United States
Securities and Exchange Commission
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT
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Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2003 Commission File No. 000-21383
APPALACHIAN BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Georgia 58-2242407
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(State of Incorporation) (I.R.S. Employer Identification Number)
829 Industrial Boulevard
Ellijay, Georgia 30540
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(Address of Principal Executive Offices) (Zip Code)
(706) 276-8000
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
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None None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.01 par value
(Title of Class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2): Yes No X
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There is no established trading market for the registrant's capital stock. The
aggregate market value of the stock held by non-affiliates of the registrant at
June 30, 2003 was $41,071,200, based on a per share price of $15, which is the
price of the last trade of which management is aware on or before such date.
Although directors and executive officers of the registrant were assumed to be
"affiliates" of the registrant for purposes of this calculation, the
classification is not to be interpreted as an admission of such status.
At March 19, 2004, there were 3,697,359 shares of the registrant's Common Stock
outstanding.
Documents Incorporated by Reference
Portions of the registrant's definitive Proxy Statement for the 2004 Annual
Meeting of Shareholders are incorporated by reference into Part III of this
report.
APPALACHIAN BANCSHARES, INC.
2003 Form 10-K Annual Report
TABLE OF CONTENTS
Item Number Page or
in Form 10-K Description Location
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PART I
Item 1. Business................................................................... 2
Item 2. Properties................................................................. 8
Item 3. Legal Proceedings.......................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders........................ 9
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................................ 9
Item 6. Selected Financial Data.................................................... 12
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................ 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................. 35
Item 8. Financial Statements and Supplementary Data................................ 35
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure................................................... 70
Item 9A. Controls and Procedures.................................................... 70
PART III
Item 10. Directors and Executive Officers of the Registrant......................... 70
Item 11. Executive Compensation..................................................... 70
Item 12. Security Ownership of Certain Beneficial Owners and Management............. 70
Item 13. Certain Relationships and Related Transactions............................. 70
Item 14. Principal Accountant Fees and Services..................................... 70
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........... 71
Signatures
1
PART I
ITEM 1. BUSINESS
History and Development of the Company
Appalachian Bancshares, Inc. (the "Company" or "Registrant") is a bank
holding company which engages in providing a full range of banking services
through Appalachian Community Bank, its commercial bank subsidiary, which
formerly was two separate subsidiary banks, Gilmer County Bank and Appalachian
Community Bank. During 2001, Appalachian Community Bank was merged with and into
Gilmer County Bank, to become one bank. The surviving bank, Gilmer County Bank,
simultaneously changed its name to Appalachian Community Bank (the "Bank"). The
merger was consummated to facilitate greater cost efficiencies of operations,
centralized management, consistency of regulatory compliance and to provide a
stronger capital base from which to serve the communities in our market areas.
The name change of Gilmer County Bank, from Gilmer County Bank to Appalachian
Community Bank, was desired to more clearly depict the overall geographic region
which the Bank services. For the immediate future, however, those branches of
the Bank that are located in Gilmer County will continue to operate under the
trade name of "Gilmer County Bank."
On November 30, 1998, the Company completed an acquisition of First
National Bank of Union County ("First National") from Century South Banks, Inc.
("Century South"). First National, renamed as "Appalachian Community Bank" in
1999, was a state chartered bank, organized in 1981, with its main banking
office located in Blairsville, Georgia. Pursuant to the terms of the acquisition
agreement, the Company acquired First National, in a cash transaction, for a
purchase price of $6.1 million, with the assumption of certain existing
liabilities and assets of First National by Century South or certain of its
affiliates. The Company funded a portion of the purchase price with the proceeds
of a private placement of 132,500 shares of the Company's common stock to
certain accredited investors. The aggregate gross proceeds of that private
placement were $2.65 million. Purchasers of shares of the Company's common stock
in that private placement are entitled to certain registration rights with
respect to such shares and are subject to certain call rights of the Company.
The Company funded the remainder of the purchase price through a $3.6 million
loan with The Bankers Bank.
The Company was incorporated as a business corporation in May 1996 under
the laws of the State of Georgia for the purpose of acquiring 100% of the issued
and outstanding shares of common stock of Gilmer County Bank. In July 1996, the
Company received approval from the Federal Reserve Bank of Atlanta and the
Georgia Department of Banking and Finance (the "DBF") to become a bank holding
company. In August 1996, the Company and Gilmer County Bank entered into a
reorganization pursuant to which the Company acquired 100% of the outstanding
shares of Gilmer County Bank, and the shareholders of Gilmer County Bank became
the shareholders of the capital stock of the Company.
Currently, the assets of the Company consist primarily of its ownership of
the capital stock of the Bank. The Company's executive office is located at 829
Industrial Boulevard, Ellijay, Georgia, and its telephone number at such
location is (706) 276-8000.
Business of the Company
The Company is authorized to engage in any activity in which a corporation
is permitted, by law, to engage, subject to applicable federal and state
regulatory restrictions on the activities of bank holding companies. The
Company's holding company structure provides it with greater flexibility than
the Bank would otherwise have, to expand and diversify its business activities
through newly formed subsidiaries or through acquisitions.
While management of the Company has no present plans to engage in any other
business activities, management may, from time to time, study the feasibility of
establishing or acquiring subsidiaries to engage in other business activities to
the extent permitted by law.
The Bank
The Bank was organized in 1994 under the laws of the State of Georgia to
conduct a commercial banking business in Gilmer County, Georgia. The Bank was
formed to meet the banking needs of individuals, small- to medium-sized
2
businesses, and farmers, especially those engaged in apple and poultry
production. The Bank was organized by a group of individuals from Gilmer County
and the surrounding area and commenced business from its main office location at
829 Industrial Boulevard, Ellijay, Georgia on March 3, 1995.
The Bank conducts business from four locations in three adjacent counties
(Gilmer, Fannin and Union) and has correspondent relationships with several
banks, including The Bankers Bank, Crescent Bank and Trust Company, SunTrust
Bank, SouthTrust Bank, National Bank of Commerce of Birmingham and the Federal
Home Loan Bank of Atlanta. The Bank's deposits are insured by the Federal
Deposit Insurance Corporation. The Bank's branches located in Gilmer County
currently operate under the trade name "Gilmer County Bank."
Banking Services and Operations
The Bank performs banking services customary for full service banks of
similar size and character. Such services include the receipt of demand and time
deposit accounts, the extension of personal and commercial loans and the
furnishing of personal and commercial checking accounts. The Bank draws most of
its customer deposits, and conducts most of its lending transactions, from and
within a primary service area encompassing Gilmer County, Fannin County, Union
County, Towns County, northern Pickens County, western Dawson County and
southeastern Murray County, Georgia.
The principal business of the Bank is to attract and accept deposits from
the public and to make loans and other investments. The principal sources of
funds for the Bank's loans and investments are (i) demand, time, savings, and
other deposits (including negotiable order of withdrawal ("NOW") accounts), (ii)
amortization and prepayment of loans granted, (iii) sales to other lenders or
institutions of loans or participation in loans, (iv) fees paid by other lenders
or institutions for servicing loans sold by the Bank to such lenders or
institutions, and (v) borrowings. The principal sources of income for the Bank
are interest and fees collected on loans, including fees received for servicing
loans sold to other lenders or institutions and, to a lesser extent, interest
and dividends collected on other investments. The principal expenses of the Bank
are (a) interest paid on savings and other deposits (including NOW accounts),
(b) interest paid on borrowings by the Bank, (c) employee compensation, (d)
office expenses, and (e) other overhead expenses.
Employees
Except for the officers of the Company, who are also officers of the Bank,
the Company does not have any employees. At December 31, 2003, the Bank had a
total of 130 employees, 108 of which were full-time employees. The Company and
the Bank are not parties to any collective bargaining agreements with employees,
and management believes that employee relations are generally good.
Lending Activities
General. The Bank is authorized to make both secured and unsecured
commercial and consumer loans to individuals, partnerships, corporations and
other entities. The Bank's lending business consists principally of making
secured real estate loans, including residential and commercial construction
loans, and primary and secondary mortgage loans for the acquisition or
improvement of personal residences. In addition, the Bank makes consumer loans
to individuals and commercial loans to small and medium-sized businesses and
professional concerns. Loans to the poultry industry constituted approximately
6.9% of the Bank's total loans at December 31, 2003.
The Bank has engaged in secondary-market mortgage activities, obtaining
commitments, through intermediaries, from secondary mortgage purchasers to
purchase mortgage loans originated by the Bank. Based on these commitments, the
Bank originates mortgage loans on terms corresponding to such commitments and
generates fee income to supplement its interest income. No mortgage loans are
held by the Bank for resale nor are any loans held for mortgage servicing.
Real Estate Loans. Loans secured by real estate are the primary component
of the Bank's loan portfolio, constituting approximately $271 million, or 81.6%,
of the Bank's total loans at December 31, 2003. These loans consist of
commercial real estate loans, construction and development loans and residential
real estate loans.
Commercial Loans. The Bank makes loans for commercial purposes to various
lines of businesses. At December 31, 2003, the Bank held approximately $32
million, or 9.7% of the Bank's total loans, in commercial loans, excluding for
these purposes commercial loans secured by real estate which are included in the
real estate category above.
3
Consumer Loans. The Bank makes a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and revolving lines of credit
such as credit cards. At December 31, 2003, the Bank held approximately $20.5
million in consumer loans, representing 6.2% of the Bank's total loans.
Loan Approval and Review. The Bank's loan approval policies provide for
various levels of officer lending authority. When the aggregate amount of
outstanding loans to a single borrower exceeds that individual officer's lending
authority, the loan request must be considered and approved by an officer with a
higher lending limit or the officers' loan committee. Individual officers'
lending limits range from $15,000 to $500,000, depending on seniority and the
type of loan. The officers' loan committee, which consists of the president,
executive vice president and senior vice president, has a lending limit of
$1,000,000 secured and up to $100,000 unsecured. Loans exceeding $1,000,000
require the approval of the majority of the directors' loan committee, which is
made up of six of the Bank's directors.
The Bank has a continuous loan review procedure, involving multiple
officers of the Bank, that is designed to promote early identification of credit
quality problems. All loan officers are charged with the responsibility of
rating their loans and reviewing those loans on a periodic basis, the frequency
of which increases as the quality of the loan decreases. The Bank has contracted
with a specialist for an independent assessment of the loan portfolio. The
specialist reviews loans on a quarterly basis.
Deposits
The Bank offers a variety of deposit programs to individuals and to small
to medium-sized businesses and other organizations at interest rates generally
consistent with local market conditions. The Bank is authorized to accept and
pay interest on deposits from individuals, corporations, partnerships and any
other types of legal entities, including fiduciaries (such as private trusts).
Qualified deposits are insured by the FDIC in an amount up to $100,000.
The following table sets forth the mix of depository accounts at the Bank
as a percentage of total deposits at December 31, 2003.
Deposit Mix
December 31, 2003
Non-interest bearing demand.............................................. 7.15%
Interest-bearing demand.................................................. 22.74%
Savings.................................................................. 14.60%
Time Deposits............................................................ 31.86%
Certificates of Deposit of $100,000 or more.............................. 23.65%
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Total.................................................................. 100.00%
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The Bank is a member of the Star ATM network of automated teller machines,
which permits the Bank's customers to perform certain transactions in numerous
cities throughout Georgia and in other states. The Bank's charter provides for
trust powers but only upon application to the DBF. To date, the Bank has not
submitted, and has no plans to submit, such an application.
Competition and Market Area
The banking business is highly competitive. The Bank competes with other
commercial banks, thrift institutions, credit unions, and money market mutual
fund providers operating in Ellijay, Georgia (Gilmer County), Blue Ridge,
Georgia (Fannin County), Blairsville, Georgia (Union County) and elsewhere. Some
banks with which the Bank competes have significantly greater resources and
higher lending limits (by virtue of their greater capitalization). Credit unions
and money market mutual fund providers with which the Bank competes may have
competitive advantages as a result of being subject to different, and possibly
less stringent, regulatory requirements.
The Bank serves the areas of Gilmer County, Fannin County, Union County,
Towns County, northern Pickens County, western Dawson County and southeastern
Murray County, Georgia. The Bank encounters competition in its primary service
area and in surrounding areas from other commercial banks. As of December 31,
2003, three non-locally-owned banks had offices in Gilmer County, two
locally-owned banks and one non-locally-owned bank had offices in Blairsville
(Union County), and four non-locally-owned banks had offices in Fannin County.
In addition, many local businesses and individuals have deposits outside the
primary service area of the Bank.
Monetary Policies
The results of operations of the Company and the Bank are significantly
affected by the credit policies of monetary authorities, particularly the Board
of Governors of the Federal Reserve System (the "Federal Reserve"). The
instruments of monetary policy employed by the Federal Reserve include open
market operations in U.S. government securities, changes in discount rates on
member bank borrowings, and changes in reserve requirements against bank
deposits. In view of changing conditions in the national economy and in the
money markets, as well as the effect of action by monetary and fiscal
authorities, including the Federal Reserve, no prediction can be made as to
possible future changes in interest rates, deposit levels, loan demand, or the
business and earnings of the Bank.
4
Supervision and Regulation
The following discussion is only intended to provide brief summaries of
significant statutes and regulations that affect the banking industry and
therefore is not complete. Changes in applicable laws or regulations, and in the
policies of regulators, may have a material effect on the Company's business and
prospects. Management cannot accurately predict the nature or extent of the
effects on the Company's business and earnings that fiscal or monetary policies,
or new federal or state laws, may have in the future.
The Company
General. As a bank holding company, the Company is subject to the Bank
Holding Company Act of 1956, which places the Company under the supervision of
the Board of Governors of the Federal Reserve. The Company must file annual
reports with the Federal Reserve and must provide it with such additional
information as it may require. In addition, the Federal Reserve periodically
examines the Company and the Bank.
Bank Holding Company Regulation. In general, the Bank Holding Company Act
limits bank holding company business to owning or controlling banks and engaging
in other banking-related activities. Bank holding companies must obtain the
Federal Reserve Board's approval before they:
o acquire direct or indirect ownership or control of any voting shares
of any bank that results in total ownership or control, directly or
indirectly, of more than 5% of the voting shares of such bank;
o merge or consolidate with another bank holding company; or
o acquire substantially all of the assets of any additional banks.
Subject to certain state laws, a bank holding company that is adequately
capitalized and adequately managed may acquire the assets of both in-state and
out-of-state banks. Under the Gramm-Leach-Bliley Act of 1999, a bank holding
company meeting certain qualifications may apply to the Federal Reserve Board to
become a financial holding company, and thereby engage (directly or through a
subsidiary) in certain activities deemed financial in nature, such as securities
brokerage and insurance underwriting.
With certain exceptions, the Bank Holding Company Act prohibits bank
holding companies from acquiring direct or indirect ownership or control of
voting shares in any company that is not a bank or a bank holding company unless
the Federal Reserve Board determines such activities are incidental or closely
related to the business of banking.
The Change in Bank Control Act of 1978 requires a person (or group of
persons acting in concert) acquiring "control" of a bank holding company to
provide the Federal Reserve Board with 60 days' prior written notice of the
proposed acquisition. Following receipt of this notice, the Federal Reserve
Board has 60 days (or up to 90 days if extended) within which to issue a notice
disapproving the proposed acquisition. In addition, any "company" must obtain
the Federal Reserve Board's approval before acquiring 25% (5% if the "company"
is a bank holding company) or more of the outstanding shares or otherwise
obtaining control over the Company.
Financial Services Modernization. The laws and regulations that affect
banks and bank holding companies underwent significant changes as a result of
the Financial Services Modernization Act of 1999, also known as the
Gramm-Leach-Bliley Act. Generally, the act (i) repealed the historical
restrictions on preventing banks from affiliating with securities firms, (ii)
5
provided a uniform framework for the activities of banks, savings institutions
and their holding companies, (iii) broadened the activities that may be
conducted by national banks and banking subsidiaries of bank holding companies,
(iv) provided an enhanced framework for protecting the privacy of consumers'
information and (v) addressed a variety of other legal and regulatory issues
affecting both day-to-day operations and long-term activities of financial
institutions.
Bank holding companies may now engage in a wider variety of financial
activities than permitted under previous law, particularly insurance and
securities activities. In addition, in a change from previous law, a bank
holding company may be owned, controlled or acquired by any company engaged in
financially related activities, so long as such company meets certain regulatory
requirements. The act also permits national banks (and certain state banks),
either directly or through operating subsidiaries, to engage in certain
non-banking financial activities.
Transactions with Affiliates. The Company and the Bank are deemed
affiliates within the meaning of the Federal Reserve Act, and transactions
between affiliates are subject to certain restrictions. Generally, the Federal
Reserve Act limits the extent to which a financial institution or its
subsidiaries may engage in "covered transactions" with an affiliate. It also
requires all transactions with an affiliate, whether or not "covered
transactions," to be on terms substantially the same, or at least as favorable
to the institution or subsidiary, as those provided to a non-affiliate. The term
"covered transaction" includes the making of loans, purchase of assets, issuance
of a guarantee and other similar types of transactions.
Tie-In Arrangements. The Company and the Bank cannot engage in certain
tie-in arrangements in connection with any extension of credit, sale or lease of
property or furnishing of services. For example, with certain exceptions,
neither the Company nor the Bank may condition an extension of credit on either
a requirement that the customer obtain additional services provided by either of
the Company or the Bank, or an agreement by the customer to refrain from
obtaining other services from a competitor. The Federal Reserve Board has
adopted exceptions to its anti-tying rules that allow banks greater flexibility
to package products with their affiliates. These exceptions were designed to
enhance competition in banking and non-banking products and to allow banks and
their affiliates to provide more efficient, lower cost service to their
customers.
State Law Restrictions. As a Georgia business corporation, the Company may
be subject to certain limitations and restrictions under applicable Georgia
corporate law.
The Bank
General. The Bank, as a Georgia state-chartered bank, is subject to
regulation and examination by the State of Georgia Department of Banking and
Finance, as well as the Federal Deposit Insurance Corporation. Georgia state
laws regulate, among other things, the scope of the Bank's business, its
investments, its payment of dividends to the Company, its required legal
reserves and the nature, lending limit, maximum interest charged and amount of
and collateral for loans. The laws and regulations governing the Bank generally
have been promulgated by Georgia to protect depositors and not to protect
shareholders of the Company or the Bank.
Community Reinvestment Act. The Community Reinvestment Act requires that,
in connection with examinations of financial institutions within their
jurisdiction, the Federal Deposit Insurance Corporation evaluate the record of
the financial institutions in meeting the credit needs of their local
communities, including low and moderate income neighborhoods, consistent with
the safe and sound operation of those banks. These factors are also considered
in evaluating mergers, acquisitions, and applications to open a branch or
facility.
Insider Credit Transactions. Banks are also subject to certain restrictions
imposed by the Federal Reserve Act on extensions of credit to executive
officers, directors, principal shareholders, or any related interests of such
persons. Extensions of credit must be made on substantially the same terms,
including interest rates and collateral, and follow credit underwriting
procedures that are not less stringent than those prevailing at the time for
comparable transactions with persons not covered above and who are not
employees. Also, such extensions of credit must not involve more than the normal
risk of repayment or present other unfavorable features.
Federal Deposit Insurance Corporation Improvement Act. Under the Federal
Deposit Insurance Corporation Improvement Act of 1991, each federal banking
agency has prescribed, by regulation, noncapital safety and soundness standards
for institutions under its authority. These standards cover internal controls,
6
information systems, and internal audit systems, loan documentation, credit
underwriting, interest rate exposure, asset growth, compensation, fees and
benefits, such other operational and managerial standards as the agency
determines to be appropriate, and standards for asset quality, earnings and
stock valuation. Management believes that the Bank meets all such standards.
Interstate Banking and Branching. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 permits nationwide interstate banking and
branching under certain circumstances. This legislation generally authorizes
interstate branching and relaxes federal law restrictions on interstate banking.
Currently, bank holding companies may purchase banks in any state, and states
may not prohibit such purchases. Additionally, banks are permitted to merge with
banks in other states as long as the home state of neither merging bank has
"opted out." The Interstate Act requires regulators to consult with community
organizations before permitting an interstate institution to close a branch in a
low-income area. Under recent Federal Deposit Insurance Corporation regulations,
banks are prohibited from using their interstate branches primarily for deposit
production. The Federal Deposit Insurance Corporation has accordingly
implemented a loan-to-deposit ratio screen to ensure compliance with this
prohibition.
