months ended
September 30, 2003, compared to $306,000 for the same period in 2002.
The increased provisions for the three and nine-month periods ended
September 30, 2003, as compared to the same periods of 2002, are directly
attributable to loan growth and two commercial relationships that the Company
recognized as charge-offs.
Noninterest Income
Noninterest income for the nine months ended September 30, 2003, was
$2,146,997 compared to $2,062,202 for the same period in 2002. This increase was
primarily due to a rise in mortgage origination fees of $358,812 offset by a
decrease in customer service fees of $200,535 in the first nine months of 2003
as compared to the same period in 2002.
Noninterest income decreased by $92,457 or 11.3% in the three months ended
September 30, 2003, as compared to the same period in 2002.
Noninterest Expenses
Noninterest expenses for the nine months ended September 30, 2003, were
$8,662,540, reflecting an 18.8% increase over the same period of 2002. The
primary components of noninterest expenses are salaries and employee benefits,
which increased to $4,058,598 for the nine months ended September 30, 2003,
14.61% percent higher than in the same period in 2002. Occupancy costs increased
$32,811 and furniture and equipment expenses increased by $24,469. Other
operating expenses rose by 30.25% to $3,415,056.
Noninterest expenses increased by $400,316 for the quarter ended September
30, 2003, as compared to the same period in 2002. Salaries and employee benefits
increased by $190,171 for the three months ended September 30, 2003, which was
15.3% higher than the same period in 2002. Occupancy costs increased by $1,959
and other operating expenses increased by $247,027 for the third quarter of 2003
as compared with the same period in 2002.
Income Taxes
The Company attempts to maximize its net income through active tax
planning. Management is attempting to reduce its tax burden by purchasing
tax-exempt securities. The provision for income taxes for the nine months ended
September 30, 2003, was $912,000, an increase of $21,140 compared to the same
period in 2002 due to increased net income.
Recently Issued Accounting Standards
In November 2002, the Auditing Standards Board issued Statement on Auditing
Standards ("SAS") No. 100, Interim Financial Information. This statement
supersedes SAS No. 71 and establishes revised standards and guidance on the
nature, timing, and extent of the procedures to be performed by an independent
accountant when conducting a review of interim financial information. This SAS
is effective for interim periods within fiscal years beginning after December
15, 2002. The impact on the interim
16
APPALACHIAN BANCSHARES, INC.
September 30, 2003
consolidated financial statements of the Company resulting from the issuance of
this auditing standard is not expected to be material.
In January 2003, the Auditing Standards Board issued SAS No. 101, Auditing
Fair Value Measurements and Disclosures. This statement establishes standards on
auditing the measurement and disclosure of assets, liabilities, and specific
components of equity presented or disclosed at fair value in financial
statements. This SAS is effective for audits of financial statements for periods
beginning on or after June 15, 2003. The impact on the audit of the Company's
consolidated financial statements resulting from the issuance of this auditing
standard is not expected to be material.
In January 2003, the Financial Accounting Standards Board ("FASB") issued
FIN 46, which clarifies the application of Accounting Research Bulletin ("ARB")
51, Consolidated Financial Statements, to certain entities (called variable
interest entities) in which equity investors do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. The disclosure requirements of this Interpretation
are effective for all financial statements of public companies for the first
interim or annual period ending after December 15, 2003. The consolidation
requirements apply to all variable interest entities created after January 31,
2003. Management is currently assessing the impact of FIN 46, and does not
expect this Interpretation to have a material impact on the Consolidated
Financial Statements.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, Amendment of Statement 133 on Derivative instruments and
Hedging Activities. The provisions of this Statement are effective for contracts
entered into or modified after June 20, 2003, and hedging relationships
designated after June 30, 2003, and generally require that contracts with
comparable characteristics be accounted for similarly. Except for the provisions
related to FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities, all provisions of this Statement should be applied
prospectively. The provisions of the Statement related to Statement 133
Implementation Issues that have been effective for fiscal quarters that begin
prior to June 15, 2003, should continue to be applied in accordance with their
respective effective dates. We do not expect the adoption of the provisions of
this Statement to have a material effect on the Company's operating results or
financial position.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires liability treatment for certain financial instruments which had
previously been recognized as equity. The provisions of this Statement are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise are effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in accounting principle for financial instruments
created before May 15, 2003, and still existing at the beginning of the interim
period of adoption. Restatement is not permitted. We do not expect the adoption
of the provisions of this Statement to have a material effect on the Company's
operating results or financial position.