Georgia has "opted in" to the Interstate Act and allows in-state banks to
merge with out-of-state banks subject to certain requirements. Georgia law
generally authorizes the acquisition of an in-state bank by an out-of-state bank
by merger with a Georgia financial institution that has been in existence for at
least 3 years prior to the acquisition. With regard to interstate bank
branching, out-of-state banks that do not already operate a branch in Georgia
may not establish de novo branches in Georgia.
Deposit Insurance. The deposits of the Bank are currently insured to a
maximum of $100,000 per depositor through a fund administered by the Federal
Deposit Insurance Corporation. All insured banks are required to pay semi-annual
deposit insurance premium assessments to the Federal Deposit Insurance
Corporation.
Capital Adequacy
Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below minimum guideline levels, the holding company or bank may be denied
approval to acquire or establish additional banks or nonbank businesses or to
open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks
and bank holding companies. These are designed to make such capital requirements
more sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are
assigned to broad risk categories, each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and off-balance sheet items. The guidelines are minimums, and the Federal
Reserve has noted that bank holding companies contemplating significant
expansion programs should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the minimum. The current guidelines
require all bank holding companies and federally-regulated banks to maintain a
minimum risk-based total capital ratio equal to 8%, of which at least 4% must be
Tier 1 capital. Tier 1 capital for bank holding companies includes common
shareholders' equity, certain qualifying perpetual preferred stock and minority
interests in equity accounts of consolidated subsidiaries, less intangibles
except as described above.
The FDIC and Federal Reserve also employ a leverage ratio, which is Tier 1
capital as a percentage of total assets less intangibles, to be used as a
supplement to risk-based guidelines. The principal objective of the leverage
ratio is to constrain the maximum degree to which a bank holding company or bank
may leverage its equity capital base. A minimum leverage ratio of 3% is required
for the most highly rated bank holding companies and banks. Other bank holding
companies, banks and bank holding companies seeking to expand, however, are
required to maintain minimum leverage ratios of at least 4% to 5%.
The Federal Deposit Insurance Corporation Improvement Act created a
statutory framework of supervisory actions indexed to the capital level of the
individual institution. Under regulations adopted by the Federal Deposit
Insurance Corporation and the Federal Reserve, an institution is assigned to one
of five capital categories depending on its total risk-based capital ratio, Tier
1 risk-based capital ratio, and leverage ratio, together with certain subjective
factors. Institutions which are deemed to be "undercapitalized" depending on the
category to which they are assigned are subject to certain mandatory supervisory
corrective actions.
7
Recent Significant Changes in Banking Laws and Regulations
International Money Laundering Abatement and Anti-Terrorist Financing Act
of 2001. On October 26, 2001, the USA PATRIOT Act was enacted. It includes the
International Money Laundering Abatement and Anti-Terrorist Financing Act of
2001 and strong measures to prevent, detect and prosecute terrorism and
international money laundering. As required by the IMLAFA, the federal banking
agencies, in cooperation with the U.S. Treasury Department, established rules
that generally apply to insured depository institutions and U.S. branches and
agencies of foreign banks.
Among other things, the new rules require that financial institutions
implement reasonable procedures to (1) verify the identity of any person opening
an account; (2) maintain records of the information used to verify the person's
identity; and (3) determine whether the person appears on any list of known or
suspected terrorists or terrorist organizations. The rules also prohibit banks
from establishing correspondent accounts with foreign shell banks with no
physical presence and encourage cooperation among financial institutions, their
regulators and law enforcement to share information regarding individuals,
entities and organizations engaged in terrorist acts or money laundering
activities. The rules also limit a financial institution's liability for
submitting a report of suspicious activity and for voluntarily disclosing a
possible violation of law to law enforcement.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of
2002 was enacted to address corporate and accounting fraud. The act established
a new accounting oversight board that enforces 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 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 from 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 2. PROPERTIES
The Company's main office is located at 829 Industrial Boulevard, Ellijay,
Georgia, between the business districts of Ellijay and East Ellijay. The 9,780
square foot building is located on approximately 1.22 acres and is owned by the
Bank. The building includes five teller stations, twenty offices, three drive-in
stations and an ATM. This location houses the Company's and the Bank's offices
and storage areas. The Bank branch at this location operates under the trade
name "Gilmer County Bank."
The Bank's branch located on Highway 515 in Blairsville, Georgia has a
drive-in window, five teller stations, eleven offices, and an ATM. The building
is owned by the Bank. The second floor of this location is vacant and may be
used by the Bank for future expansion.
The Bank's branch located in East Ellijay, Georgia, which operates under
the trade name "Gilmer County Bank," has three teller stations, a drive-in
window and an ATM. The Bank has a long-term lease for this location and pays
annual rent of $31,400.
The Bank's branch in Blue Ridge, Georgia has a drive-in window, three
teller stations, four offices, and an ATM. The Bank has a 24-month lease (with
an additiona1 24 month renewal option) for the land on which this branch is
located and pays annual rent of $32,000. The Bank has purchased 2.6 acres in
Blue Ridge to construct a permanent branch location. Construction has begun on a
9,000 square foot branch and a 3,500 square foot community building.
Construction is expected to be completed by June 1, 2004.
8
The Bank's operations area is located in a building owned by the Bank
located at 9 Russell Drive, Ellijay, Georgia. This location houses the Bank's
computer center, accounting, bookkeeping and data processing services. In
addition, the building includes an additional 8,000 approximate square feet,
which is leased by the Bank to two separate third parties for $67,200 per year.
The bank also leases a building directly behind the operations building, which
contains additional operations employees. The bank has a two-year lease for this
space and pays annual rent of $16,800.
Management believes that the physical facilities maintained by the Company
and the Bank are suitable for their current operations.
ITEM 3. LEGAL PROCEEDINGS
The Company is not aware of any material pending legal proceedings to which
the Company or the Bank are a party or to which any of their property is
subject, other than ordinary routine legal proceedings incidental to the
business of the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders of the Company during
the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Information
There is no established trading market for the Company's common stock,
$0.01 par value per share (the "Common Stock"), which has been traded inactively
in private transactions. Therefore, no reliable information is available as to
trades of the Common Stock or as to the prices at which Common Stock has traded.
In 1998, Wachovia Securities, Inc. was approved as a market maker for the
Company's Common Stock.
In July 2003, the Company paid a ten percent stock dividend (the "Stock
Dividend") to shareholders of record as of May 27, 2003. All amounts presented
in this Report and in the financial statements are adjusted to reflect the Stock
Dividend. The Stock Dividend created a small decrease in shareholders' equity
for cash paid in lieu of fractional shares in the amount of $1,931.
[The remainder of this page intentionally left blank]
9
Management has reviewed the limited information available as to the ranges
at which the Common Stock has been sold and is aware of trades that occurred
during 2003. To the best of management's knowledge, the last trade in December
2003 was executed at a price of $15.00 per share. The per share price data
regarding the Common Stock is provided for information purposes only and should
not be viewed as indicative of the actual or market value of the Common Stock.
Estimated Price
Range Per Share
-------------------------------
High Low
------------- --------------
2003:
First Quarter................................................................. $ 16.00 $ 15.00
Second Quarter................................................................ 15.00 15.00
Third Quarter................................................................. 15.00 15.00
Fourth Quarter................................................................ 15.00 13.37
2002:
First Quarter................................................................. $ 17.00 $ 15.00
Second Quarter................................................................ 16.00 15.00
Third Quarter................................................................. 15.00 15.00
Fourth Quarter................................................................ 15.00 15.00
Holders
At March 19, 2004, the Company had 3,697,359 shares of Common Stock
outstanding held by approximately 1,408 shareholders of record.
Recent Sales of Unregistered Securities
On December 2, 2002, the Company commenced a private placement offering, to
accredited investors only, of up to 200,000 shares of Common Stock, at an
aggregate offering price of $3,000,000 ($15.00 per share) (the "Offering"). The
Company sold 180,687 shares of Common Stock through the Offering, which expired
on June 30, 2003. The Offering was made without the services of an underwriter
and without any advertising or promotion, and sales therein were solicited only
by certain of the Company's executive officers and directors, none of whom
received any commission or remuneration for their efforts. Further, the
securities sold in the Offering were exempt from registration under the
Securities Act of 1933, as amended (the "Securities Act"), based on the
exemption set forth in Rule 506 of Regulation D, promulgated under the
Securities Act, which provides that registration is not required where, among
other things, all of the purchasers in such an offering are "accredited
investors," as that term is defined in Section 2(a)(15) of the Securities Act
and Rule 501 of Regulation D. Purchasers of shares of Common Stock in the
Offering are entitled to certain registration rights with respect to such shares
and are subject to certain call rights of the Company.
Dividends
The Bank is subject to restrictions on the payment of dividends under
Georgia law and the regulations of the DBF. The Company is also subject to
limits on payment of dividends by the rules, regulations and policies of federal
banking authorities. The primary source of funds available for the payment of
cash dividends by the Company are dividends from the Bank. There are various
statutory and regulatory limitations on the payment of dividends by the Bank, as
well as by the Company to its shareholders. No assurance can be given that any
dividends will be declared by the Company in the future, or if declared, what
amounts would be declared or whether such dividends would continue. The Company
has not paid any cash dividends to date. The Company paid a 10% stock dividend
on July 1, 2003.
10
Securities Authorized for Issuance Under Equity Compensation Plans
At a prior Annual Meeting, the Company's shareholders adopted a Stock
Compensation Program (the "Stock Program"). The following table reflects the
number of shares to be issued upon the exercise of options granted under the
Stock Program, the weighted-average exercise price of all such options, and the
total number of shares of Common Stock reserved for the issuance upon the
exercise of authorized, but not-yet-granted options, as of December 31, 2003.
Number of
Number of Equity Securities
Securities Remaining
to be Issued Weighted-average Available for
Upon the Exercise Exercise Price Future Issuance
of Outstanding of Outstanding Under the
Plan Category Options Options Stock Program
- ------------------------------------ ------------------ ----------------- -----------------
Equity Compensation Plans
Approved by Shareholders.................... 433,140 $ 5.65 233,900
Equity Compensation Plans
Not Approved by Shareholders................ -- -- --
------------------ ----------------- -----------------
Total....................................... 433,140 $ 5.65 233,900
================== ================= =================
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11
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated financial data of the
Company for the year ended December 31, 2003, and the previous four years. All
averages are daily averages.
Years Ended December 31,
------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- --------- ---------- ----------
(Dollars in thousands except per share data and ratios)
Earnings Summary
Interest income.................................. $ 22,996 $ 22,892 $ 23,890 $ 21,970 $ 16,139
Interest expense................................. 8,257 11,425 13,675 13,325 9,139
Net interest income.............................. 14,739 11,467 10,215 8,645 7,000
Provision for loan losses........................ 1,465 1,028 1,294 922 880
Noninterest income............................... 2,797 2,937 2,411 1,159 845
Noninterest expense.............................. 11,732 9,702 7,831 6,381 5,561
Income tax expense............................... 1,253 1,006 963 872 139
Net income....................................... 3,086 2,668 2,538 1,629 1,265
Per Share Data
(Retroactively adjusted to give effect to stock splits/dividends)
Net income - basic............................... $ 0.86 $ 0.81 $ 0.81 $ 0.54 $ 0.44
Net income - diluted............................. 0.81 0.76 0.75 0.50 0.40
Cash dividends declared per common share......... 0.00 0.00 0.00 0.00 0.00
Selected Period End Balances
Total assets..................................... 409,617 384,024 319,679 270,943 223,315
Loans............................................ 332,307 298,063 250,569 214,124 169,106
Securities....................................... 55,363 40,375 49,394 32,541 28,536
Earning assets................................... 388,530 354,593 303,923 253,263 207,501
Deposits......................................... 332,919 316,283 264,028 214,169 186,730
Long-term borrowings............................. 36,879 34,736 29,654 34,539 16,964
Shareholders' equity............................. 31,082 25,619 20,591 17,669 12,421
Shares outstanding............................... 3,659 3,439 3,170 3,143 1,480
Selected Average Balances
Total assets..................................... 393,553 354,164 299,167 259,799 203,703
Loans............................................ 316,605 276,733 234,031 204,436 150,691
Securities....................................... 49,951 50,933 40,462 34,393 33,192
Earning assets................................... 370,654 333,777 280,884 243,038 191,540
Deposits......................................... 320,833 290,961 241,933 206,787 175,025
Long-term borrowings............................. 35,782 34,017 33,028 29,024 12,798
Shareholders' equity............................. 28,447 22,454 19,821 15,045 11,950
Shares outstanding - basic....................... 3,610 3,278 3,146 3,031 2,917
Ratios
Return on average assets......................... 0.78% 0.75% 0.85% 0.63% 0.62%
Return on average equity......................... 10.85 11.88 12.80 10.83 10.59
Net interest spread.............................. 3.90 3.32 3.75 3.39 3.52
Total capital.................................... 11.55 8.59 8.32 8.25 7.41
Tier 1 capital................................... 10.46 7.54 7.16 7.22 6.34
Leverage ratio................................... 8.58 6.07 5.87 5.72 5.22
Average equity to average assets................. 7.23 6.34 6.63 5.79 5.87
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The purpose of the following discussion is to address information relating
to the financial condition and results of operations of the Company that may not
be readily apparent from a review of the consolidated financial statements and
notes thereto, included in this Report. This discussion should be read in
conjunction with information provided in the Company's consolidated financial
statements and notes thereto. Unless otherwise noted, the discussion of net
interest income in this financial review is presented on a taxable equivalent
basis to facilitate performance comparisons among various taxable and tax-exempt
assets.
Forward-Looking Statements
Certain of the statements made in this Report and in documents incorporated
by reference herein, 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. The words "expect,"
"anticipate," "intend," "plan," "believe," "seek," "estimate" and similar
expressions are intended to identify such forward-looking statements. 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 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.
Summary
The Company's net income of $3,086,580 for the year ended December 31, 2003
represented an increase of $418,572 or 15.7%. The Company's net income of
$2,668,008 for the year ended December 31, 2002, represents an increase of
$129,910 or 5.1%. The Company's net income of $2,538,098 for the year ended
December 31, 2001, represented an increase of $908,667 or 55.8%. The increase in
net income for these periods relates to increased loan growth and improved
interest rate management coupled with proper management of expenses.
Earnings per share increased to $0.86 ($0.81 on a diluted basis) in 2003,
up from $0.81 ($0.76 on a diluted basis) in 2002 and $0.81 ($0.75 on a diluted
basis) in 2001. Return on average assets, which reflects the Bank's ability to
utilize its assets, was 0.78% in 2003, compared to 0.75% in 2002, and 0.85% in
2001. Return on average shareholders' equity decreased to 10.85% in 2003 and
decreased to 11.88% in 2002, compared to 12.80% in 2001. The decline in this
ratio is due in large part to continued growth and expansion in the Company.
During 2002 and 2003, the Company sold 180,687 shares of common stock for net
proceeds of $2,710,306 to support future expansion. Options exercised in 2003
and 2002 generated proceeds of $529,330 and $1,021,498, respectively. Also
during 2002, the Company issued and sold 12,859 shares to its 401(k) plan for
$163,660.
The Company plans to continue its objectives of maintaining asset quality
and providing superior service to its customers. The Company's strategic plan in
the short run includes controlled growth with a focus on developing banking
relationships. The Company plans to provide the best value in deposit services
and loan products to its customers. During 2003, the Company placed a strong
focus on improving the net interest margin. Pricing models were put in place to
assist loan officers with structuring loan products to fit our customers' needs,
as well as deposit pricing models to assist with funds management. The Company
is also taking advantage of alternative funding sources when needed. Some of the
alternative sources include the national CD market, brokered CD market, the
Federal Home Loan Bank and repurchase agreements. The results of this effort are
beginning to show in the Company's margin and bottom line.
13
Critical Accounting Policies
The Company has established various accounting policies which govern the
application of generally accepted accounting principles in the preparation of
the financial statements. Certain accounting policies involve significant
judgments and assumptions by management that have a material impact on the
carrying value of certain assets and liabilities. Management considers such
accounting policies to be critical accounting policies. The judgments and
assumptions used by management are based on historical experience and other
factors, which are believed to be reasonable under the circumstances. Because of
the nature of the judgments and assumptions made by management, actual results
could differ from these judgments and estimates that could have a material
impact on the carrying values of assets and liabilities and the results of
operations of the Company. The Company believes the allowance for loan losses is
a critical accounting policy that requires the most significant judgments and
estimate used in the preparation of the Consolidated Financial Statements. Refer
to Note 1 to the Consolidated Financial Statements, Summary of Significant
Accounting Policies, and the allowance for loan loss discussions in Note 7 and
Item 7 for a description of the estimation processes and methodology related to
the allowance for loan losses.
Financial Condition
Earning Assets
The Bank's earning assets, which include deposits in other banks, federal
funds sold, securities and loans, averaged $370,654,000, or 94.2% of average
total assets in 2003, $333,777,000, or 94.2% of average total assets, in 2002,
compared to $280,884,000, or 93.9% of average total assets, in 2001. The mix of
average earning assets comprised the following percentages:
December 31,
----------------------------------------
2003 2002 2001
----------- ----------- -----------
Deposits in other banks................................................ 0.21% 0.30% 0.14%
Federal funds sold..................................................... 0.89 1.53 2.13
Investment securities.................................................. 13.48 15.26 14.41
Loans.................................................................. 85.42 82.91 83.32
The mix of average earning assets reflects management's attempt to maximize
interest income while maintaining acceptable levels of risk.
The management of the Company considers many criteria in managing earning
assets, including creditworthiness, diversification, maturity, and interest rate
sensitivity. The following table sets forth the Company's interest-earning
assets by category at December 31 in each of the last three years.
December 31,
----------------------------------------
2003 2002 2001
----------- ----------- -----------
(In thousands)
Interest-bearing deposits with banks.................................... $ 274 $ 8,399 $ 746
Securities.............................................................. 55,363 40,375 49,394
Federal funds sold...................................................... 586 7,756 3,214
Loans:
Real estate.......................................................... 271,217 238,768 202,107
Commercial and other................................................. 61,090 59,295 48,462
----------- ----------- -----------
Total loans........................................................ 332,307 298,063 250,569
----------- ----------- -----------
Interest-earning assets ................................................ $ 388,530 $ 354,593 $ 303,923
=========== =========== ===========
The Bank has intentionally avoided the growing national market in loans to
finance leveraged buy-outs, and has participated in no nationally syndicated
leveraged buy-out loans. It has also avoided exposure to lesser developed
country ("LDC") debt, and has no LDC loans in its portfolio.
Federal Funds Sold
Management maintains federal funds sold as a tool in managing the Bank's
daily cash needs. Federal funds sold at December 31, 2003 and 2002 were $586,000
and $7,756,000, respectively. Average federal funds sold for 2003 was
approximately $3,314,000, or 0.89% of average earning assets, and for 2002 was
approximately $5,104,000, or 1.53% of average earning assets. The decrease in
year-end federal funds resulted from the Bank's focus on improving the
net-interest margin. The Bank worked towards minimizing federal funds sold in
this low rate environment to maximize its use of earning assets.
14
Securities Portfolio
At December 31, 2002, $40,374,902 of the Bank's securities were classified
as available-for-sale, while at December 31, 2003, $55,363,327 of the Bank's
securities were classified as available-for-sale.
The composition of the Bank's securities portfolio reflects the Company's
investment strategy of maximizing portfolio yields subject to risk and liquidity
considerations. The primary objectives of the Company's investment strategy are
to maintain an appropriate level of liquidity, and to provide a tool with which
to control the Bank's interest rate position while, at the same time, producing
adequate levels of interest income. Management of the maturity of the portfolio
is necessary to provide liquidity and to control interest rate risk. During
2003, gross securities sales were $5,368,830 and maturities were $23,121,518,
representing 10.75% and 46.29%, respectively, of the average portfolio for the
year. Net losses associated with sales and maturities totaled $16,978 in 2003.
Gross unrealized gains in the portfolio amounted to $966,919 at year-end 2003
and unrealized losses amounted to $316,263. During 2002, gross sales amounted to
$12,597,325 and maturities amounted to $34,322,603, representing 24.7% and 67.4%
of the average portfolio, respectively. Net gains associated with sales and
maturities totaled $285,525 in 2002. Gross unrealized gains in the portfolio
amounted to $698,255 at year-end 2002 and unrealized losses amounted to $17,876.
Mortgage-backed securities have varying degrees of risk of impairment of
principal, as opposed to U.S. Treasury and U.S. government agency obligations,
which are considered to contain virtually no default or prepayment risk.
Impairment risk is primarily associated with accelerated prepayments,
particularly with respect to longer maturities purchased at a premium and
interest-only strip securities. The Bank's purchases of mortgage-backed
securities during 2003, 2002 and 2001 did not include securities with these
characteristics. The recoverability of the Bank's investments in mortgage-backed
securities is reviewed periodically, and the Company intends to make appropriate
adjustments to income for impaired values.
The following table presents the carrying amounts of the securities
portfolio at December 31 in each of the last three years.
Securities Portfolio
December 31,
----------------------------------------------
2003 2002 2001
------------- ------------- --------------
(In thousands)
Securities Available-for-Sale:
U.S. treasury and government agencies........................ $ 20,074 $ 8,579 $ 14,691
Mortgage-backed securities................................... 19,205 14,759 19,340
State and municipal securities............................... 14,355 15,314 13,805
Equity securities............................................ 1,729 1,723 1,558
------------- ------------- --------------
Total...................................................... $ 55,363 $ 40,375 $ 49,394
============= ============= ==============
In 2003, average taxable securities were 69.9% of the portfolio, compared
to 68.2% in 2002 and 69.7% in 2001.
15
The maturities and weighted average yields of the investments in the 2003
portfolio of securities are presented below. The average maturity of the
securities portfolio is 7.27 years with an average yield of 5.28%. Taxable
equivalent adjustments (using a 34 percent tax rate) have been made in
calculating yields on tax-exempt obligations.
Security Portfolio Maturity Schedule
Maturing
------------------------------------------------------------------------------
Within After One But After Five But After
One Year Within Five Years Within Ten Years Ten Years
----------------- ------------------ ----------------- ----------------
Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ----- -------- ----- -------- -----
(Amounts in thousands, except percentages)
Securities Available-for-Sale
U.S. Government agencies...... $ -- 0.00% $ 16,072 2.95% $ 4,002 3.30% $ -- 0.00%
Mortgage-backed............... 7,362 2.67 7,580 3.82 537 5.34 3,726 4.90
State and municipal........... -- 0.00 276 6.12 2,214 28.60 11,865 7.42
Equity securities............. -- 0.00 -- 0.00 -- 0.00 1,729 3.50
-------- --------- -------- --------
Total Securities................. $ 7,362 $ 23,928 $ 6,753 $ 17,320
======== ========= ======== ========
There were no securities held by the Company of which the aggregate value
on December 31, 2003 exceeded ten percent of shareholders' equity at that date.
(Securities which are payable from and secured by the same source of revenue or
taxing authority are considered to be securities of a single issuer. Securities
of the U.S. Government and U.S. Government agencies and corporations are not
included.)
There has been no significant impact on the Company's consolidated
financial statements as a result of the provisions of Statement of Financial
Accounting Standards No. 119, Disclosure about Derivative Financial Instruments
and Fair Value of Financial Instruments.
Loan Portfolio
Loans make up the largest component of the Bank's earning assets. At
December 31, 2003, the Bank's total loans were $332,306,446, compared to total
loans of $298,063,055 at the end of 2002. In 2003, average net loans represented
85.4% of average earning assets and 80.4% of total average assets, while in 2002
average net loans represented 82.9% of average earning assets and 78.1% of total
average assets. This was the result of continued strong loan demand and the
expansion of the Bank's branch in Blue Ridge, Georgia. The ratio of total loans
to total deposits was 99.8% in 2003 and 94.2% in 2002.
The following table shows the classification of loans by major category at
December 31, 2003, and for each of the preceding four years.
Loan Portfolio
December 31,
-------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------------- ----------------- ------------------ ---------------- ----------------
Percent Percent Percent Percent Percent
Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total
------- -------- ------- -------- ------- -------- ------- -------- ------- --------
(Dollars in thousands)
Commercial, financial
.and agricultural $ 34,613 10.4% $ 33,449 11.2% $ 29,092 11.6% $ 36,320 17.0% $ 35,375 20.9%
Real estate - construction 104,619 31.5 73,242 24.6 54,255 21.7 22,057 10.3 13,941 8.2
Real estate - other (1) 166,598 50.1 165,526 55.5 147,852 59.0 136,718 63.8 103,413 61.2
Consumer......... 20,535 6.2 20,296 6.8 19,370 7.7 17,254 8.1 15,026 8.9
Other loans...... 5,942 1.8 5,550 1.9 -- 0.0 1,775 0.8 1,351 0.8
------- ------- ------- ------ ------- ------- ------- ------ ------- ------
332,307 100.0% 298,063 100.0% 250,569 100.0% 214,124 100.0% 169,106 100.0%
======= ====== ======= ======= ======
Allowance for loan losses (3,610) (3,238) (2,995) (2,211) (1,849)
------- ------- ------- ------- -------
Net loans........ $328,697 $294,825 $247,574 $211,913 $167,257
======== ======== ======= ======= =======
(1) The "real estate - other" category includes multi-family residential, home equity, commercial real estate and undeveloped
agricultural real estate loans.
16
The following table shows the maturity distribution of selected loan
classifications at December 31, 2003, and an analysis of these loans maturing in
over one year.
Selected Loan Maturity and Interest Rate Sensitivity
Rate Structure for Loans
Maturity Maturing Over One Year
--------------------------------------------------- -----------------------------
Over One
One Year Over Predetermined Floating or
Year or Through Five Interest Adjustable
Less Five Years Years Total Rate Rate
----------- ----------- ----------- ----------- ------------- --------------
(Amounts in thousands)
Commercial, financial
and agricultural............ $ 27,942 $ 6,088 $ 583 $ 34,613 $ 4,650 $ 2,021
Real estate - construction..... 89,926 14,608 85 104,619 10,337 4,356
----------- ----------- ----------- ----------- ------------- --------------
Total....................... $ 117,868 $ 20,696 $ 668 $ 139,232 $ 14,987 $ 6,377
=========== =========== =========== =========== ============= ==============
For the purposes of this schedule, loans that have reached the fixed
contractual floor rate are treated as having a pre-determined interest rate.
Summary of Loan Loss Experience
The provision for loan losses, which is charged to operating results, is
based on the growth of the loan portfolio, the amount of net loan losses
incurred and management's estimation of potential future losses based on an
evaluation of the risk in the loan portfolio. Management believes that the
$3,609,794 in the allowance for loan losses at December 31, 2003, (1.09% of
total net outstanding loans at that date) was adequate to absorb known risks in
the portfolio, based upon the Bank's historical experience. No assurance can be
given, however, that increased loan volume, adverse economic conditions or other
circumstances will not result in increased losses in the Bank's loan portfolio.
[The remainder of this page intentionally left blank]
17
The following table sets forth certain information with respect to the
Bank's loans, net of unearned income, and the allowance for loan losses for 2003
as well as each of the preceding four years:
Analysis of Loan Loss Experience
Year ended December 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(Amounts in thousands, except ratios)
Allowance for loan losses at beginning of year $ 3,238 $ 2,995 $ 2,211 $ 1,849 $ 1,686
Loans charged off:
Commercial, financial, and agricultural.. 277 89 240 404 461
Real estate-construction................. 28 50 -- -- --
Real estate - other...................... 638 427 134 49 22
Consumer................................. 265 250 170 138 278
----------- ----------- ----------- ----------- -----------
Total loans charged off................ 1,208 816 544 591 761
----------- ----------- ----------- ----------- -----------
Recoveries on loans previously charged off:
Commercial, financial, and agricultural.. 25 5 8 9 15
Real estate-construction................. 3 -- -- -- --
Real estate-other........................ 50 -- 6 -- --
Consumer................................. 37 26 20 22 29
----------- ----------- ----------- ----------- -----------
Total recoveries on loans previously
charged off 115 31 34 31 44
----------- ----------- ----------- ----------- -----------
Net loans charged off....................... 1,093 785 510 560 717
----------- ----------- ----------- ----------- -----------
Provision for loan losses................... 1,465 1,028 1,294 922 880
----------- ----------- ----------- ----------- -----------
Allowance for loan losses, at end of period. $ 3,610 $ 3,238 $ 2,995 $ 2,211 $ 1,849
=========== =========== =========== =========== ===========
Loans, net of unearned income, at end of period$ 332,307 $ 298,063 $ 250,569 $ 214,124 $ 169,106
=========== =========== =========== =========== ===========
Average loans, net of unearned income,
outstanding for the period.................. $ 316,605 $ 276,733 $ 234,031 $ 204,436 $ 150,691
=========== =========== =========== =========== ===========
Ratios:
Allowance at end of period to loans, net of
unearned income.......................... 1.09% 1.09% 1.20% 1.03% 1.09%
Allowance at end of period to average loans,
net of unearned income................... 1.14 1.17 1.28 1.08 1.23
Net charge-offs to average loans, net of
unearned income.......................... 0.35 0.28 0.22 0.27 0.48
Net charge-offs to allowance at end of period 30.28 24.24 17.03 25.33 38.78
Recoveries to prior year charge-offs........ 14.09 5.70 5.75 4.07 32.35
In assessing adequacy, management relies predominantly on its ongoing
review of the loan portfolio, which is undertaken both to ascertain whether
there are probable losses that must be charged off and to assess the risk
characteristics of the portfolio in the aggregate. This review takes into
consideration the judgments of the responsible lending officers and senior
management, and also those of bank regulatory agencies that review the loan
portfolio as part of the regular bank examination process. In evaluating the
allowance, management also considers the loan loss experience of the Bank, the
amount of past due and nonperforming loans, current and anticipated economic
conditions, lender requirements and other appropriate information.
18
Management allocated the allowance for loan losses to specific loan classes
as follows:
Allocation of Allowance for Loan Losses
December 31,
-----------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------- ----------------- --------------- ---------------- ----------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
--------- -------- ------- -------- ------- -------- ------ -------- ------- --------
(Dollars in Thousands)
Domestic Loans (1)
Commercial, financial
and agricultural $ 1,257 10% $ 1,615 11% $ 807 12% $ 387 17% $ 349 21%
Real estate -
construction.... 184 32 85 25 193 22 199 10 152 8
Real estate - other 1,277 50 1,044 55 1,760 59 1,381 64 1,120 61
Consumer.......... 267 6 168 7 235 7 244 8 228 9
Other............. 625 2 326 2 -- 0 -- 1 -- 1
--------- ------- ------- ------- ------- ------- ------ ------- ------- -------
Total........... $ 3,610 100% 3,238 100% $ 2,995 100% $2,211 100% $ 1,849 100%
========= ======= ======= ======= ======= ======= ====== ======= ======= =======
(1) The Bank had no foreign loans.
Nonperforming Assets
Nonperforming assets include nonperforming loans and foreclosed real estate
held for sale. Nonperforming loans include loans classified as nonaccrual or
renegotiated. The Bank's policy is to place a loan on nonaccrual status when it
is contractually past due 90 days or more as to payment of principal or
interest, unless the collateral value is greater than both the principal due and
the accrued interest. At the time a loan is placed on nonaccrual status,
interest previously accrued but not collected is reversed and charged against
current earnings. Recognition of any interest after a loan has been placed on
nonaccrual status is accounted for on a cash basis.
The Bank had nonperforming assets at December 31, 2003, 2002, 2001, 2000,
and 1999 of approximately $2,385,000, $6,143,000, $1,787,000, $556,000 and
$368,000, respectively.
The following table presents information concerning outstanding balances of
nonperforming assets at December 31, 2003, and for each of the preceding four
years.
Nonperforming Assets
December 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(Amounts in thousands, except ratios)
Nonaccruing loans .......................... $ 1,127 $ 4,823 $ 1,642 $ 385 $ 344
Loans past due 90 days or more.............. 521 334 12 24 24
Restructured loans.......................... -- -- -- -- --
----------- ----------- ----------- ----------- -----------
Total nonperforming loans................ 1,648 5,157 1,654 409 368
Nonaccruing securities...................... -- -- -- -- --
Other real estate........................... 737 986 133 147 --
----------- ----------- ----------- ----------- -----------
Total nonperforming assets............... $ 2,385 $ 6,143 $ 1,787 $ 556 $ 368
=========== =========== =========== =========== ===========
Ratios:
Loan loss allowance to total
nonperforming assets 1.51 0.53 1.68 3.98 5.02
=========== =========== =========== =========== ===========
Total nonperforming loans to total loans
(net of unearned interest)............. 0.50% 1.73% 0.66% 0.26% 0.22%
=========== =========== =========== =========== ===========
Total nonperforming assets to total assets 0.58% 1.60% 0.56% 0.21% 0.16%
=========== ========= =========== ============ ===========
19
It is the general policy of the Bank to stop accruing interest income and
place the recognition of interest on a cash basis when any commercial,
industrial or real estate loan is past due as to principal or interest and the
ultimate collection of either is in doubt. Accrual of interest income on
consumer installment loans is suspended when any payment of principal or
interest, or both, is more than ninety days delinquent. When a loan is placed on
a nonaccrual basis, any interest previously accrued but not collected is
reversed against current income unless the collateral for the loan is sufficient
to cover the accrued interest or a guarantor assures payment of interest. For
each of the five years in the period ended December 31, 2003, the difference
between gross interest income that would have been recorded in such period, if
the nonaccruing loans had been current in accordance with their original terms,
and the amount of interest income on those loans, that was included in such
period's net income, was negligible.
There has been no significant impact on the Company's consolidated
financial statements as a result of the provisions of Statement of Financial
Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan,
or Statement of Accounting Standards No. 118, Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures.
Deposits
The Company's primary source of funds is derived from deposits of the
Bank's customers. Average deposits increased 10.3%, from approximately
$290,961,000 in 2002 to approximately $320,833,000 in 2003. At December 31,
2003, total deposits were $332,918,948, of which $309,123,161 (92.9%) were
interest bearing, at December 31, 2002, total deposits were $316,282,756, of
which $294,385,698 (93.1%) were interest bearing, and at December 31, 2001,
total deposits were $264,028,007, of which $247,194,423 (93.6%) were interest
bearing. The continued growth of the Bank fueled the growth in the deposit base.
The Company intends to emphasize internal deposit growth in order to expand the
consumer bases of the Bank and to continue to fund asset growth when
appropriate. Alternative funding sources such as national CDs and brokered
deposits were used to supplement funding sources. Brokered deposits were
$10,000,000 at December 31, 2003.
The average amounts of, and the average rate paid on, each of the following
categories of deposits, for the years ended December 31, 2003, 2002 and 2001,
are as follows:
Years ended December 31,
-----------------------------------------------------------------------------
2003 2002 2001
------------------------ ------------------------ -------------------------
Amount Rate Amount Rate Amount Rate
----------- ----------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Noninterest-bearing demand deposits. $ 22,056 0.00% $ 19,549 0.00% $ 13,972 0.00%
Demand.............................. 83,040 1.42 62,492 1.93 39,100 2.55
Savings............................. 45,318 0.92 41,359 1.72 35,513 3.03
Time deposits....................... 170,419 3.15 167,561 4.44 153,348 6.02
----------- ---------- -----------
Total interest-bearing deposits.. 298,777 2.33 271,412 3.45 227,961 4.95
----------- ---------- -----------
Total average deposits........... $ 320,833 2.17 $ 290,961 3.21 $ 241,933 4.67
=========== ========== ===========
The two categories of lowest cost deposits comprised the following
percentages of average total deposits during 2003: average noninterest-bearing
demand deposits, 6.87 percent; and average savings deposits, 14.13 percent. Of
average time deposits, approximately 38.89 percent were large denomination
certificates of deposit. The maturities of the time certificates of deposit of
$100,000 or more, issued by the Bank at December 31, 2003, are summarized in the
table below.
Maturities of Large Time Deposits
Time
Certificates
of Deposit
--------------
(Amounts in thousands)
Three months or less..................................................................... $ 15,818
Over three through six months............................................................ 16,957
Over six through twelve months........................................................... 29,836
Over twelve months....................................................................... 23,945
--------------
Total............................................................................... $ 86,556
==============
20
Short-term Borrowings
Securities sold under agreements to repurchase amounted to $4,085,992 at
December 31, 2003, compared to $5,928,624 at December 31, 2002, and $1,732,699
at December 31, 2001. The weighted average rates were 1.23%, 1.60% and 3.20% for
2003, 2002 and 2001, respectively. Securities sold under agreements to
repurchase averaged $5,488,443 during 2003, $4,061,294 during 2002, and
$1,930,051 during 2001. The maximum amount outstanding at any month end during
2003 was $8,211,269, during 2002 was $5,928,624, and during 2001 was $3,144,208.
The total amount of securities sold under agreements to repurchase are
associated with the cash flow needs of the Bank's corporate customers who
participate in repurchase agreements. In addition, the Company had federal funds
purchased that amounted to $3,000,000 at year-end 2003, and $-0- at year-end
2002, compared to $1,932,000 at year-end 2001.
Long-term Debt
Borrowed funds consist primarily of long-term debt. The Bank had
$21,000,000 in available lines to purchase Federal Funds, on an unsecured basis,
from commercial banks. The Bank was approved to borrow up to approximately
$61,360,000 under various short-term and long-term programs offered by the
Federal Home Loan Bank of Atlanta. These borrowings are secured under a blanket
lien agreement on certain qualifying mortgage instruments in loan and securities
portfolios. The unused portion of these available funds amounted to
approximately $30,600,000 at year-end 2003. Long-term debt consisted of various
commitments with scheduled maturities from one to six years. In addition, during
2002 the Company borrowed $4.6 million from another financial institution (See
"Capital Resources: Term Loan" below). This loan was repaid during 2003.
On August 28, 2003, Appalachian Capital Trust I ("the Trust"), a Delaware
statutory trust established by the Company, received $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. In accordance with the provisions of Financial Interpretation No.
46, the Company accounts for the Trust Preferred Securities as a long-term debt
liability to the Trust in the amount of $6,186,000. Subject to certain
limitations, the Trust Preferred Securities qualify as Tier 1 capital.
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. Interest that the bank plans to pay on the
trust preferred securities debt is included in the table of maturities below.
The following table sets forth the expected debt service for the next five
years based on interest rates and repayment provisions as of December 31, 2003.
Maturities of Long-term Debt
(In thousands)
2004 2005 2006 2007 2008
--------- --------- -------- -------- -----------
Interest on indebtedness......................... $ 830 $ 869 $ 614 $ 500 $ 466
Repayment of principal........................... 7,243 6,200 6,200 700 5,350
--------- --------- -------- ---------- -----------
$ 8,073 $ 7,069 $ 6,814 $ 1,200 $ 5,816
========= ========= ======== ========== ===========
Shareholders' Equity
Shareholders' equity increased $5,463,064, from December 31, 2002 to
December 31, 2003, due in part to net earnings of $3,086,580. The increase was
also a result of the issuance of 82,170 shares of stock through the exercise of
options for $529,330 and the reissuance of 128,240 shares out of treasury stock
for $1,923,601.
All amounts presented in this report and in the financial statements are
adjusted to reflect the 10% stock dividend effected in July 2003, as well as the
2-for-1 stock split effected in April 2000. See ITEM 5, "Market Information."
Return on Equity and Assets
21
The following table summarizes certain financial ratios for the Company for
the years ended December 31, 2003, 2002 and 2001.
Return on Equity and Assets
Year ended December 31,
----------------------------------------------
2003 2002 2001
------------- ------------- --------------
Return on average assets............................. 0.78% 0.75% 0.85%
Return on average equity............................. 10.85 11.88 12.80
Dividend payout ratio................................ 0.00 0.00 0.00
Average equity to average assets ratio............... 7.23 6.34 6.63
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. A majority of the
Company's capital requirements have come from proceeds from the Bank's initial
stock offering in 1994, proceeds of $2.65 million from a private placement of
Common Stock in November 1998, proceeds of $4.4 million from a public offering
in 2000, proceeds of $787,000 from a private offering of Common Stock and $1.0
million from the exercise of options in 2002, through the retention of earnings
and the sale of Common Stock to the Company's 401(k) plan in 2002, proceeds of
$1.9 million from a private offering of Common Stock and $529,000 from the
exercise of options in 2003.