17
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Recently Passed Legislation
Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 (the "Sarbanes-Oxley Act") was adopted, in order to address corporate and
accounting fraud. The Sarbanes-Oxley Act establishes a new accounting oversight
board that will enforce auditing standards and restricts the scope of services
that accounting firms may provide to their public company audit clients. Among
other things, it also (i) requires chief executive officers and chief financial
officers to certify to the accuracy of periodic reports filed with the
Securities and Exchange Commission (the "SEC"); (ii) imposes new disclosure
requirements regarding internal controls, off-balance-sheet transactions, and
pro forma (non-GAAP) disclosures; (iii) accelerates the time frame for reporting
of insider transactions and periodic disclosures by certain public companies;
and (iv) requires companies to disclose whether or not they have adopted a code
of ethics for senior financial officers and whether the audit committee includes
at least one "audit committee financial expert."
The Sarbanes-Oxley Act requires the SEC, based on certain enumerated
factors, to regularly and systematically review corporate filings. To deter
wrongdoing, the Sarbanes-Oxley Act, (i) subjects bonuses issued to top
executives to disgorgement if a restatement of a company's financial statements
was due to corporate misconduct; (ii) prohibits an officer or director
misleading or coercing an auditor; (iii) prohibits insider trades during pension
fund "blackout periods"; (iv) imposes new criminal penalties for fraud and other
wrongful acts; and (v) extends the period during which certain securities fraud
lawsuits can be brought against a company or its officers.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At September 30, 2003, there have been no material changes in information
that would be provided under this Item 3, from the quantitative and qualitative
disclosures about market risk provided in Company's Annual Report on Form 10-K
for the year ended December 31, 2002. Consequently, the information provided in
this Item 3 is the same as that provided in Items 7 and 7A of the Company's
Annual Report on Form 10-K for the year ended December 31, 2002.
Interest Rate Sensitivity Management
Interest rate sensitivity is a function of the repricing characteristics of
the Bank's portfolios of assets and liabilities. These repricing characteristics
are the time frames within which the interest-bearing assets and liabilities are
subject to changes in interest rates, either at replacement or maturity during
the life of the instruments. Sensitivity is measured as the difference between
the volume of assets and liabilities in the Bank's current portfolio that is
subject to repricing in future time periods. The differences are known as
interest rate sensitivity gaps and are usually calculated separately for
segments of time, ranging from zero to thirty days, thirty-one to ninety days,
ninety-one days to one year, one to five years, over five years and on a
cumulative basis.
18
APPALACHIAN BANCSHARES, INC.
September 30, 2003
The following tables show interest rate sensitivity gaps for these
different intervals as of December 31, 2002.