On August 28, 2003, Appalachian Capital Trust I ("the Trust"), a Delaware
statutory trust established by the Company, received $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 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 of $186,000
and as a long-term debt liability in the amount of $6,186,000. 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.
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. 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. The
Company began making interest payments on July 1, 2002. Principal was due in
seven equal annual installments, each in the amount of $657,000, beginning on
March 31, 2003. The entire outstanding balance of the Term Loan, together with
all accrued and unpaid interest, would have been due and payable in a final
installment on March 31, 2010. The Term Loan contained certain affirmative and
negative covenants, including, but not limited to, requiring the Company to
cause the Bank at all times to maintain certain minimum capital ratios, and to
maintain a minimum ratio of loan and lease losses to gross loans. In September
2003, the Company paid off this entire balance with part of the proceeds from
the trust preferred issuance.
Federal Capital Standards. Regulatory authorities are placing increased
emphasis on the maintenance of adequate capital. In 1990, new risk-based capital
requirements became effective under the Federal Deposit Insurance Corporation
Improvement Act. The guidelines take into consideration risk factors, as defined
by regulators, associated with various categories of assets, both on and off the
balance sheet. Under the guidelines, capital strength is measured in two tiers,
which are used in conjunction with risk-adjusted assets to determine the
22
risk-based capital ratios. The Company's Tier 1 capital, which consists of
common equity, paid-in capital, retained earnings and qualifying trust preferred
securities (less intangible assets and treasury stock), amounted to $34.7
million at December 31, 2003. Tier 2 capital components include supplemental
capital components such as qualifying allowance for loan losses and trust
preferred securities not qualified for Tier 1 capital. Tier 1 capital, plus the
Tier 2 capital components, is referred to as Total Capital and was $38.3 million
at year-end 2003. The Company's percentage ratios as calculated under regulatory
guidelines were 10.46% and 11.55% for Tier 1 and Total Capital, respectively, at
year-end 2003. The Company's Tier 1 Capital and Total Capital exceeded the
minimum ratios of 4% and 8%, 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 December 31, 2003, the Company's leverage ratio was 8.58%,
exceeding the regulatory minimum requirement of 4%.
The table below illustrates the Company's regulatory capital ratios under
federal guidelines at December 31, 2003, 2002 and 2001:
Capital Adequacy Ratios
Years ended December 31,
Statutory ----------------------------------------
Minimum 2003 2002 2001
------------ ----------- ----------- -----------
(Amounts in thousands, except percentages)
Tier 1 Capital.......................................... $ 34,681 $ 23,089 $ 18,538
Tier 2 Capital.......................................... 3,610 3,238 2,995
----------- ----------- -----------
Total Qualifying Capital................................ $ 38,291 $ 26,327 $ 21,533
=========== =========== ===========
Risk Adjusted Total Assets (including
off-balance-sheet exposures)............................ $ 331,638 $ 306,405 $ 256,985
Tier 1 Risk-Based Capital Ratio......................... 4.0% 10.46% 7.54% 7.16%
Total Risk-Basked Capital Ratio......................... 8.0 11.55 8.59 8.32
Leverage Ratio.......................................... 4.0 8.58 6.07 5.87
In 2001, the Bank paid dividends to the Company of $250,000, which were
used by the Company for the repayment of debt and other expenses. In 2003 and
2002, the Bank did not pay dividends to the Company.
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 abilities 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
financial intermediary and, therefore, would not be able to meet the production
and growth needs of the communities it serves.
The primary purpose of management of assets and liabilities is not only to
assure adequate liquidity in order for the Bank to meet the needs of its
customers, but also to maintain an appropriate balance between
interest-sensitive assets and interest-sensitive liabilities so that the Company
can also meet the investment requirements of its shareholders. Daily monitoring
of the sources and uses of funds is necessary to maintain an acceptable cash
position that meets both requirements. In the banking environment, both assets
and liabilities are considered sources of liquidity funding; therefore, both are
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.
Real estate construction and commercial, financial and agricultural loans that
mature in one year or less equaled approximately $117.9 million or 35.5% of the
total loan portfolio at December 31, 2003, and investment securities maturing in
one year or less equaled $7.4 million or 13.3% of the portfolio. Other sources
of liquidity include short-term investments such as federal funds sold.
23
The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
the end of fiscal 2003, funds were also available through the purchase of
federal funds from correspondent commercial banks from available lines of up to
an aggregate of $21,000,000.
In an effort to maintain and improve the liquidity position of the Bank,
management applied for membership with 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 stands at approximately
$61,360,000 as of December 31, 2003. This line is subject to collateral
availability. At December 31, 2003, the outstanding balance of the Bank's credit
line was $30,692,858. See Note 12 to the Notes to Consolidated Financial
Statements herein.
Off-Balance Sheet Arrangements
In the normal course of business, the Company offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement, and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements. Commitments to extend credit, credit card arrangements, commercial
letters of credit, and standby letters of credit all include exposure to some
credit loss in the event of nonperformance of the customer. The Company's credit
policies and procedures for credit commitments and financial guarantees are the
same as those for extension of credit that are recorded on the statement of
financial condition. Because these instruments have fixed maturity dates, and
because many of them expire without being drawn upon, they do not generally
present any significant liquidity risk to the Company. Management conducts
regular reviews of these instruments on an individual customer basis, and the
results are considered in assessing the adequacy of the Company's allowance for
loan losses. Management does not anticipate any material losses as a result of
these commitments.
Following is a discussion of these commitments:
Standby Letters of Credit: These agreements are used by the Bank's
customers as a means of improving their credit standings in their dealings with
others. Under these agreements, the Bank agrees to honor certain financial
commitments in the event that its customers are unable to do so. The amount of
credit risk involved in issuing letters of credit in the event of nonperformance
by the other party is the contract amount. As of December 31, 2003 and 2002, the
Bank has issued standby letters of credit of approximately $1,111,000 and
$1,320,000. The Bank records a liability for the estimated fair value of these
standby letters of credit based on the fees charged for these arrangements.
Loan Commitments: As of December 31, 2003 and 2002, the Bank had
commitments outstanding to extend credit totaling approximately $43,436,000 and
$35,890,000, respectively. These commitments generally require the customers to
maintain certain credit standards. Management does not anticipate any material
losses as a result of these commitments.
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24
Contractual Obligations
The Company and the Bank have various contractual obligations that they
must fund as part of their normal operations. The following table shows
aggregate information about their contractual obligations, including interest,
and the periods in which payments are due. The amounts and time periods are
measured from December 31, 2003.
Payments due by period (in thousands)
-----------------------------------------------------------------------
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
-------------- ------------ ----------- ----------- -----------
Long-Term Debt........................ $ 40,414 $ 8,073 $ 13,883 $ 7,016 $ 11,442
Capital Lease Obligations............. -- -- -- -- --
Operating Lease Obligations........... 1,021 64 83 71 803
Other Long-Term Liabilities
Reflected on the Company's
Balance Sheet under GAAP........... -- -- --- -- --
-------------- ------------ ------------ ----------- -----------
Total................................. $ 41,435 $ 8,137 $ 13,966 $ 7,087 $ 12,245
============== ============ =========== =========== ===========
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.
[The remainder of this page intentionally left blank]
25
The following tables show interest rate sensitivity gaps for these
different intervals as of December 31, 2003.
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............................ $ 22,353 $ 112,122 $ 82,653 $ 105,881 $ 8,171 $ 331,180
Securities:
Taxable........................ 415 -- 6,947 23,652 9,994 41,008
Tax-exempt..................... -- -- -- 276 14,079 14,355
Time deposits in other banks..... 274 -- -- -- -- 274
Federal funds sold............... 586 -- -- -- -- 586
----------- ----------- ----------- ----------- ----------- -----------
23,628 112,122 89,600 129,809 32,244 387,403
----------- ----------- ----------- ----------- ----------- -----------
Interest-bearing liabilities (2)
Demand deposits (3).............. 25,236 25,236 25,236 -- -- 75,708
Savings deposits (3)............. 16,202 16,203 16,203 -- -- 48,608
Time deposits.................... 12,230 26,714 95,827 50,036 -- 184,807
Other short-term borrowings...... 7,086 -- -- -- -- 7,086
Long-term debt................... 100 550 6,593 18,450 11,186 36,879
----------- ----------- ----------- ----------- ----------- -----------
60,854 68,703 143,859 68,486 11,186 353,088
----------- ----------- ----------- ----------- ----------- -----------
Interest sensitivity gap............ $ (37,226) $ 43,419 $ (54,259) $ 61,323 $ 21,058 $ 34,315
=========== =========== =========== =========== =========== ===========
Cumulative interest sensitivity gap. $ (37,226) $ 6,193 $ (48,066) $ 13,257 $ 34,315
=========== =========== =========== =========== ===========
Ratio of interest-earning assets to
interest-bearing liabilities..... 0.39 1.63 0.62 1.90 2.88
=========== =========== =========== =========== ===========
Cumulative ratio.................... 0.39 1.05 0.82 1.06 1.10
=========== =========== =========== =========== ===========
Ratio of cumulative gap to total
interest-earning assets.......... (0.10) 0.02 (0.12) 0.03 0.09
=========== =========== =========== =========== ===========
_________________
(1) Excludes nonaccrual loans and securities.
(2) Excludes matured certificates which have not been redeemed by the customer and on which no interest is accruing.
(3) Demand and savings deposits are assumed to be subject to movement into other deposit instruments in equal amounts during the
0-30 day period, the 31-90 day period, and the 91-365 day period.
The above table indicates that, in a rising interest rate environment, the
Company's earnings may be adversely affected in the 0-365 day periods where
liabilities will reprice faster than assets. As seen in the preceding table, for
the first 30 days of repricing opportunity, there is an excess of
interest-bearing liabilities over earning assets of approximately $37 million.
For the first 365 days, interest-bearing liabilities exceed earning assets by
approximately $48 million. During this one-year time frame, 77.4% of all
interest-bearing liabilities will reprice compared to 58.2% 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.
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.
26
The table below shows, for the periods indicated, the daily average
balances outstanding for the major categories of interest-bearing assets and
interest-bearing liabilities, and the average interest rate earned or paid
thereon. Such yields are calculated by dividing income or expense by the average
balance of the corresponding assets or liabilities.
Average Balances, Interest Income/Expense and Yields/Rates
Taxable Equivalent Basis
Years Ended December 31,
------------------------------------------------------------------------------------
2003 2002 2001
---------------------------- -------------------------- --------------------------
Interest Average Interest Average Interest Average
Average Income/ Yields/ Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates Balance Expense Rates
------- -------- ------- ------- -------- ------- ------- -------- -------
(Dollars in thousands)
Assets
Earning assets:
Loans, net of unearned
income (1)....... $316,605 $ 21,227 6.70% $276,733 $ 20,420 7.38% $234,031 $ 21,295 9.10%
Securities:
Taxable.......... 34,938 1,059 3.03 34,718 1,647 4.74 28,212 1,743 6.18
Tax-exempt....... 15,013 1,073 7.15 16,215 1,201 7.41 12,250 816 6.66
-------- ------- -------- ------- -------- -------
Total securities... 49,951 2,132 4.27 50,933 2,848 5.59 40,462 2,559 6.32
Interest-bearing deposits 784 30 3.83 1,007 13 1.29 387 5 1.29
Federal funds sold. 3,314 37 1.12 5,104 79 1.55 6,004 367 6.11
-------- ------- -------- ------- -------- -------
Total interest-
earning assets (2) 370,654 23,426 6.32 333,777 23,360 7.00 280,884 24,226 8.62
Non interest-earning assets:
Cash and due from banks 8,118 6,909 5,190
Premises and equipment 8,795 7,835 6,791
Accrued interest and
other assets..... 9,436 8,790 8,889
Allowance for loan losses (3,450) (3,147) (2,587)
-------- -------- --------
Total assets............ $393,553 $354,164 $299,167
======== ======== ========
Liabilities and
Shareholders' Equity
Interest-bearing liabilities:
Demand deposits.... $ 83,040 1,178 1.42% $ 62,492 1,209 1.93% $ 39,100 996 2.55%
Savings deposits... 45,318 418 0.92 41,359 712 1.72 35,513 1,075 3.03
Time deposits...... 170,419 5,363 3.15 167,561 7,432 4.44 153,348 9,224 6.02
-------- ------- -------- ------- -------- -------
Total deposits... 298,777 6,959 2.33 271,412 9,353 3.45 227,961 11,295 4.95
Other short-term borrowings 6,422 83 1.29 4,667 77 1.65 2,278 100 4.39
Long-term debt....... 35,782 1,214 3.39 34,017 1,995 5.86 33,028 2,280 6.90
-------- ------- -------- ------- -------- -------
Total interest-
bearing liabilities 340,981 8,256 2.42 310,096 11,425 3.68 263,267 13,675 5.19
------- ------- -------
Noninterest-bearing liabilities:
Demand deposits.... 22,056 19,549 13,972
Accrued interest and
other liabilities 2,069 2,065 2,107
Shareholders' equity 28,447 22,454 19,821
-------- -------- --------
Total liabilities and
shareholders' equity. $393,553 $354,164 $299,167
======== ======== ========
Net interest income/net
interest spread...... 15,170 3.90% 11,935 3.31% 10,551 3.43%
====== ====== ======
Net yield on earning assets 4.09% 3.58% 3.76%
====== ====== ======
Taxable equivalent adjustment:
Loans................ 63 57 57
Investment securities 367 411 279
------- ------- -------
Total taxable
equivalent adjustment 430 468 336
------- ------- -------
Net interest income..... $ 14,740 $ 11,467 $ 10,215
======== ======== ========
(1) Average loans include nonaccrual loans. All loans and deposits are domestic
(2) Tax equivalent adjustments have been based on an assumed tax rate of 34
percent, and do not give effect to the disallowance for federal income tax
purpose of interest expense related to certain tax-exempt earning assets.
27
The following tables set forth, for the years ended December 31, 2003, 2002
and 2001, a summary of the changes in interest income and interest expense
resulting from changes in interest rates and in changes in the volume of earning
assets and interest-bearing liabilities, segregated by category. The change due
to volume is calculated by multiplying the change in volume by the prior year's
rate. The change due to rate is calculated by multiplying the change in rate by
the prior year's volume. The change attributable to both volume and rate is
calculated by multiplying the change in volume by the change in rate. Figures
are presented on a taxable equivalent basis.
Rate/Volume Variance Analysis
Taxable Equivalent Basis
Average Volume Change in Volume Average Rate
------------------------------- -------------------- -------------------------------
2003 2002 2001 2003-2002 2002-2001 2003 2002 2001
--------- --------- --------- --------- --------- -------- -------- ---------
Earning assets: (Dollars in thousands)
Loans, net of unearned
income (1) $ 316,605 $ 276,733 $ 234,031 $ 39,872 $ 42,702 6.70% 7.38% 9.10%
Investment Securities:
Taxable................. 34,938 34,718 28,212 220 6,506 3.03 4.74 6.18
Tax exempt.............. 15,013 16,215 12,250 (1,202) 3,965 7.15 7.41 6.66
--------- --------- --------- ---------- ---------
Total investment
securities 49,951 50,933 40,462 (982) 10,471 4.27 5.59 6.32
--------- --------- --------- --------- ---------
Interest-bearing deposits
with other banks 784 1,007 387 (223) 620 3.83 1.29 1.29
Federal funds sold......... 3,314 5,104 6,004 (1,790) (900) 1.12 1.55 6.11
--------- --------- --------- --------- ---------
Total earning assets.. $ 370,654 $ 333,777 $ 280,884 $ 36,877 $ 52,893 6.32 7.00 8.62
========= ========= ========= ========= =========
Interest-bearing liabilities:
Deposits:
Demand.................. $ 83,040 $ 62,492 $ 39,100 $ 20,548 $ 23,392 1.42 1.93 2.55
Savings................. 45,318 41,359 35,513 3,959 5,846 0.92 1.72 3.03
Time.................... 170,419 167,561 153,348 2,858 14,213 3.15 4.44 6.02
--------- --------- --------- --------- ---------
Total deposits........ 298,777 271,412 227,961 27,365 43,451 2.33 3.45 4.95
Other short-term borrowings 6,422 4,667 2,278 1,755 2,389 1.29 1.65 4.39
Long-term debt............. 35,782 34,017 33,028 1,765 989 3.39 5.86 6.90
--------- --------- --------- --------- ---------
Total interest-bearing
liabilities......... $ 340,981 $ 310,096 $ 263,267 $ 30,885 $ 46,829 2.42 3.68 5.19
========= ========= ========= ========= =========
Net interest income/net
interest spread 3.90 3.31 3.43
Net yield on earning assets 4.09 3.58 3.76
Net cost of funds.......... 2.23 3.42 4.87
Variance Attributed to (1)
Interest -----------------------------------
Income/Expense Variance 2003 2002
--------------------------- -------------------- -------------- ----------------
2003 2002 2001 2003-2002 2002-2001 Volume Rate Volume Rate
-------- ------- ------- --------- --------- ------- ------- ------- -------
(Dollars in thousands)
Earning assets:
Loans, net of
unearned income....... $ 21,227 $20,420 $21,295 $ 807 $ (875) $ 2,778 $(1,971) $ 3,525 $(4,400)
Investment Securities:
Taxable................ 1,059 1,647 1,743 (588) (96) 10 (598) 355 (451)
Tax exempt............. 1,073 1,201 816 (128) 385 (87) (41) 286 99
-------- ------- ------- --------- ------- ------- ------- ------- -------
Total investment
securities 2,132 2,848 2,559 (716) 289 (77) (639) 641 (352)
-------- ------- ------- --------- ------- ------- ------- ------- -------
Interest-bearing deposits
with other banks....... 30 13 5 17 8 (3) 20 8 --
Federal funds sold....... 37 79 367 (42) (288) (23) (19) (48) (240)
-------- ------- ------- --------- ------- ------- ------- ------- -------
Total earning assets.. 23,426 23,360 24,226 66 (866) 2,675 (2,609) 4,126 (4,992)
-------- ------- ------- --------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Deposits:
Demand................. 1,178 1,209 996 (31) 213 339 (370) 494 (281)
Savings................ 418 712 1,075 (294) (363) 63 (357) 156 (519)
Time................... 5,363 7,432 9,224 (2,069) (1,792) 125 (2,194) 796 (2,588)
------- ------- ------- --------- --------- ------- ------- ------- -------
Total deposits........ 6,959 9,353 11,295 (2,394) (1,942) 527 (2,921) 1,446 (3,388)
Other short-term borrowings 83 77 100 6 (23) 25 (19) 64 (87)
Long-term debt........... 1,214 1,995 2,280 (781) (285) 99 (880) 67 (352)
-------- ------- ------- --------- ------- ------- ------- ------- -------
Total interest-
bearing liabilities. 8,256 11,425 13,675 (3,169) (2,250) 651 (3,820) 1,577 (3,827)
-------- ------- ------- --------- ------- ------- ------- ------- -------
Net interest income/net
interest spread.......... $ 15,170 $11,935 $10,551 $ 3,235 $ 1,384 $ 2,024 $ 1,211 $ 2,549 $(1,165)
======== ======= ======= ========= ======= ======= ======= ======= =======
(1) The change in interest due to both rate and volume has been allocated to
volume and rate changes in proportion to the relationship of the absolute
dollar amounts of the change in each.
28
Results of Operations
Comparison of Years Ended December 31, 2003 and 2002
Net Interest Income
Net interest income is the principal source of the Bank's earnings stream
and represents the difference, or spread, between interest and fee income
generated from earning assets and the interest expense paid on deposits and
borrowed funds. Fluctuations in interest rates as well as volume and mix changes
in earning assets and interest-bearing liabilities materially impact net
interest income. Net interest income increased $3,272,748 or 28.5% to
$14,739,700 at December 31, 2003, compared to $11,466,952 at December 31, 2002.
This increase was caused by an increase in the Bank's loan portfolio and a
decrease in interest rates on deposit liabilities due to management's focus on
funds management.
Interest and fees earned on loans increased 3.9% to $21,163,875 in 2003,
compared to $20,363,641 in 2002. The increase in 2003 was primarily attributable
to the increase in the Bank's loan portfolio.
Interest earned on taxable securities decreased 35.7% to $1,058,688 in 2003
from $1,646,592 in 2002, while interest earned on non-taxable securities
decreased from $790,127 to $706,115 during the same period. The variance in the
income figures reflects a reallocation in the portfolio to maximize the earning
capacity of the portfolio.
During 2003, interest on federal funds sold decreased $41,579 or 52.7% from
2002. This decrease in income is the result of the Bank managing its funding
needs to take advantage of the low interest rate environment. Interest on
deposits with other banks increased to $30,224 in 2003, from $13,039 in 2002.
The trend in net interest income is also evaluated in terms of average
rates using the net interest margin and the interest rate spread. The net
interest margin, or the net yield on earning assets, is computed by dividing
fully taxable equivalent net interest income by average earning assets. This
ratio represents the difference between the average yield returned on average
earning assets and the average rate paid for funds used to support those earning
assets, including both interest-bearing and noninterest-bearing sources. The net
interest margin for 2003 was 4.09% compared to a net interest margin of 3.58% in
2002.
The interest rate spread measures the difference between the average yield
on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread calculation provides a more direct perspective
on the effect of market interest rate movements. The net interest spread was
3.90% in 2003, compared to 3.31% in 2002.
Interest Expense
Total interest expense decreased $3,168,824 or 27.7% to $8,256,564 in 2003,
from $11,425,388 in 2002. This decrease was the combined effect of the
short-term nature of the Bank's time deposits as well as management's focus on
funds management and the net interest margin. The average rate paid on
interest-bearing deposits in 2003 and 2002 was 2.33% and 3.45%, respectively.
The effect of these changes was to decrease the interest expense on
interest-bearing deposits to $6,959,433 in 2003, from $9,352,768 in 2002, a
decrease of $2,393,335 or 25.6%.
Noninterest Income
Noninterest income for 2003 and 2002 totaled $2,797,180 and $2,937,144,
respectively. These amounts are primarily from customer service fees, insurance
commissions and fees on services to customers. Mortgage origination fees
increased from $1,049,443 in 2002 to $1,276,787 in 2003, primarily due to a high
volume of mortgage refinancings in 2003 due to the historically low interest
rates.
Noninterest Expenses
Noninterest expenses totaled $11,731,985 in 2003, $9,702,148 in 2002, and
$7,831,363 in 2001. Salaries and benefits increased $790,885 or 16.3% to
$5,645,790 in 2003, due to the Company's decision to strengthen its management
29
in anticipation of future growth as well as the opening of a branch in Blue
Ridge, Georgia. Occupancy expenses totaled $980,704, an increase of $364,878 or
59.3% over the 2002 total of $615,826. Furniture and equipment expenses
decreased $290,336 or 31.5% in 2003, due to the cost of opening the branch in
Blue Ridge, Georgia during 2002. Other operating expenses increased $1,164,410
or 35.2% to $4,474,256 in 2003, due mainly to the fact that 2003 was the first
full year of operations of the branch in Blue Ridge, Georgia.
The table below sets forth the Company's noninterest expenses for the
periods indicated.
Years ended December 31,
---------------------------
2003 2002
----------- -----------
(Amounts in thousands)
Salaries and employee benefits.................................................... $ 5,646 $ 4,756
Occupancy expense................................................................. 981 616
Professional and regulatory fees.................................................. 948 676
Furniture and equipment expense................................................... 631 922
Data processing................................................................... 570 84
Advertising....................................................................... 516 567
Supplies.......................................................................... 338 308
Director and committee fees....................................................... 315 405
Taxes and licenses................................................................ 276 157
FDIC & state assessments.......................................................... 179 78
Postage........................................................................... 150 164
Amortization expense.............................................................. 94 76
Correspondent bank charges........................................................ 90 78
Insurance......................................................................... 47 46
Checking account expense.......................................................... 41 60
Other............................................................................. 910 709
----------- -----------
Total.......................................................................... $ 11,732 $ 9,702
=========== ===========
Income Taxes
Net operating income of $4,339,895 in 2003 resulted in $1,253,315 of income
tax expense, which represents an income tax rate of 28.9%. The Company's net
operating income of $3,673,948 in 2002 resulted in $1,005,940 of income tax
expense, which represented an income tax rate of 27.4%.
[The remainder of this page intentionally left blank]
30
Comparison of Years Ended December 31, 2002 and 2001
Net Interest Income
Net interest income is the principal source of the Bank's earnings stream
and represents the difference, or spread, between interest and fee income
generated from earning assets and the interest expense paid on deposits and
borrowed funds. Fluctuations in interest rates as well as volume and mix changes
in earning assets and interest-bearing liabilities materially impact net
interest income. Net interest income increased $1,251,831 or 12.3% to
$11,466,952 at December 31, 2002, compared to $10,215,121 at December 31, 2001.
This increase was caused by growth in the Bank's loan portfolio, as well as the
payoff of several Federal Home Loan Bank advances.
Interest and fees earned on loans decreased 4.1% to $20,363,641 in 2002,
compared to $21,238,058 in 2001. The decrease in 2002 was primarily attributable
to the Federal Reserve's decision to lower interest rates during 2002.
Interest earned on taxable securities decreased 5.6% to $1,646,592 in 2002
from $1,743,440 in 2001, while interest earned on non-taxable securities
increased from $536,689 to $790,127 during the same period. The variance in the
income figures reflects a reallocation in the portfolio to maximize the earning
capacity of the portfolio.
During 2002, interest on federal funds sold decreased $287,929 or 78.5%
from 2001. This decrease in income is the result of the Bank managing its
funding needs to take advantage of the low interest rate environment. Interest
on deposits with other banks increased to $13,039 in 2002, from $4,891 in 2001.
The trend in net interest income is also evaluated in terms of average
rates using the net interest margin and the interest rate spread. The net
interest margin, or the net yield on earning assets, is computed by dividing
fully taxable equivalent net interest income by average earning assets. This
ratio represents the difference between the average yield returned on average
earning assets and the average rate paid for funds used to support those earning
assets, including both interest-bearing and noninterest-bearing sources. The net
interest margin for 2002 was 3.58% compared to a net interest rate margin of
3.76% in 2001.
The interest rate spread measures the difference between the average yield
on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread calculation provides a more direct perspective
on the effect of market interest rate movements. The net interest spread was
3.31% in 2002, compared to 3.43% in 2001.
[The remainder of this page intentionally left blank]
31
Interest Expense
Total interest expense decreased $2,249,439 or 16.4% to $11,425,388 in
2002, from $13,674,827 in 2001. This decrease was the combined effect of the
Federal Reserve's decision to lower interest rates as well as management's
decision to reduce its cost of funds by prepaying Federal Home Loan Bank
advances. The average rate paid on interest-bearing deposits in 2002 and 2001
was 3.45% and 4.95%, respectively. The effect of these changes was to decrease
the interest expense on interest-bearing deposits to $9,352,768 in 2002, from
$11,294,581 in 2001, a decrease of $1,941,813 or 17.2%.
Noninterest Income
Noninterest income for 2002 and 2001 totaled $2,937,144 and $2,411,428,
respectively. These amounts are primarily from customer service fees, insurance
commissions and fees on services to customers.
Noninterest Expenses
Noninterest expenses totaled $9,702,148 in 2002 and $7,831,363 in 2001.
Salaries and benefits increased $1,017,972 or 26.5% to $4,854,905 in 2002, due
to the Company's decision to strengthen its management in anticipation of future
growth as well as the opening of a branch in Blue Ridge, Georgia. Occupancy
expenses totaled $615,826, an increase of $104,016 or 20.3% over the 2001 total
of $511,810. Furniture and equipment expenses increased $464,265 or 101.5% in
2002, due to the opening of the branch in Blue Ridge, Georgia. Other operating
expenses increased $284,532 or 9.4% to $3,309,846 in 2002, due mainly to the
opening of the branch in Blue Ridge, Georgia as well as the Company's decision
to exit the service bureau business and cease operations of AIM.
The table below sets forth the Company's noninterest expenses for the
periods indicated.
Years ended December 31,
---------------------------
2002 2001
----------- -----------
(Amounts in thousands)
Salaries and employee benefits.................................................... $ 4,756 $ 3,744
Furniture and equipment expense................................................... 922 457
Professional and regulatory fees.................................................. 676 469
Occupancy expense................................................................. 616 512
Advertising....................................................................... 567 441
Director and committee fees....................................................... 405 412
Supplies.......................................................................... 308 264
Postage........................................................................... 164 127
Taxes and licenses................................................................ 157 132
Data processing................................................................... 84 395
FDIC & state assessments.......................................................... 78 163
Correspondent bank charges........................................................ 78 84
Amortization expense.............................................................. 76 118
Checking account expense.......................................................... 60 57
Insurance......................................................................... 46 42
Other............................................................................. 709 414
----------- -----------
Total.......................................................................... $ 9,702 $ 7,831
=========== ===========
Income Taxes
Net operating income of $3,673,948 in 2002 resulted in $1,005,940 of income
tax expense, which represents an income tax rate of 27.4%. The Company's net
operating income of $3,500,686 in 2001 resulted in $962,588 of income tax
expense, which represented an income tax rate of 27.5%.
32
Impact of Inflation and Changing Prices
A bank's asset and liability structure is substantially different from that
of an industrial company in that virtually all assets and liabilities of a bank
are monetary in nature. Management believes the impact of inflation on financial
results depends upon the ability of the Bank to react to changes in interest
rates and by such reaction to reduce the inflationary impact on performance.
Interest rates do not necessarily move in the same direction, or at the same
magnitude, as the prices of other goods and services. As discussed previously,
management seeks to manage the relationship between interest-sensitive assets
and liabilities in order to protect against wide interest rate fluctuations,
including those resulting from inflation.
Various information shown elsewhere in this Report will assist the Company
in the understanding of how well the Bank is positioned to react to changing
interest rates and inflationary trends. In particular, the summary of net
interest income, the maturity distributions, the composition of the loan and
security portfolios and the data on the interest sensitivity of loans and
deposits should be considered.
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.
33
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, 2003
Projected change in:
Interest income.................................................................. (20.40)% 19.28%
Interest expense................................................................. (35.54) 48.77
Net interest income.............................................................. (13.64) 6.12
Recently Issued Accounting Standards
In January 2003, the Auditing Standards Board issued Statement on Auditing
Standards ("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
adoption of SAS No. 101 did not have a material impact on the Company's
consolidated financial statements.
In April 2003, the Financial Accounting Standards Board ("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 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. The adoption of the
provisions of this statement did not 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. The adoption of the provisions
of this statement did not have a material effect on the Company's operating
results or financial position.
In December 2003, the FASB revised previously issued SFAS No. 132,
Employers' Disclosures about Pensions and Other Postretirement. This statement
revises employers' disclosures about pension plans and other postretirement
benefit plans. It does not change the measurement or recognition of those plans
required by FASB Statements No. 87, Employers' Accounting for Pensions, No. 88,
Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. This statement retains the
disclosure requirements contained in FASB Statement No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits, which it replaces.
It requires additional disclosures to those in the original Statement 132 about
the assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. The
required information should be provided separately for pension plans and for
other postretirement benefit plans. The provisions of this statement are
effective for financial statements with fiscal years ending after December 15,
3003. The interim-period disclosures required by this statement are effective
for interim periods beginning after December 15, 2003. The adoption of the
provisions of this revised statement did not have a material effect on the
Company's operating results or financial position.
In December 2003, the FASB revised previously issued FIN 46, Consolidation
of Variable Interest Entities, 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
34
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The reporting and
disclosure requirements of this Interpretation are effective for all financial
statements of public companies for the first period ending after December 15,
2003 and for all other types of entities for periods ending after March 15,
2004. The adoption of this interpretation did not have a material impact on the
Company's consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information in response to this Item 7A is incorporated by reference from
the following sections of Item 7 of this report: "Interest Rate Sensitivity
Management" and "Market Risk."
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data required by
Regulation S-X and by Item 302 of Regulation S-K are set forth in the pages
below.
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Financial Statements
Page(s)
Independent Auditors' Report................................................................................ 36
Consolidated Statements of Financial Condition as of December 31, 2003 and 2002............................. 37
Consolidated Statements of Income for the Years Ended
December 31, 2003, 2002 and 2001.......................................................................... 38
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001.......................................................................... 39
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001.......................................................................... 40
Notes to Consolidated Financial Statements.................................................................. 41
Quarterly Results (Unaudited)............................................................................... 69
35
Schauer Taylor Cox Vise Morgan & Fowler, P.C.
Certified Public Accountants and Consultants
150 Olde Towne Road
Birmingham, Alabama 35216
Douglas B. Schauer, CPA Donald G. Vise, CPA Dale E. Fowler, CPA
Edward R. Taylor, CPA Phillip D. Morgan, CPA Steven W. Brown, CPA
W. Ernest Cox, CPA Steven D. Miller, CPA
_____________ * * * ______________
Michael Bryant, CPA Telephone - 205.822.3488 Russell D. Payne, CPA
M. Bryant King, CPA Wats - 800.466.3488 Stewart T. Wilson, CPA
Fax - 205.822.3541
Email - Firm@schauertaylor.com
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Appalachian Bancshares, Inc. and Subsidiaries
Ellijay, Georgia
We have audited the accompanying consolidated statements of financial condition
of Appalachian Bancshares, Inc. (a Georgia corporation) and subsidiaries as of
December 31, 2003 and 2002, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Appalachian Bancshares, Inc. and subsidiaries as of December 31, 2003 and 2002,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America.
As described in Note 1, these consolidated financial statements have been
revised to include the transitional disclosures required by Statement of
Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible
Assets, which was adopted by the Company as of January 1, 2002.
Birmingham, Alabama
February 3, 2004
/s/ Schauer Taylor Cox Vise Morgan & Fowler, P.C.
Registrant of PCAOB
Member of AICPA & ASCPA
36
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 2003 and 2002
2003 2002
--------------- ----------------
Assets
Cash and due from banks................................................... $ 6,530,984 $ 14,701,857
Interest-bearing deposits with other banks................................ 273,841 8,398,840
Federal funds sold........................................................ 586,000 7,756,000
--------------- ----------------
Cash and Cash Equivalents............................................. 7,390,825 30,856,697
Securities available-for-sale............................................. 55,363,327 40,374,902
Loans, net of unearned income............................................. 332,306,446 298,063,055
Allowance for loan losses................................................. (3,609,794) (3,237,898)
--------------- ----------------
Net Loans............................................................. 328,696,652 294,825,157
Premises and equipment, net............................................... 9,161,652 8,771,352
Accrued interest.......................................................... 2,289,994 2,240,920
Cash surrender value on life insurance.................................... 2,592,416 2,483,243
Intangibles, net.......................................................... 2,157,433 2,081,264
Other assets.............................................................. 1,965,179 2,390,550
--------------- ----------------
Total Assets.......................................................... $ 409,617,478 $ 384,024,085
=============== ================
Liabilities and Shareholders' Equity
Liabilities
Deposits
Noninterest-bearing..................................................... $ 23,795,787 $ 21,897,058
Interest-bearing........................................................ 309,123,161 294,385,698
--------------- ----------------
Total Deposits........................................................ 332,918,948 316,282,756
Short-term borrowings..................................................... 7,085,992 5,928,624
Accrued interest.......................................................... 670,614 976,156
Long-term debt............................................................ 30,692,858 34,735,714
Subordinated long-term capital notes...................................... 6,186,000 --
Other liabilities......................................................... 980,713 481,546
--------------- ----------------
Total Liabilities..................................................... 378,535,125 358,404,796
--------------- ----------------
Shareholders' Equity
Preferred stock, 20,000,000 shares authorized, none issued................ -- --
Common stock, par value $0.01 per share, 20,000,000 shares authorized,
3,734,686 shares issued in 2003 and 3,639,821 shares issued in 2002..... 37,347 36,398
Paid-in capital........................................................... 22,727,208 21,115,556
Retained earnings......................................................... 8,588,160 5,805,986
Accumulated other comprehensive income: net unrealized holding
gains (losses) on securities available-for-sale, net of deferred income
tax..................................................................... 429,434 449,050
Treasury stock, 75,973 and 200,553 shares at cost......................... (699,796) (1,787,701)
--------------- ----------------
Total Shareholders' Equity............................................ 31,082,353 25,619,289
--------------- ----------------
Total Liabilities and Shareholders' Equity................................... $ 409,617,478 $ 384,024,085
=============== ================
See notes to consolidated financial statemeents
37
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Interest Income
Interest and fees on loans.............................. $ 21,163,875 $ 20,363,641 $ 21,238,058
Interest on investment securities:
Taxable securities.................................... 1,058,688 1,646,592 1,743,440
Nontaxable securities................................. 706,115 790,127 536,689
Interest on deposits in other banks..................... 30,224 13,039 4,891
Interest on federal funds sold.......................... 37,362 78,941 366,870
--------------- --------------- ----------------
Total Interest Income............................... 22,996,264 22,892,340 23,889,948
--------------- --------------- ----------------
Interest Expense
Interest on deposits.................................... 6,959,433 9,352,768 11,294,581
Interest on federal funds purchased and securities sold
under agreements to repurchase........................ 82,722 76,968 100,124
Interest on long-term debt.............................. 1,129,209 1,995,652 2,280,122
Interest on Subordinated Debentures..................... 85,200 -- --
--------------- --------------- ----------------
Total Interest Expense.............................. 8,256,564 11,425,388 13,674,827
--------------- --------------- ----------------
Net Interest Income........................................ 14,739,700 11,466,952 10,215,121
Provision for loan losses............................... 1,465,000 1,028,000 1,294,500
--------------- --------------- ----------------
Net Interest Income After Provision For Loan Losses........ 13,274,700 10,438,952 8,920,621
Noninterest Income
Customer service fees................................... 844,669 1,058,298 661,715
Insurance commissions................................... 61,824 77,987 60,665
Mortgage origination fees............................... 1,276,787 1,049,443 1,063,157
Other operating income.................................. 630,878 465,891 478,915
Investment securities gains (losses).................... (16,978) 285,525 146,976
--------------- --------------- ----------------
Total Noninterest Income............................ 2,797,180 2,937,144 2,411,428
--------------- --------------- ----------------
Noninterest Expenses
Salaries and employee benefits.......................... 5,645,790 4,854,905 3,836,933
Occupancy expense....................................... 980,704 615,826 511,810
Furniture and equipment expense......................... 631,235 921,571 457,306
Other operating expenses................................ 4,474,256 3,309,846 3,025,314
--------------- --------------- ----------------
Total Noninterest Expenses.......................... 11,731,985 9,702,148 7,831,363
--------------- --------------- ----------------
Income before income taxes................................. 4,339,895 3,673,948 3,500,686
Income tax expense......................................... 1,253,315 1,005,940 962,588
--------------- --------------- ----------------
Net Income................................................. $ 3,086,580 $ 2,668,008 $ 2,538,098
=============== =============== ================
Earnings Per Common Share
Basic................................................... $ 0.86 $ 0.81 $ 0.81
Diluted................................................. 0.81 0.76 0.75
Cash Dividends Declared Per Common Share................... 0.00 0.00 0.00
Weighted Average Shares Outstanding
Basic................................................... 3,609,728 3,277,787 3,145,651
Diluted................................................. 3,809,625 3,508,019 3,389,404
See notes to consolidated financial statements
38
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2003, 2002 and 2001
Accumulated
Other
Compre-
hensive
Common Paid-in Retained Income Treasury
Stock Capital Earnings (Loss) Stock Total
----------- ------------ ------------ ---------- ----------- ------------
Balance at December 31, 2000........ $ 31,102 $ 14,606,889 $ 5,289,795 $ (3,094) $(2,255,205) $ 17,669,487
Retroactive effect of 10%
stock dividend................... 2,882 4,319,623 (4,322,505) -- -- --
Net income 2001..................... -- -- 2,538,098 -- -- 2,538,098
Unrealized gains on available-
for-sale securities, net of
reclassification adjustment,
net of tax of $31,379............ -- -- -- 63,916 -- 63,916
------------
Comprehensive income................ -- -- -- -- -- 2,602,014
------------
Proceeds from sale of common
stock to 401(k) plan............. 206 287,102 -- -- -- 287,308
Proceeds from exercise of options... 39 32,342 -- -- -- 32,381
----------- ----------- ------------ ---------- ----------- ------------
Balance at December 31, 2001........ 34,229 19,245,956 3,505,388 60,822 (2,255,205) 20,591,190
Retroactive effect of 10%
stock dividend................... 244 367,166 (367,410) -- -- --
Net income 2002..................... -- -- 2,668,008 -- -- 2,668,008
Unrealized gains on available-
for-sale securities, net of
reclassification adjustment,
net of tax of $199,997........... -- -- -- 388,228 -- 388,228
------------
Comprehensive income................ -- -- -- -- -- 3,056,236
------------
Proceeds from sale of common
stock to 401(k) plan............. 117 163,543 -- -- -- 163,660
Proceeds from exercise of options... 1,808 1,019,690 -- -- -- 1,021,498
Proceeds from issuance of
treasury stock................... -- 319,201 -- -- 467,504 786,705
----------- ----------- ------------ ---------- ----------- ------------
Balance at December 31, 2002........ 36,398 21,115,556 5,805,986 449,050 (1,787,701) 25,619,289
Retroactive effect of 10%
stock dividend................... 202 302,273 (304,406) -- -- (1,931)
Net income 2003..................... -- -- 3,086,580 -- -- 3,086,580
Unrealized losses on available-
for-sale securities, net of
reclassification adjustment,
net of tax of ($10,107).......... -- -- -- (19,616) -- (19,616)
------------
Comprehensive income................ -- -- -- -- -- 3,066,964
------------
Effect of exercise and issuance of
stock options.................... 747 528,583 -- -- -- 529,330
Proceeds from issuance of
treasury stock................... -- 780,796 -- -- 1,142,805 1,923,601
Acquisition of treasury stock....... -- -- -- -- (54,900) (54,900)
----------- ----------- ------------ ---------- ----------- ------------
Balance at December 31, 2003........ $ 37,347 $22,727,208 $ 8,588,160 $ 429,434 $ (699,796) $ 31,082,353
=========== ============ ============ =========== ============ ============
See notes to consolidated financial statements
39
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------------- --------------- ----------------
Operating Activities
Net income.............................................. $ 3,086,580 $ 2,668,008 $ 2,538,098
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, amortization, and accretion, net........ 1,312,067 1,171,023 861,950
Provision for loan losses............................. 1,465,000 1,028,000 1,294,500
Deferred tax benefit.................................. (20,000) (49,000) (181,725)
Realized security (gains) losses, net................. 16,978 (285,525) (146,976)
Loss on disposition of other real estate.............. 42,143 40,757 47,124
Increase in cash surrender value on life insurance.... (109,173) (113,377) (114,510)
(Increase) decrease in accrued interest receivable.... (49,074) 258,072 (44,913)
Decrease in accrued interest payable.................. (305,542) (290,790) (94,950)
Other, net............................................ 694,584 (51,421) 183,274
--------------- --------------- ----------------
Net Cash Provided By Operating Activities........... 6,133,563 4,375,747 4,341,872
--------------- --------------- ----------------
Investing Activities
Proceeds from sales of premises and equipment........... 27,746 -- --
Proceeds from sales of securities available-for-sale.... 5,368,830 12,597,325 7,777,064
Proceeds from maturity, calls and paydown of
securities available-for-sale......................... 23,121,518 34,322,603 19,540,135
Purchase of securities available-for-sale............... (43,960,542) (37,442,014) (44,027,017)
Net increase in loans to customers...................... (36,321,605) (49,462,737) (37,068,598)
Capital expenditures, net............................... (1,211,594) (2,605,882) (878,572)
Proceeds from disposition of foreclosed real estate..... 1,248,201 236,615 42,715
--------------- --------------- ----------------
Net Cash Used In Investing Activities............... (51,727,446) (42,354,090) (54,614,273)
--------------- --------------- ----------------
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts.................................. 2,458,008 45,209,010 17,041,106
Net increase in certificates of deposit................. 14,178,184 7,045,739 32,818,078
Net increase in short-term borrowings................... 1,157,368 2,263,925 819,344
Issuance of long-term debt.............................. 33,736,000 23,000,000 --
Repayment of long-term debt............................. (31,592,858) (17,917,857) (4,884,524)
Issuance of common stock................................ 302,800 889,260 319,689
Sale of treasury stock.................................. 1,923,601 786,705 --
Purchase of treasury stock.............................. (54,900) -- --
Compensation associated with issuance of stock options.. 21,739 -- --
Cash in lieu of fractional shares on stock dividend..... (1,931) -- --
--------------- --------------- ----------------
Net Cash Provided By Financing Activities........... 22,128,011 61,276,782 46,113,693
--------------- --------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents....... (23,465,872) 23,298,439 (4,158,708)
Cash and Cash Equivalents at Beginning of Year............. 30,856,697 7,558,258 11,716,966
--------------- --------------- ----------------
Cash and Cash Equivalents at End of Year................... $ 7,390,825 $ 30,856,697 $ 7,558,258
=============== =============== ================
See notes to consolidated financial statements
40
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies
The accompanying consolidated financial statements include the accounts of
Appalachian Bancshares, Inc. (the "Company") (a Georgia corporation) and its
wholly-owned subsidiaries: Appalachian Community Bank (the "Bank") and
Appalachian Information Management, Inc. ("AIM"). During 2001, the two previous
bank subsidiaries, Gilmer County Bank and Appalachian Community Bank (formerly
known as First National Bank of Union County) were merged. The surviving bank
simultaneously changed its name to Appalachian Community Bank. See Note 2 for a
more detailed discussion of this business combination. AIM was formed as a
wholly-owned subsidiary of the Bank. 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; however, the Bank continues to provide limited,
administrative services, formerly provided by AIM, to another bank on a
subcontract basis. Management anticipates that the discontinuance of AIM's
operations will not have a material effect on the Company's operations or
financial condition. AIM provided in-house data services to the Bank and offered
data processing services to other institutions (see Note 3). All significant
intercompany transactions and balances have been eliminated in consolidation.