Interest Rate Sensitivity Analysis
0-30 31-90 90-365 1-5 Over 5
Days Days Days Years Years Total
----------- ----------- ----------- ----------- ----------- -----------
(In thousands, except ratios)
Interest-earning assets (1)
Loans............................ $ 18,574 $ 24,524 $ 101,548 $ 129,561 $ 19,033 $ 293,240
Securities:
Taxable........................ -- 2,127 6,566 8,827 7,541 25,061
Tax-exempt..................... -- -- 104 1,732 13,478 15,314
Time deposits in other banks..... 8,399 -- -- -- -- 8,399
Federal funds sold............... 7,756 -- -- -- -- 7,756
----------- ----------- ----------- ----------- ----------- -----------
34,729 26,651 108,218 140,120 40,052 349,770
----------- ----------- ----------- ----------- ----------- -----------
Interest-bearing liabilities (2)
Demand deposits (3).............. 27,513 27,512 27,512 -- -- 82,537
Savings deposits (3)............. 13,741 13,740 13,740 -- -- 41,221
Time deposits.................... 11,570 23,321 99,494 36,243 -- 170,628
Other short-term borrowings...... 5,929 -- -- -- -- 5,929
Long-term debt................... 2,100 7,150 11,793 8,343 5,350 34,736
----------- ----------- ----------- ----------- ----------- -----------
60,853 71,723 152,539 44,586 5,350 335,051
----------- ----------- ----------- ----------- ----------- -----------
Interest sensitivity gap............ $ (26,124) $ (45,072) $ (44,321) $ 95,534 $ 34,702 $ 14,719
=========== =========== =========== =========== =========== ===========
Cumulative interest sensitivity gap. $ (26,124) $ (71,196) $ (115,517) $ (19,983) $ 14,719
=========== =========== =========== =========== ===========
Ratio of interest-earning assets to
interest-bearing liabilities..... 0.57 0.37 0.71 3.14 7.49
=========== =========== =========== =========== ===========
Cumulative ratio.................... 0.57 0.46 0.59 0.94 1.04
=========== =========== =========== =========== ===========
Ratio of cumulative gap to total
interest-earning assets.......... (0.07) (0.20) (0.33) (0.06) 0.04
=========== =========== =========== =========== ===========
(1) Excludes nonaccrual loans and securities.
(2) Excludes matured certificates which have not been redeemed by the customer
and on which no interest is accruing.
(3) Demand and savings deposits are assumed to be subject to movement into
other deposit instruments in equal amounts during the 0-30 day period, the
31-90 day period, and the 91-365 day period.
The above table indicates that, in a rising interest rate environment, the
Company's earnings may be adversely affected in the 0-365 day periods where
liabilities will reprice faster than assets. As seen in the preceding table, for
the first 30 days of repricing opportunity, there is an excess of earning
liabilities over interest-bearing assets of approximately $26 million. For the
first 365 days, interest-bearing liabilities exceed earning assets by
approximately $116 million. During this one-year time frame, 85.1% of all
interest-bearing liabilities will reprice compared to 48.5% of all
interest-earning assets. Changes in the mix of earning assets or supporting
liabilities can either increase or decrease the net interest margin without
affecting interest rate sensitivity. In addition, the interest rate spread
between an asset and its supporting liability can vary significantly while the
timing of repricing for both the asset and the liability remain the same, thus
impacting net interest income. It should be noted, therefore, that a matched
interest-sensitive position by itself would not ensure maximum net interest
income.
19
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Management continually evaluates the condition of the economy, the pattern
of market interest rates and other economic data to determine the types of
investments that should be made and at what maturities. Using this analysis,
management from time to time assumes calculated interest rate sensitivity gap
positions to maximize net interest income based upon anticipated movements in
the general level of interest rates.
Market Risk
Market risk is the risk arising from adverse changes in the fair value of
financial instruments due to a change in interest rates, exchange rates and
equity prices. The Company's primary market risk is interest rate risk.
The primary objective of Asset/Liability Management of the Company is to
manage interest rate risk and achieve reasonable stability in net interest
income throughout interest rate cycles. This is achieved by maintaining the
proper balance of rate sensitive earning assets and rate sensitive liabilities.
The relationship of rate sensitive earning assets to rate sensitive liabilities
is the principal factor in projecting the effect that fluctuating interest rates
will have on future net interest income. Rate sensitive earning assets and
interest-bearing liabilities are those that can be repriced to current market
rates within a relatively short time period. Management monitors the rate
sensitivity of earning assets and interest-bearing liabilities over the entire
life of these instruments, but places particular emphasis on the first year and
through three years.
The Company has not experienced a high level of volatility in net interest
income primarily because of the relatively large base of core deposits that do
not reprice on a contractual basis. These deposit products include regular
savings, interest-bearing transaction accounts and money market savings
accounts. Balances for these accounts are reported based on historical repricing
experienced at each bank. However, the rates paid are typically not directly
related to market interest rates, since management has some discretion in
adjusting these rates as market rates change.