Unless otherwise indicated herein, the financial results of the Company refer to
the Company and the Bank on a consolidated basis. The Bank provides a full range
of banking services to individual and corporate customers in North Georgia and
the surrounding areas.
The Company operates predominantly in the domestic commercial banking industry.
The accounting and reporting policies of the Company conform to generally
accepted accounting principles in the United States of America and to general
practice within the banking industry. The following summarizes the most
significant of these policies.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
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 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.
Securities
Securities are classified as either held-to-maturity, available-for-sale or
trading.
Held-to-maturity securities are securities for which management has the ability
and intent to hold until maturity. These securities are carried at amortized
cost, adjusted for amortization of premiums and accretion of discount, to the
earlier of the maturity or call date.
41
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Securities available-for-sale represent those securities intended to be held for
an indefinite period of time, including securities that management intends to
use as part of its asset/liability strategy, or that may be sold in response to
changes in interest rates, changes in prepayment risk, the need to increase
regulatory capital, or other similar factors. Securities available-for-sale are
recorded at market value with unrealized gains and losses net of any tax effect,
added or deducted directly from shareholders' equity.
Securities carried in trading accounts are carried at market value with
unrealized gains and losses reflected in income.
Realized and unrealized gains and losses are based on the specific
identification method.
Declines in the fair value of individual held-to maturity and available-for-sale
securities below their cost that are other than temporary result in write-downs
of the individual securities to their fair value. The related write-downs are
included in earnings as realized losses.
The Company has no trading or held-to-maturity securities.
Loans
Loans are stated at unpaid principal balances, less the allowance for loan
losses, net deferred loan fees and unearned discounts.
Unearned discounts on installment loans are recognized as income over the term
of the loans using a method that approximates the interest method.
Loan origination and commitment fees, as well as certain origination costs, when
material, are deferred and amortized as a yield adjustment over the lives of the
related loans using the interest method.
Allowance for Loan Losses
A loan is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Uncollateralized loans are measured for impairment based on the
present value of expected future cash flows discounted at the historical
effective interest rate, while all collateral-dependent loans are measured for
impairment based on the fair value of the collateral. Smaller balance
homogeneous loans, which consist of residential mortgages and consumer loans,
are evaluated collectively and reserves are established based on historical loss
experience.
The allowance for loan losses is established through charges to earnings in the
form of a provision for loan losses. Increases and decreases in the allowance
due to changes in the measurement of the impaired loans are included in the
provision for loan losses. Loans continue to be classified as impaired unless
they are brought fully current and the collection of scheduled interest and
principal is considered probable. When a loan or portion of a loan is determined
to be uncollectable, the portion deemed uncollectable is charged against the
allowance and subsequent recoveries, if any, are credited to the allowance.
Management's periodic evaluation of the adequacy of the allowance is based on
the Bank's past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrowers' ability to
42
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
repay, estimated value of any underlying collateral, and an analysis of current
economic conditions. While management believes that it has established the
allowance in accordance with generally accepted accounting principles and has
taken into account the views of its regulators and the current economic
environment, there can be no assurance that in the future the Bank's regulators
or its economic environment will not require further increases in the allowance.
Income Recognition on Impaired and Nonaccrual Loans
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well collateralized and in the process
of collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged off, the loan is generally classified as nonaccrual. Loans
that are on a current payment status or past due less than 90 days may also be
classified as nonaccrual if repayment in full of principal and/or interest is in
doubt.
Loans may be returned to accrual status when all principal and interest amounts
contractually due are reasonably assured of repayment within an acceptable
period of time, and there is a sustained period of repayment performance by the
borrower, in accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectability of the
recorded loan balance is doubtful, collections of interest and principal are
generally applied as a reduction to principal outstanding, except in the case of
loans with scheduled amortizations where the payment is generally applied to the
oldest payment due. When the future collectability of the recorded loan balance
is expected, interest income may be recognized on a cash basis. In the case
where a nonaccrual loan has been partially charged off, recognition of interest
on a cash basis is limited to that which would have been recognized on the
recorded loan balance at the contractual interest rate. Receipts in excess of
that amount are recorded as recoveries to the allowance for loan losses until
prior charge offs have been fully recovered. Interest income recognized on a
cash basis was immaterial for the years ended December 31, 2003, 2002 and 2001.
Premises and Equipment
Land is carried at cost. Other premises and equipment are carried at cost, net
of accumulated depreciation. Depreciation is provided generally by straight-line
methods based principally on the estimated useful lives of the respective
assets. Maintenance and repairs are expensed as incurred, while major additions
and improvements are capitalized. Gains and losses on dispositions are included
in current operations.
Foreclosed Real Estate
Foreclosed real estate includes both formally foreclosed property and
in-substance foreclosed property. In-substance foreclosed properties are those
properties for which the institution has taken physical possession, regardless
of whether formal foreclosure proceedings have taken place.
At the time of foreclosure, foreclosed real estate is recorded at the lower of
the carrying amount or fair value less cost to sell, which becomes the
property's new basis. Any write-downs based on the asset's fair value at date of
acquisition are charged to the allowance for loan losses. After foreclosure,
these assets are carried at the lower of their new cost basis or fair value less
cost to sell.
Costs incurred in maintaining foreclosed real estate and subsequent adjustments
to the carrying amount of the property are included in income (loss) on
foreclosed real estate.
43
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Advertising Costs
The Company's policy is to expense advertising costs as incurred. Advertising
expense for the years ended December 31, 2003, 2002 and 2001 amounted to
approximately $516,000, $567,000 and $441,000, respectively.
Income Taxes
Income taxes are provided for the tax effects of the transactions reported in
the financial statements and consist of taxes currently due plus deferred taxes
related primarily to differences between the basis of available-for-sale
securities, allowance for loan losses, estimated losses on foreclosed real
estate, and accumulated depreciation for financial and income tax reporting. The
deferred tax assets and liabilities represent the future tax return consequences
of those differences, which will either be taxable or deductible when the assets
and liabilities are recovered or settled. Deferred tax assets and liabilities
are reflected at income tax rates applicable to the period in which the deferred
tax assets or liabilities are expected to be realized or settled. As changes in
tax laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes. The Company files consolidated income
tax returns with its subsidiaries.
Stock-Based Compensation
At December 31, 2003, the Company had a stock-based employee compensation plan,
which is more fully described in Note 19. Prior to 2003, the Company accounted
for this plan under the recognition and measurement provisions of APB No. 25,
Accounting for Stock Issued to Employees, and the related Interpretations.
Accordingly, no stock-based compensation cost was included in net earnings for
the years ended December 31, 2002 and 2001, as all options granted under this
plan had an exercise price equal to the market value of the underlying common
stock on the date of grant. Effective January 1, 2003, the Company adopted the
fair value recognition provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, as provided by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
SFAS No. 148 allows for a prospective method of adoption of SFAS No. 123,
whereby the Company can prospectively account for the current expense of options
granted during 2003 and thereafter. Results of prior years have not been
restated. The following table illustrates the effects on net income and earnings
per share if the fair value based method had been applied to all outstanding
awards in each period.
Years Ended December 31,
--------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Net Income, as reported........................... $ 3,086,580 $ 2,668,008 $ 2,538,098
Add: Stock-based compensation expense
included in net income, net of related taxes... 21,739 -- --
Deduct: Total stock-based employee
compensation expense determined under
the fair value method for all awards,
net of related taxes........................... (63,350) (106,367) (122,515)
------------------ ------------------ ------------------
Pro Forma Net Income.............................. $ 3,044,969 $ 2,561,641 $ 2,415,583
================== ================== ==================
44
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Years Ended December 31,
--------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Basic Earnings per Common Share
As reported.................................. $ 0.86 $ 0.81 $ 0.81
Pro Forma.................................... 0.84 0.78 0.77
Diluted Earnings per Common Share
As reported.................................. 0.81 0.76 0.75
Pro Forma.................................... 0.80 0.73 0.71
Weighted average fair value of options
granted during the year...................... 4.20 -- 4.18
Assumptions:
Average risk free interest rate.............. 4.95% -- 4.95%
Average expected volatility.................. 22.53 -- 24.20
Expected dividend yield...................... 1.90 -- 1.90
Expected life................................ 7.5 years -- 7.5 years
The effects of applying SFAS No. 123 as amended by SFAS No. 148 for providing
proforma disclosures are not likely to be representative of the effects on
reported earnings for future years, nor are the dividend estimates
representative of commitments on the part of the Company's Board.
Employee Benefit Plan
The Company has a 401(k) profit-sharing plan covering substantially all of its
employees. Eligible participating employees may elect to contribute tax-deferred
contributions. Company contributions to the plan are determined by the board of
directors.
Intangibles
Intangibles consist primarily of goodwill, debt issuance costs, and noncompete
agreements. The goodwill intangible represents a premium paid on the purchase of
assets and deposit liabilities. The asset is stated at cost, net of accumulated
amortization, which was provided using the straight-line method over the
estimated useful life of 20 years, until the Financial Accounting Standards
Board (the "FASB") issued SFAS No. 142, Goodwill and Other Intangible Assets, in
June 2001. Debt issuance costs represent costs incurred in the Trust Preferred
transaction which is more fully discussed in Note 13. The noncompete intangible
represents an amount paid to a former employee who agrees to certain
stipulations concerning future employment spelled out in a noncompete agreement.
The asset is stated at cost, net of accumulated amortization, which is provided
using the straight-line method over the estimated useful life of 2 years.
The adoption of new accounting standards effective January 1, 2002, mandates the
discontinuance of periodic amortization and requires the Company to measure the
recorded goodwill for impairment as of January 1, 2002, and at least annually
thereafter. The initial assessment of the Company's intangible asset (Goodwill)
as of January 1, 2002, and the annual assessments as of December 31, 2003 and
2002, indicate that no impairment of values existed at those dates.
45
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Off Balance Sheet Financial Instruments
In the ordinary course of business the Company has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commitments under credit card arrangements, commercial letters of credit
and standby letters of credit. Such financial instruments are recorded in the
financial statements when they are funded. See Note 17 for a further discussion
of these financial instruments.
The Company also has available as a source of short-term financing the purchase
of federal funds from other commercial banks from an available line of up to $21
million and a line of credit with the Federal Home Loan Bank of up to
approximately $61,360,000 of which $30,600,000 is available and unused, subject
to proper collateralization.
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 consolidated financial statements and related
footnotes provide details related to segment reporting.
Reclassifications
Certain amounts in 2002 and 2001 have been reclassified to conform with the 2003
presentation.
Recently Issued Accounting Standards
In January 2003, the Auditing Standards Board issued Statement on Auditing
Standards ("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
adoption of SAS No. 101 did not have a material impact on the Company's
consolidated financial statements.
In April 2003, the FASB issued 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 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. The adoption of the provisions of this statement did
not 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
46
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
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. The
adoption of the provisions of this statement did not have a material effect on
the Company's operating results or financial position.
In December 2003, the FASB revised previously issued SFAS No. 132, Employers'
Disclosures about Pensions and Other Postretirement. This statement revises
employers' disclosures about pension plans and other postretirement benefit
plans. It does not change the measurement or recognition of those plans required
by FASB Statements No. 87, Employers' Accounting for Pensions, No. 88,
Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. This statement retains the
disclosure requirements contained in FASB Statement No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits, which it replaces.
It requires additional disclosures to those in the original Statement 132 about
the assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. The
required information should be provided separately for pension plans and for
other postretirement benefit plans. The provisions of this statement are
effective for financial statements with fiscal years ending after December 15,
2003. The interim-period disclosures required by this statement are effective
for interim periods beginning after December 15, 2003. The adoption of the
provisions of this revised statement did not have a material effect on the
Company's operating results or financial position.
In December 2003, the FASB revised previously issued FIN 46, Consolidation of
Variable Interest Entities, 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 reporting and
disclosure requirements of this Interpretation are effective for all financial
statements of public companies for the first period ending after December 15,
2003 and for all other types of entities for periods ending after March 15,
2004. The adoption of this interpretation did not have a material impact on the
Company's consolidated financial statements.
Earnings per Common Share
Basic earnings per common share are computed by dividing earnings available to
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflect per share amounts that would have
resulted if dilutive potential common stock had been converted to common stock,
as prescribed by SFAS No. 128, Earnings per Share. In July 2003, the Company
issued a 10% stock dividend. All per share amounts included in these
consolidated financial statements have been retroactively adjusted to give
effect to this dividend. The following reconciles the weighted average number of
shares outstanding:
2003 2002 2001
--------------- --------------- ----------------
Weighted average of common shares outstanding.............. 3,609,728 3,277,787 3,145,651
Effect of dilutive options................................. 199,897 230,232 243,753
--------------- --------------- ----------------
Weighted average of common shares outstanding
effected for dilution................................... 3,809,625 3,508,019 3,389,404
=============== =============== ================
47
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 1 - Summary of Significant Accounting Policies - Continued
Comprehensive Income
Comprehensive income is generally defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from non-owner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.
Comprehensive income is the total of net income and all other non-owner changes
in equity. Items that are to be recognized under accounting standards as
components of comprehensive income are displayed in statements of shareholders'
equity.
In the calculation of comprehensive income, certain reclassification adjustments
are made to avoid double counting items that are displayed as part of net income
for a period that also had been displayed as part of other comprehensive income
in that period or earlier periods. The disclosure of the reclassification
amounts and other details of other comprehensive income are as follows:
Years Ended December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Unrealized gains (losses) on securities
Unrealized holding gains arising during period........... $ (46,701) $ 873,750 $ 242,271
Reclassification adjustments for (gains) losses
included in net income................................. 16,978 (285,525) (146,976)
--------------- --------------- ----------------
Net unrealized gains(losses)............................. (29,723) 588,225 95,295
Income tax related to items of other
comprehensive income................................... 10,107 (199,997) (31,379)
--------------- --------------- ----------------
Other comprehensive income (loss)........................... $ (19,616) $ 388,228 $ 63,916
=============== =============== ================
Statements of Cash Flows
The Company includes cash, due from banks, and short-term investments as cash
equivalents in preparing the consolidated statements of cash flows. The
following is supplemental disclosure to the statements of cash flows for the
three years ended December 31, 2003.