The Company uses additional tools to monitor and manage interest rate
sensitivity. One of the primary tools is simulation analysis. Simulation
analysis is the primary method of estimating earnings at risk and capital at
risk under varying interest rate conditions. Simulation analysis is used to test
the sensitivity of the Company's net interest income and shareholders' equity to
both the level of interest rates and the slope of the yield curve. Simulation
analysis accounts for the expected timing and magnitude of assets and liability
cash flows, as well as the expected timing and magnitude of deposits that do not
reprice on a contractual basis. In addition, simulation analysis includes
adjustments for the lag between movements in market interest rates on loans and
interest-bearing deposits. These adjustments are made to reflect more accurately
possible future cash flows, repricing behavior and ultimately net interest
income. The estimated impact on the Company's net interest income before
provision for loan loss sensitivity over a one-year time horizon is shown below.
Such analysis assumes a sustained parallel shift in interest rates and the
Company's estimate of how interest-bearing transaction accounts will reprice in
each scenario. Actual results will differ from simulated results due to timing,
magnitude and frequency of interest rate changes and changes in market
conditions and management's strategies, among other factors.
20
APPALACHIAN BANCSHARES, INC.
September 30, 2003
Percentage Increase
(Decrease) in Interest
Income/Expense Given
Interest Rate Shifts
--------------------------------
Down 200 Up 200
Basis Points Basis Points
-------------- --------------
For the Twelve Months After December 31, 2002
Projected change in:
Interest income........................................................... (11.43)% 11.57%
Interest expense.......................................................... (12.18) 13.21
-------------- --------------
Net interest income....................................................... (11.04)% 10.70%
============== ==============
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this quarterly report, the Company
has evaluated the effectiveness of its disclosure controls and procedures
pursuant to Exchange Act Rule 13a-15. This evaluation was performed under the
supervision and with the participation of management, including the chief
executive officer and the chief financial officer. Based on this evaluation, the
chief executive officer and chief financial officer have concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be disclosed in this quarterly report has been
communicated to them in a manner appropriate to allow timely decisions regarding
required disclosure.
Changes in Internal Controls
Subsequent to the date of the chief executive officer's and the chief
financial officer's evaluation, there were no significant changes in internal
controls or other factors that could significantly affect internal controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
[The remainder of this page intentionally left blank]
21
APPALACHIAN BANCSHARES, INC.
September 30, 2003
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
On August 28, 2003, the Company, through its affiliate Appalachian Capital
Trust I, issued $6,000,000 in variable-rate trust preferred securities known as
Appalachian Capital Trust I Preferred Securities (the "Trust Preferred
Securities"). The Trust Preferred Securities were issued and sold in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended, as a transaction by an issuer not involving a public
offering. An underwriting fee of 3% of the amount of issuance was payable to
Citigroup under the terms of the transaction. The Company used $4,009,634 of the
proceeds from the issuance of the Trust Preferred Securities (the "Trust
Preferred Proceeds") to prepay its outstanding correspondent-bank lines of
credit, on September 9, 2003. The Company then contributed $500,000 of the Trust
Preferred Proceeds to the capital of the Bank on September 29, 2003, retaining
the remaining balance of the Trust Preferred Proceeds in the amount of
$1,490,366 for operating expenses and as a future source of capital for the
Bank.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits. The following Exhibits are filed with this report:
Exhibit No. Exhibit Page
----------- ----------------------------------------------------------- ---------
4.1 Indenture, dated as of August 28, 2003, between Appalachian
Bancshares, Inc., as issuer, and Wilmington Trust Company, as
trustee (contained as an exhibit to the Company's Current Report
filed on Form 8-K, dated October 23, 2003).
10.1 Amended and Restated Declaration of Trust, dated as of August 28,
2003, by and among Appalachian Bancshares, Inc., as Sponsor,
Wilmington Trust Company, as Institutional Trustee and Delaware
Trustee, and Tracy Newton and Darren Cantlay, as Administrators
of Appalachian Capital Trust I (contained as an exhibit to the
Company's Current Report filed on Form 8-K, dated October 23,
2003).
10.2 Indenture, dated as of August 28, 2003, between Appalachian
Bancshares, Inc., as issuer, and Wilmington Trust Company, as
trustee (filed as Exhibit 4.1 hereto)
10.3 Guarantee Agreement, dated as of August 28, 2003, between
Appalachian Bancshares, Inc., as guarantor, and Wilmington Trust
Company, as trustee (contained as an exhibit to the Company's
Current Report filed on Form 8-K, dated October 23, 2003).
11 Computation of Earnings Per Share 24
31.1 Certificate of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. 25
31.2 Certificate of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. 26
32 Certificate pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 27
(b) Reports on Form 8-K.
The Company filed no reports on Form 8-K during the quarter for which
this report is filed.
22
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Company has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: November 14, 2003
APPALACHIAN BANCSHARES, INC.
/s/ Tracy R. Newton
--------------------------------------
Tracy R. Newton
President and CEO
(Duly authorized officer)
/s/ Darren M. Cantlay
--------------------------------------
Darren M. Cantlay
Chief Financial Officer
(Principal financial officer)
23
EXHIBIT 11
APPALACHIAN BANCSHARES, INC.
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
The following tabulation presents the calculation of basic and diluted
earnings per common share for the three-month and nine-month periods ended
September 30, 2003 and September 30, 2002. Average shares outstanding have been
retroactively adjusted on an equivalent share basis for the effects of the 10%
stock dividend as discussed in the notes to the financial statements.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------ -----------------------------
2003 2002 2003 2002
------------- ------------- ------------- --------------
Basic Earnings Per Share:
Net Income.................................... $ 796,853 $ 675,551 $ 2,069,983 $ 1,788,480
============= ============= ============= ==============
Earnings on common shares..................... 796,853 675.551 2,069,983 1,788,480
============= ============= ============= ==============
Weighted average common shares
outstanding - basic......................... 3,660,485 3,294,797 3,599,384 3,254,820
============= ============= ============= ==============
Basic earnings per common share............... $ 0.22 $ 0.21 0.58 0.55
============= ============= ============= ==============
Diluted Earnings Per Share:
Net Income.................................... $ 796,853 $ 675,551 $ 2,069,983 $ 1,788,480
============= ============= ============= ==============
Weighted average common shares
outstanding - diluted....................... 3,822,959 3,537,214 3,771,632 3,466,481
============= ============= ============= ==============
Diluted earnings per common share............. $ 0.21 $ 0.19 0.55 0.52
============= ============= ============= ==============
24
EXHIBIT 31.1
CERTIFICATE
I, Tracy R. Newton, certify that:
I have reviewed this quarterly report on Form 10-Q of Appalachian
Bancshares, Inc.;
Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];
and
(c) Disclosed in this report any change in the registrant's internal
controls over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2003
/s/ Tracy R. Newton
- -------------------------------------
Tracy R. Newton
President and Chief Executive Officer
25
EXHIBIT 31.2
CERTIFICATE
I, Darren M. Cantlay, certify that:
I have reviewed this quarterly report on Form 10-Q of Appalachian
Bancshares, Inc.;
Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];
and
(c) Disclosed in this report any change in the registrant's internal
controls over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 14, 2003
/s/ Darren M. Cantlay
- ------------------------------------
Darren M. Cantlay
Chief Financial Officer
26
EXHIBIT 32
CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Appalachian Bancshares, Inc.
(the "Company") on Form 10-Q for the quarterly period ended September 30, 2003
as filed with the Securities and Exchange Commission on the date hereof (the
"Report"), the undersigned, Tracy R. Newton, President and Chief Executive
Officer of the Company, and Darren C. Cantlay, Chief Financial Officer, do
hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of our
knowledge:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
Date: November 14, 2003 By: /s/ Tracy R. Newton
-------------------------------------
Tracy R. Newton
President and Chief Executive Officer
Date: November 14, 2003 By: /s/ Darren M. Cantlay
-------------------------------------
Darren M. Cantlay
Chief Financial Officer
27