Years Ended December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Cash paid during the year for interest................... $ 8,562,106 $ 11,716,178 $ 13,769,777
Cash paid during the year for income taxes............... 836,039 1,050,345 1,061,461
Non-cash Disclosures:
Loans transferred to foreclose real estate............... 1,517,302 1,477,804 732,882
Net increase (decrease) in unrealized gains and
losses on securities available-for-sale................ (29,723) 588,225 95,295
Proceeds from sales of foreclosed real estate
financed through loans................................. 532,192 294,290 619,445
Tax benefit of the exercise of non qualified options..... 204,791 295,898 15,981
48
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 2 - Business Combination
Effective August 13, 2001, the Company's wholly-owned bank subsidiaries, Gilmer
County Bank and Appalachian Community Bank, were merged together. Regulatory
approval for the merger was received by the Company from the Federal Deposit
Insurance Corporation ("FDIC") and the Georgia Department of Banking and
Finance. Pursuant to the merger, Gilmer County Bank, as the surviving bank in
the merger, changed its legal name from Gilmer County Bank to Appalachian
Community Bank. However, its offices located in Gilmer County continue to
operate under the trade name of "Gilmer County Bank."
Note 3 - Discontinued Operations
In August 2002, the Company announced its intentions to close down the
operations of its subsidiary, Appalachian Information Management, Inc. ("AIM").
The operations of AIM ceased on November 12, 2002.
Disposition of the assets of the discontinued operations began in September
2002. At December 31, 2003, the remaining assets (primarily fixed assets and
prepaid expenses) net of related reserves and other liabilities are included in
premises and equipment and other assets in the accompanying consolidated
statement of financial condition and continue to be held for productive use.
An impairment loss of approximately $43,000 was recognized by the Company in the
year 2002 related to this discontinued function.
In light of the Company discontinuing the operations of AIM, its data processing
provider, the Company signed a 5-year contract with Fiserv Solutions, Inc. to
provide the Company with data processing services vacated by the closure of AIM.
The contract contains a 3-year renewable option along with a detailed fee
schedule for the different services it is likely to perform.
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49
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 4 - Restrictions On Cash and Due From Bank Accounts
The Company is required to maintain average reserve balances either in vault
cash or on deposit with the Federal Reserve Bank. At December 31, 2003 and 2002,
the average amount of the required reserves was $302,000 and $5,742,000,
respectively.
Note 5 - Securities
The carrying amounts of securities as shown in the consolidated statement of
financial condition of the Company and their approximate fair values at December
31, 2003 and 2002 are presented below.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- ------------- ------------- --------------
Securities Available-for-Sale
- -----------------------------
December 31, 2003:
U.S. Government and agency securities............ $ 20,273,622 $ 69,052 $ 268,234 $ 20,074,440
State and municipal securities................... 13,572,237 782,726 -- 14,354,963
Mortgage-backed securities....................... 19,137,512 115,141 48,029 19,204,624
Equity securities................................ 1,729,300 -- -- 1,729,300
-------------- ------------- ------------- --------------
$ 54,712,671 $ 966,919 $ 316,263 $ 55,363,327
============== ============= ============= ==============
December 31, 2002:
U.S. Government and agency securities............ $ 8,481,531 $ 97,643 $ -- $ 8,579,174
State and municipal securities................... 14,847,957 466,696 861 15,313,792
Mortgage-backed securities....................... 14,642,135 133,916 17,015 14,759,036
Equity securities................................ 1,722,900 -- -- 1,722,900
-------------- ------------- ------------- --------------
$ 39,694,523 $ 698,255 $ 17,876 $ 40,374,902
============== ============= ============= ==============
At December 31, 2003, the Company's available-for-sale securities reflected net
unrealized gains of $650,656 that resulted in an increase in stockholders'
equity of $429,434 net of deferred tax liability. At December 31, 2002, the
Company's available-for-sale securities reflected net unrealized gains of
$680,379, which resulted in an increase in stockholders' equity of $449,050, net
of deferred tax liability.
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50
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 5 - Securities - Continued
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position, at December 31,
2003.
Less Than 12 Months 12 Months or More Total
--------------------------- -------------------------- ---------------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------- ----------- ------------- ----------- ------------- -----------
Securities Available-for-Sale
- -----------------------------
U.S. Government and
agency securities....... $ 11,485,843 $ 268,234 $ -- $ -- $ 11,485,843 $ 268,234
Mortgage-backed
securities.............. 5,623,743 48,029 -- -- 5,623,743 48,029
------------- ----------- ------------- ----------- ------------- -----------
$ 17,109,586 $ 316,263 $ -- $ -- $ 17,109,586 $ 316,263
============= =========== ============= =========== ============= ===========
Management evaluates securities for other-than temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (1) the length of time and the extent
to which the fair value has been less than cost, (2) the financial condition and
near-term prospects of the issuer, and (3) the intent and ability of the
Corporation to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.
The contractual maturities of securities available-for-sale at December 31,
2003, are shown as follows. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Amortized Estimated
Cost Fair Value
--------------- ----------------
Securities Available-for-Sale
- -----------------------------
Due in one year or less.................................................. $ 7,312,256 $ 7,362,329
Due after one year through five years.................................... 24,110,911 23,928,477
Due after five years through ten years................................... 6,619,133 6,753,197
Due after ten years...................................................... 14,941,071 15,590,024
Equity securities........................................................ 1,729,300 1,729,300
--------------- ----------------
$ 54,712,671 $ 55,363,327
=============== ================
Mortgage-backed securities have been included in the maturity tables based upon
guaranteed payoff date of each security.
51
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 5 - Securities - Continued
Gross realized gains and losses on the sale of securities available-for-sale for
each of the three years in the period ended December 31, 2003, were as follows:
2003 2002 2001
--------------- --------------- ----------------
Gross realized gains........................................ $ 24,243 $ 290,227 $ 174,983
Gross realized losses....................................... 41,221 4,702 28,007
Equity securities include a restricted investment in Federal Home Loan Bank
stock, which must be maintained to secure the available line of credit. The
amount of investment in this stock amounted to $1,543,300 and $1,722,900 at
December 31, 2003 and 2002, respectively. Equity securities also include an
investment in Appalachian Capital Trust I. The amount of investment in the trust
amounted to $186,000 and $-0- at December 31, 2003 and 2002, respectively.
The carrying value of investment securities pledged to secure public funds on
deposit, securities sold under agreements to repurchase, and for other purposes
as required by law amounted to approximately $24,912,754 and $9,092,000 at
December 31, 2003 and 2002, respectively.
Note 6 - Loans
The Company grants loans to customers primarily in the North Georgia area. The
major classifications of loans as of December 31, 2003 and 2002 were as follows:
December 31,
----------------------------------
2003 2002
--------------- ----------------
Commercial, financial and agricultural...................................... $ 34,613,388 $ 33,448,866
Real estate - construction.................................................. 104,619,438 73,242,467
Real estate - mortgage...................................................... 166,597,728 165,525,831
Consumer.................................................................... 20,534,760 20,295,311
Other loans................................................................. 5,941,132 5,550,580
--------------- ----------------
332,306,446 298,063,055
Allowance for loan losses................................................... (3,609,794) (3,237,898)
--------------- ----------------
Net loans................................................................... $ 328,696,652 $ 294,825,157
=============== ================
Total loans which the Company considered to be impaired at December 31, 2003 and
2002 were $1,126,727 and $4,823,000, respectively. All of these loans were on
nonaccrual status and had related allowances of $169,009 and $723,450,
respectively. Impaired loans consisted primarily of commercial loans as of
December 31, 2003 and 2002. The average recorded investment in impaired loans
for the years ended December 31, 2003 and 2002 was approximately $2,248,000 and
$3,232,500, respectively. No material amount of interest income was recognized
on impaired loans for the years ended December 31, 2003 and 2002. For the year
ended December 31, 2003, the difference between gross interest income that would
have been recorded in such period if the nonaccruing loans had been current in
accordance with their original terms and the amount of interest income on those
loans that was included in such period's net income was approximately $148,000.
In the year ended December 31, 2002, the amount was $425,000.
The Company has no commitments to loan additional funds to the borrowers of
nonaccrual loans.
52
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 7 - Allowance for Loan Losses
Changes in the allowance for loan losses for each of the three years ended
December 31, 2003, 2002 and 2001 are as follows:
December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Balance at beginning of year................................ $ 3,237,898 $ 2,995,362 $ 2,210,603
Charge-offs................................................. (1,207,788) (816,701) (543,800)
Recoveries.................................................. 114,684 31,237 34,059
--------------- --------------- ----------------
Net charge-offs.......................................... (1,093,104) (785,464) (509,741)
Provision for loan losses................................... 1,465,000 1,028,000 1,294,500
--------------- --------------- ----------------
Balance at end of year...................................... $ 3,609,794 $ 3,237,898 $ 2,995,362
=============== =============== ================
Note 8 - Premises and Equipment
Premises and equipment were as follows:
December 31,
----------------------------------
2003 2002
--------------- ----------------
Land ...................................................................... $ 2,080,417 $ 2,080,417
Buildings and improvements.................................................. 4,778,078 4,757,454
Furniture and equipment..................................................... 3,514,899 3,498,374
Computer equipment and software............................................. 1,305,985 1,188,018
Automobiles................................................................. 175,524 140,982
Construction in progress.................................................... 676,613 43,713
--------------- ----------------
12,531,516 11,708,958
Allowance for depreciation.................................................. (3,369,864) (2,937,606)
--------------- ----------------
$ 9,161,652 $ 8,771,352
=============== ================
The provision for depreciation charged to occupancy and furniture and equipment
expense for the years ended December 31, 2003, 2002 and 2001 was $784,918,
$679,960 and $640,220, respectively.
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53
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 9 - Intangibles
Acquired goodwill and other intangible assets as of December 31, 2003 and 2002
are detailed as follows:
Amortizable Intangibles
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
--------------- ------------- -------------------
As of December 31, 2003:
Noncompete agreements.................................... $ 165,000 $ 158,125 $ 6,875
Debt issuance costs...................................... 170,000 11,333 158,667
--------------- --------------- ----------------
Total.................................................... $ 335,000 $ 169,458 $ 165,542
=============== =============== ================
As of December 31, 2002:
Noncompete agreements.................................... $ 165,000 $ 75,627 $ 89,373
-------------- -------------- ---------------
Total.................................................... $ 165,000 $ 75,627 $ 89,373
=============== =============== ================
Aggregate amortization expense for amortizable intangible assets for the years
ended December 31, 2003 and 2002 was $93,831 and $75,627, respectively.
Estimated annual amortization expense for the following years ending December 31
is as follows:
2004 2005 2006 2007 2008
----------- ----------- ----------- ----------- -----------
Estimated annual amortization expense............ $ 40,875 $ 34,000 $ 34,000 $ 34,000 $ 22,667
Acquired Goodwill:
2003 2002
--------------- ----------------
Goodwill from bank acquisition.............................................. $ 1,991,891 $ 1,991,891
=============== ================
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54
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 9 - Intangibles - Continued
The following table presents net income and earnings per share as reported and
adjusted to exclude tax effected amortization of goodwill that is no longer
being amortized.
Years Ended December 31
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Reported Net income......................................... $ 3,086,580 $ 2,668,008 $ 2,538,098
Add back Goodwill amortization, net of tax.................. -- -- 117,747
--------------- --------------- ----------------
Adjusted net income......................................... $ 3,086,580 $ 2,668,008 $ 2,655,845
=============== =============== ================
Basic earnings per share:
Reported net income.................................... $ 0.86 $ 0.81 $ 0.81
Goodwill amortization.................................. 0.00 0.00 0.03
--------------- --------------- ---------------
Adjusted net income.................................... $ 0.86 $ 0.81 $ 0.84
=============== =============== ===============
Diluted earnings per share:
Reported net income.................................... $ 0.81 $ 0.76 $ 0.75
Goodwill amortization.................................. 0.00 0.00 0.03
--------------- --------------- ---------------
Adjusted net income.................................... $ 0.81 $ 0.76 $ 0.78
=============== =============== ===============
Note 10 - Deposits
The aggregate amounts of time deposits of $100,000 or more, including
certificates of deposit of $100,000 or more at December 31, 2003 and 2002 were
$86,556,043 and $60,533,038, respectively. Time deposits of less than $100,000
totaled $98,250,531 and $110,095,352 at December 31, 2003 and 2002,
respectively. Demand deposits reclassified as loan balances as of December 31,
2003 and 2002 amounted to $117,253 and $60,286, respectively.
The maturities of time certificates of deposit and other time deposits issued by
the Company at December 31, 2003, are as follows:
Time
Certificates
of Deposit
----------------
Years ending December 31,
-------------------------
2004...................................................................... $ 134,770,727
2005...................................................................... 36,952,176
2006...................................................................... 7,586,228
2007...................................................................... 5,196,944
2008...................................................................... 300,499
----------------
$ 184,806,574
================
55
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 11 - Short-term Borrowings
Short-term borrowings at December 31, 2003 and 2002 consist of the following:
2003 2002
--------------- ----------------
Federal funds purchased..................................................... $ 3,000,000 $ --
Securities sold under agreements to repurchase.............................. 4,085,992 5,928,624
--------------- ----------------
$ 7,085,992 $ 5,928,624
=============== ================
Securities sold under agreements to repurchase are reflected at the amount of
cash received in connection with the transaction. Information concerning
securities sold under agreements to repurchase is summarized as follows:
2003 2002
--------------- ----------------
Average balance during the year............................................. $ 5,488,443 $ 4,061,294
Average interest rate during the year....................................... 1.23% 1.60%
Maximum month-end balance during the year................................... $ 8,211,269 $ 5,928,624
U.S. Agency, municipal and mortgage-backed securities underlying the agreements
at year end:
Carrying value.............................................................. $ 5,887,249 $ 6,106,585
Estimated fair value........................................................ 5,887,249 6,106,585
Note 12 - Long-term Debt
At December 31, 2003 and 2002, the Company had notes payable totaling
$30,692,858 and $34,735,714, respectively.
Long-term debt consists of the following at December 31:
2003 2002
--------------- ----------------
Notes payable on line of credit at FHLB, with varying maturities; from
March 2004 through September 2012, interest rate varies from 0.72% to 7.74%,
secured by residential mortgages............................................... $ 30,692,858 $ 30,135,714
Note payable to another financial institution, interest at prime less
0.25%; interest paid quarterly with principal payments of $657,000 to be
made annually, secured by 100% of the outstanding shares of Appalachian
Community Bank................................................................ -- 4,600,000
--------------- ----------------
$ 30,692,858 $ 34,735,714
=============== ================
56
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 12 - Long-term Debt - Continued
Maturities of long-term debt following December 31, 2003 are as follows:
Years ending December 31,
-------------------------
2004...................................................................... $ 7,242,858
2005...................................................................... 6,200,000
2006...................................................................... 6,200,000
2007...................................................................... 700,000
2008...................................................................... 5,350,000
Thereafter................................................................ 5,000,000
----------------
$ 30,692,858
================
Note 13 - Subordinated Long-term Capital Notes
On August 28, 2003, Appalachian Capital Trust I ("the Trust"), a Delaware
statutory trust established by the Company, received $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. In accordance with the provisions of Financial Interpretation No.
46, the Company accounts for the Trust Preferred Securities as a long-term debt
liability to the Trust in the amount of $6,186,000. Subject to certain
limitations, the Trust Preferred Securities qualify as Tier 1 capital.
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.
Note 14 - Shareholders' Equity
At December 31, 2003 and 2002, shareholders' equity of the Company consisted of
the following:
Preferred Stock: At December 31, 2003, 20,000,000 shares authorized, none issued
and none outstanding.
Common Stock: At December 31, 2003, 20,000,000 shares authorized, 3,734,686
shares issued and 3,658,713 outstanding with a par value of $0.01 per share. At
December 31, 2002, 20,000,000 shares authorized, 3,639,821 shares issued and
3,439,268 outstanding with a par value of $0.01 per share. Voting rights equal
to one vote per share.
Paid-in Capital: Represents the funds received in excess of par value upon the
issuance of stock, net of issuance costs and the tax benefits of non-statutory
stock options.
Retained Earnings: Represents the accumulated net earnings of the Company.
Accumulated Other Comprehensive Income (Loss): Represents the change in equity
during each period from the effects of unrealized holding gains and losses on
securities available-for-sale, net of tax.
57
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 14 - Shareholders' Equity - Continued
Treasury Stock: Represents 75,973 and 200,533 shares of common stock at December
31, 2003 and 2002, at cost.
In 2003, the Company purchased 3,660 shares of its common stock for a cost of
$54,900, which were added to treasury stock at cost. The Company also sold
128,240 shares of its treasury stock for $1,923,601. In addition, 82,170 options
were exercised for an amount equaling $529,330, including tax benefit. A 10%
stock dividend of 332,826 shares was also issued in 2003.
In 2002, the Company issued 12,859 shares of stock to its 401(k) Plan for
$163,660. The Company also sold 52,447 shares of its treasury stock for
$786,705. In addition, 198,880 options were exercised for an amount equaling
$1,021,498, including tax benefit.
In 2001, the Company sold 22,575 shares of stock to its 401(k) plan for
$287,308. In addition, 4,290 options were exercised for an amount equaling
$32,381, including tax benefit.
The Company is required to maintain minimum amounts of capital to total "risk
weighted" assets, as defined by the banking regulators. The Company's ratios as
of December 31, 2003 and 2002 are disclosed in the regulatory matters note
following.
The board of directors of any state-chartered bank in Georgia may declare and
pay cash dividends on its outstanding capital stock without any request for
approval of the Bank's regulatory agency if the following conditions are met:
1. Total classified assets at the most recent examination of the Bank do not
exceed 80% of equity capital.
2. The aggregate amount of dividends declared in the calendar year does not
exceed 50% of the prior year's net income.
3. The ratio of equity capital to adjusted assets shall not be less than 6%.
As of December 31, 2003, the Bank could declare dividends of approximately
$1,819,000 without regulatory consent, subject to the Bank's compliance with
regulatory capital restrictions. It is anticipated that any such dividends would
be used for the payment of long-term debt service.
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58
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 15 - Other Operating Expenses
Other operating expenses consist of the following:
2003 2002 2001
--------------- --------------- ----------------
Professional fees.......................................... $ 948,335 $ 675,728 $ 469,267
Data processing............................................ 569,915 83,572 395,270
Advertising................................................ 516,036 566,684 440,651
Stationery and supplies.................................... 337,712 307,937 264,271
Director and committee fees................................ 314,500 306,282 318,720
Taxes and licenses......................................... 275,528 157,459 132,472
Education.................................................. 196,231 95,107 37,386
FDIC and state assessments................................. 178,917 77,503 163,421
Postage.................................................... 150,268 163,746 126,668
Amortization............................................... 93,833 75,624 117,747
Correspondent bank charges................................. 90,461 77,829 84,294
Insurance.................................................. 47,465 45,997 42,463
Checking account expense................................... 41,311 60,286 56,805
Dues and subscriptions..................................... 40,403 45,594 39,546
Other...................................................... 673,341 570,498 336,333
--------------- --------------- ----------------
Total other operating expenses.......................... $ 4,474,256 $ 3,309,846 $ 3,025,314
=============== =============== ================
Note 16 - Income Taxes
Federal and state income taxes receivable (payable) as of December 31, 2003 and
2002 included in other assets and other liabilities were as follows:
2003 2002
--------------- ----------------
Current
Federal.................................................................. $ 151,850 $ 328,516
State.................................................................... (89,939) (34,120)
The components of the net deferred income tax asset included in other assets are
as follows:
2003 2002
--------------- ----------------
Deferred tax asset:
Federal.................................................................. $ 984,391 $ 895,595
State.................................................................... 87,399 79,347
--------------- ----------------
Total deferred income tax asset........................................ 1,071,790 974,942
--------------- ----------------
Deferred tax liability:
Federal.................................................................. (537,179) (476,096)
State.................................................................... (48,834) (43,175)
--------------- ----------------
Total deferred income tax liability.................................... (586,013) (519,271)
--------------- ----------------
Net deferred tax asset...................................................... $ 485,777 $ 455,671
=============== ================
59
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 16 - Income Taxes - Continued
The tax effects of each type of income and expense item that gave rise to
deferred taxes are:
2003 2002
--------------- ----------------
Net unrealized gains on securities available-for-sale....................... $ (221,223) $ (231,329)
Depreciation................................................................ (364,790) (287,942)
Allowance for loan losses................................................... 975,477 913,888
Deferred compensation....................................................... 68,277 60,578
Other....................................................................... 28,036 476
--------------- ----------------
$ 485,777 $ 455,671
=============== ================
The components of income tax expense (benefit) for the years 2003, 2002 and 2001
are as follows:
2003 2002 2001
--------------- --------------- ----------------
Current
Federal................................................. $ 1,150,739 $ 960,471 $ 1,038,142
State................................................... 122,576 94,469 106,171
Deferred
Federal................................................. (19,000) (45,000) (179,725)
State................................................... (1,000) (4,000) (2,000)
--------------- --------------- ----------------
$ 1,253,315 $ 1,005,940 $ 962,588
=============== =============== ================
Tax effects of securities transactions resulted in an increase (decrease) in
income taxes for 2003, 2002 and 2001 of approximately $(5,773), $97,079 and
$49,972, respectively.
The principal reasons for the difference in the effective tax rate and the
federal statutory rate are as follows for the years ended December 31, 2003,
2002 and 2001.
2003 2002 2001
--------------- --------------- ----------------
Statutory federal income tax rate......................... 34.0% 34.0% 34.0%
Effect on rate of:
Tax-exempt securities.................................. (5.5) (7.3) (5.2)
Tax-exempt loans....................................... (1.0) (1.0) (1.1)
Interest expense disallowance.......................... 0.5 0.9 0.6
State income tax, net of federal tax................... 1.9 1.6 1.9
Other.................................................. (1.0) (0.8) (2.7)
---------------- ---------------- ------------
Effective income tax rate................................. 28.9% 27.4% 27.5%
================ ================ ============
60
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 17 - Commitments and Contingencies
In the normal course of business, the Company offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement, and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements. Commitments to extend credit, credit card arrangements, commercial
letters of credit, and standby letters of credit all include exposure to some
credit loss in the event of nonperformance of the customer. The Company's credit
policies and procedures for credit commitments and financial guarantees are the
same as those for extension of credit that are recorded on the statement of
financial condition. Because these instruments have fixed maturity dates, and
because many of them expire without being drawn upon, they do not generally
present any significant liquidity risk to the Company. Management conducts
regular reviews of these instruments on an individual customer basis, and the
results are considered in assessing the adequacy of the Company's allowance for
loan losses. Management does not anticipate any material losses as a result of
these commitments.
Following is a discussion of these commitments:
Standby Letters of Credit: These agreements are used by the Company's customers
as a means of improving their credit standings in their dealings with others.
Under these agreements, the Company agrees to honor certain financial
commitments in the event that its customers are unable to do so. The amount of
credit risk involved in issuing letters of credit in the event of nonperformance
by the other party is the contract amount. As of December 31, 2003 and 2002, the
Company has issued standby letters of credit of approximately $1,111,000 and
$1,320,000. The Company records a liability for the estimated fair value of
these standby letters of credit based on the fees charged for these
arrangements.
Loan Commitments: As of December 31, 2003 and 2002, the Company had commitments
outstanding to extend credit totaling approximately $43,436,000 and $35,890,000,
respectively. These commitments generally require the customers to maintain
certain credit standards. Management does not anticipate any material losses as
a result of these commitments.
Litigation: The Company is party to litigation and claims arising in the normal
course of business. Management, after consultation with legal counsel, believes
that the liabilities, if any, arising from such litigation and claims are not
material to the financial statements.
Note 18 - Concentrations of Credit
All of the Company's loans, commitments and standby letters of credit have been
granted to customers in the Company's market area. Substantially all such
customers are depositors of the Company. The concentrations of credit by type of
loan are set forth in Note 6. The commitments to extend credit relate primarily
to unused real estate draw lines. Commercial and standby letters of credit were
granted primarily to commercial borrowers.
The Company maintains its cash accounts at various commercial banks in Georgia.
The total cash balances are insured by the FDIC up to $100,000. Total uninsured
balances held at other commercial banks amounted to $235,380 and $11,490,407 at
December 31, 2003 and 2002, respectively.
61
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 19 - Stock Option Plans
The Company has adopted its 1997 Employee Stock Incentive Plan and its 1997
Directors' Non-qualified Stock Option Plan under which it has granted statutory
and nonstatutory stock options to certain directors and employees. The options
granted provide for these directors and employees to purchase shares of the
Company's $0.01 par value common stock at the market value at the dates of
grant. The options granted may be exercised within ten years from the dates of
grant subject to vesting requirements. On April 1, 2003, the Company approved
and adopted the 2003 Stock Option Plan.
The following sets forth certain information regarding stock options for the
years ended December 31, 2003, 2002 and 2001. Stock option shares and prices
have been adjusted to reflect the effects of the 10% stock dividend in 2003.
Fixed Options
2003 2002 2001
---------------------- ------------------------ ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- ---------- ----------- ---------- -------- -----------
Outstanding at beginning of year...... 502,810 $ 5.11 702,790 $ 4.71 659,340 $ 4.11
Granted............................... 18,000 13.92 -- -- 55,000 12.73
Exercised............................. (82,170) 3.69 (198,880) 3.65 (4,290) 3.83
Forfeited............................. (5,500) 13.64 (1,100) 13.64 (7,260) 11.65
---------- ----------- --------
Outstanding at end of year............ 433,140 5.65 502,810 5.11 702,790 4.71
========== =========== ========
Exercisable at end of year............ 362,780 4.57 417,230 4.18 459,470 3.82
========== =========== ========
Weighted average fair value
of options granted................. $ 4.20 $ -- $ 4.18
========== =========== ========
Information pertaining to options outstanding at December 31, 2003 is as
follows:
Outstanding Expiration Options
Number Date Exercisable
--------------- --------------- ----------------
10/07/03 Options with an Exercise Price of $15.00.......... 2,500 10/07/13 --
07/01/03 Options with an Exercise Price of $15.00.......... 10,000 07/01/13 --
01/16/03 Options with an Exercise Price of $12.73.......... 5,500 01/16/13 --
07/10/01 Options with an Exercise Price of $12.73.......... 55,000 07/10/11 22,000
06/30/00 Options with an Exercise Price of $13.64.......... 2,200 06/30/10 1,320
06/22/99 Options with an Exercise Price of $5.45........... 87,560 06/22/09 69,080
06/01/97 Options with an Exercise Price of $3.64........... 270,380 06/01/07 270,380
--------------- ----------------
Total Options Issued....................................... 433,140 362,780
=============== ================
The Company's options outstanding have a weighted average contractual life of
4.62 years.
62
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 20 - Regulatory Matters
The Company and its subsidiary bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could have
a direct material effect on the Company and its subsidiary bank and the
consolidated financial statements. Under capital adequacy guidelines and the
regulatory framework from prompt corrective action, the Company and its
subsidiary bank must meet specific capital guidelines that involve quantitative
measures of their assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and its subsidiary bank to maintain minimum amounts and
ratios (set forth in the table below) of total and Tier 1 Capital (as defined in
the regulations) to risk weighted assets (as defined), and of Tier 1 Capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2003, that the Company and the Bank meet all capital adequacy requirements to
which they are subject.
As of December 31, 2003, the most recent notification from the applicable
regulatory agencies categorized Appalachian Community Bank, the subsidiary bank,
as well capitalized under the regulatory framework for prompt corrective action.
To become well capitalized the Company and its subsidiary bank must maintain
minimum Total Capital, Tier 1 Capital and Tier 1 Leverage ratios as set forth in
the table below.
The Company's and Bank's actual capital amounts and ratios are also presented in
the table.
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
----------------------- ------------------------ ------------------------
Amount Ratio Amount Ratio Amount Ratio
------------ --------- ------------- -------- -------------- --------
(in Thousands)
As of December 31, 2003:
Total Capital
Consolidated...................... $ 38,291 11.55% $ 26,531 8.00% N/A N/A
Appalachian Community Bank........ 36,130 10.91 26,491 8.00 $ 33,114 10.00%
Tier 1 Capital
Consolidated...................... 34,681 10.46 13,266 4.00 N/A N/A
Appalachian Community Bank........ 32,520 9.82 13,246 4.00 19,869 6.00
Tier 1 Leverage
Consolidated...................... 34,681 8.58 16,167 4.00 N/A N/A
Appalachian Community Bank........ 32,520 8.30 15,663 4.00 19,579 5.00
As of December 31, 2002:
Total Capital
Consolidated...................... $ 26,327 8.59% $ 24,512 8.00% N/A N/A
Appalachian Community Bank........ 30,537 10.00 24,425 8.00 $ 30,532 10.00%
Tier 1 Capital
Consolidated...................... 23,089 7.54 12,256 4.00 N/A N/A
Appalachian Community Bank........ 27,299 8.94 12,213 4.00 18,319 6.00
Tier 1 Leverage
Consolidated...................... 23,089 6.07 15,225 4.00 N/A N/A
Appalachian Community Bank 27,299 7.17 15,225 4.00 19,032 5.00
63
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 21 - Employee Benefit Plan
The Company adopted a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code. Employer and employee contributions may be
made in the form of cash or Company stock. The Company's contribution to the
plan is determined by the board of directors. The Company made discretionary
cash contributions to the plan of approximately $300,238 in 2003, $215,353 in
2002 and $223,678 in 2001.
Note 22 - Leases
The Company has a number of operating lease agreements, involving land,
buildings and equipment. These leases are noncancellable and expire on various
dates through the year 2028. The leases provide for renewal options and
generally require the Company to pay maintenance, insurance and property taxes.
For the years ended December 31, 2003, 2002 and 2001, rental expense for
operating leases was approximately $81,500, $68,412 and $50,600, respectively.
Future minimum lease payments under noncancellable operating leases at December
31, 2003, are as follows:
Years Ending December 31,
-------------------------
2004........................................................................ $ 64,581
2005........................................................................ 47,220
2006........................................................................ 35,773
2007........................................................................ 35,538
2008........................................................................ 34,617
Thereafter.................................................................. 803,252
----------------
Total minimum lease payments................................................ $ 1,020,981
================
Note 23 - Related Party Transactions
Loans: Certain directors, executive officers and principal shareholders,
including their immediate families and associates were loan customers of the
Company during 2003 and 2002. Such loans are made in the ordinary course of
business at normal credit terms, including interest rates and collateral and do
not represent more than a normal risk of collection. A summary of activity and
amounts outstanding are as follows:
2003 2002
--------------- ----------------
Balance at Beginning of Year................................................. $ 7,814,802 $ 8,456,182
New loans.................................................................... 1,257,065 2,373,027
Repayments................................................................... (853,748) (2,330,592)
Participations sold.......................................................... 1,011,183 (572,269)
Change in related parties.................................................... 143,261 (111,546)
--------------- ----------------
Balance at End of Year....................................................... $ 9,372,563 $ 7,814,802
=============== ================
Deposits: Deposits held from related parties were $2,224,390 and $1,344,094 at
December 31, 2003 and 2002, respectively.
Lease: The Bank leases a facility from a partnership which includes directors of
the Company. The lease commenced in May 2001 and had an initial term of 24
months. The Company exercised its option to renew this lease during 2003 for a
period of one year for an annual expense of $33,000. The lease will expire in
May 2004.
64
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 24 - Litigation
While the Company and its subsidiaries are party to various legal proceedings
arising from the ordinary course of business, management believes after
consultation with legal counsel that there are no proceedings threatened or
pending against the Company that will, individually or in the aggregate, have a
material adverse effect on the business or financial condition of the Company.
Note 25 - Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Short-Term Investments: For those short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Securities: For securities and marketable equity securities held for investment
purposes, fair values are based on quoted market prices or dealer quotes. For
other securities held as investments, fair value equals quoted market price, if
available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar securities.
Loans: For certain homogeneous categories of loans, such as some residential
mortgages, credit card receivables, and other consumer loans, fair value is
estimated using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The fair value of other types
of loans is estimated by discounting the future cash flows using the current
rates at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
Accrued Interest Receivable: The carrying amount of accrued interest receivable
approximates its fair value.
Deposits: The fair value of demand deposits, savings accounts, and certain money
market deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposit of similar remaining maturities.
Accrued Interest Payable: The carrying amount of accrued interest payable
approximates its fair value.
Short-term Borrowings: The fair value of short-term borrowings, including
securities sold under agreements to repurchase, is estimated to be approximately
the same as the carrying amount.
Long-Term Debt: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate fair value of existing debt.
Commitments to Extend Credit, Letters of Credit, and Financial Guarantees
Written: The fair value of commitments and letters of credit is estimated to be
approximately the fees charged for these arrangements.
65
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 25 - Fair Value of Financial Instruments - Continued
The estimated fair values of the Company's financial instruments as of December
31, 2003 and 2002 are as follows:
2003 2002
---------------------------- ------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------- ------------- ---------------
(in thousands)
Financial Assets
Cash and short-term investments.................. $ 7,391 $ 7,391 $ 30,857 $ 30,857
Securities....................................... 55,363 55,363 40,375 40,375
Loans............................................ 332,306 332,859 298,063 299,334
Accrued interest receivable...................... 2,290 2,290 2,241 2,241
------------ ------------- ------------- ---------------
Total Financial Assets......................... $ 397,350 $ 397,903 $ 371,536 $ 372,807
============ ============= ============= ===============
Financial Liabilities
Deposits......................................... $ 332,919 $ 324,654 $ 316,283 $ 319,075
Short-term borrowings............................ 7,086 7,086 5,929 5,929
Accrued interest payable......................... 671 671 976 976
Long-term debt................................... 36,879 39,022 34,736 36,782
------------ ------------- ------------- ---------------
Total Financial Liabilities.................... $ 377,555 $ 371,433 $ 357,924 $ 362,762
============ ============= ============= ===============
Unrecognized financial instruments
Commitments to extend credit..................... $ 43,436 $ 326 $ 35,890 $ 269
Standby letters of credit........................ 1,111 8 1,320 10
------------ ------------- ------------- ---------------
Total Unrecognized Financial
Instruments.................................. $ 44,547 $ 334 $ 37,210 $ 279
============ ============= ============= ===============
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66
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 26 - Condensed Parent Information
Statements of Financial Condition
December 31,
----------------------------------
2003 2002
--------------- ----------------
Assets
Cash and due from banks................................................... $ 1,146,218 $ 5,343
Investment in subsidiaries (equity method) eliminated
upon consolidation...................................................... 34,948,116 29,828,837
Securities available for sale............................................. 186,000 --
Other assets.............................................................. 1,127,252 385,109
--------------- ----------------
Total Assets............................................................ $ 37,407,586 $ 30,219,289
=============== ================
Liabilities and Shareholders' Equity
Note payable.............................................................. $ -- $ 4,600,000
Subordinated long-term capital notes...................................... 6,186,000 --
Other liabilities......................................................... 139,233 --
--------------- ----------------
Total Liabilities....................................................... 6,325,233 4,600,000
--------------- ----------------
Total Shareholders' Equity.............................................. 31,082,353 25,619,289
--------------- ----------------
Total Liabilities and Shareholders' Equity.............................. $ 37,407,586 $ 30,219,289
=============== ================
Statements of Income
Years ended December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Income
Interest................................................ $ -- $ -- $ --
Dividends from subsidiaries - eliminated
upon consolidation.................................... -- -- 250,000
--------------- --------------- ----------------
-- -- 250,000
Expenses
Interest................................................ 201,454 205,218 319,067
Other expenses.......................................... 729,245 496,725 490,156
--------------- --------------- ----------------
930,699 701,943 809,223
--------------- --------------- ----------------
Loss before income taxes and equity in undistributed
earnings of subsidiaries................................ (930,699) (701,943) (559,223)
Income tax benefits........................................ 378,685 257,277 307,196
--------------- --------------- ----------------
Loss before equity in undistributed earnings
of subsidiaries......................................... (552,014) (444,666) (252,027)
Equity in undistributed earnings of subsidiaries........... 3,638,594 3,112,674 2,790,125
--------------- --------------- ----------------
Net Income............................................ $ 3,086,580 $ 2,668,008 $ 2,538,098
=============== =============== ================
67
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 26 - Condensed Parent Information - Continued
Statements of Cash Flow
Years ended December 31,
-----------------------------------------------------
2003 2002 2001
--------------- --------------- ----------------
Operating Activities
Net Income.............................................. $ 3,086,580 $ 2,668,008 $ 2,538,098
Adjustments to reconcile net income to net cash
provided by operating activities
Equity in undistributed income of subsidiaries........ (3,638,594) (3,112,674) (2,790,125)
Increase (decrease) in accrued interest payable....... 85,200 -- (108,739)
Other................................................. (483,620) (272,079) 224,262
--------------- --------------- ----------------
Net Cash Used In Operating Activities............... (950,434) (716,745) (136,504)
--------------- --------------- ----------------
Investing Activities
Investment in preferred securities trust................ (186,000) -- --
Capital injection in subsidiaries....................... (1,500,000) (1,150,000) --
--------------- --------------- ----------------
Net Cash Used In Investing Activities............... (1,686,000) (1,150,000) --
--------------- --------------- ----------------
Financing Activities
Proceeds from issuance of long-term debt................ 6,186,000 -- --
Repayment of long-term debt............................. (4,600,000) -- --
Proceeds from issuance of common stock.................. 302,800 889,260 319,689
Purchases of treasury stock............................. (54,900) -- --
Compensation associated with issuance of options........ 21,739 -- --
Proceeds from issuance of treasury stock................ 1,923,601 -- --
Cash paid in lieu of fractional shares on stock dividend (1,931) 786,705 --
--------------- --------------- ----------------
Net Cash Provided By Financing Activities........... 3,777,309 1,675,965 319,689
--------------- --------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents....... 1,140,875 (190,780) 183,185
Cash and Cash Equivalents at Beginning of Year............. 5,343 196,123 12,938
--------------- --------------- ----------------
Cash and Cash Equivalents at End of Year................... $ 1,146,218 $ 5,343 $ 196,123
=============== =============== ================
Cash paid during the year for:
Interest................................................ $ 116,254 $ 205,218 $ 427,806
[The remainder of this page intentionally left blank]
68
APPALACHIAN BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001
Note 27 - Quarterly Results of Operations (Unaudited)
Selected quarterly results of operations for the four quarters of each of the
years ended December 31, 2003, 2002 and 2001 are as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------------- ------------- ------------- ------------- ----------------
(In Thousands Except Per Share Data)
2003:
Total interest income.............. $ 5,645 $ 5,673 $ 5,831 $ 5,847 $ 22,996
Total interest expense............. 2,416 2,234 1,897 1,710 8,257
Provision for loan losses.......... 360 360 385 360 1,465
Net interest income after
provision for loan losses....... 2,869 3,079 3,549 3,777 13,274
Securities gains (losses).......... (17) -- -- -- (17)
Total noninterest income........... 721 824 619 650 2,814
Total noninterest expense.......... 2,690 2,966 3,006 3,069 11,731
Income tax expense................. 256 291 365 341 1,253
Net income......................... 627 646 797 1,017 3,087
Per Common Share:
Basic earnings.................. 0.18 0.18 0.22 0.28 0.86
Diluted earnings................ 0.17 0.17 0.21 0.26 0.81
2002:
Total interest income.............. $ 5,455 $ 5,614 $ 5,883 $ 5,940 $ 22,892
Total interest expense............. 2,890 2,825 2,827 2,883 11,425
Provision for loan losses.......... 146 216 306 360 1,028
Net interest income after
provision for loan losses....... 2,419 2,573 2,750 2,697 10,439
Securities gains (losses).......... 20 7 1 258 286
Total noninterest income........... 602 721 881 447 2,651
Total noninterest expense.......... 2,095 2,594 2,605 2,408 9,702
Income tax expense................. 295 245 351 115 1,006
Net income......................... 651 462 676 879 2,668
Per Common Share:
Basic earnings.................. 0.20 0.14 0.21 0.26 0.81
Diluted earnings................ 0.18 0.13 0.19 0.26 0.76
2001:
Total interest income.............. $ 6,021 $ 5,955 $ 5,979 $ 5,935 $ 23,890
Total interest expense............. 3,648 3,386 3,389 3,252 13,675
Provision for loan losses.......... 366 126 326 476 1,294
Net interest income after
provision for loan losses....... 2,007 2,443 2,264 2,207 8,921
Securities gains (losses).......... 94 24 (19) 48 147
Total noninterest income........... 597 443 510 714 2,264
Total noninterest expense.......... 1,832 1,859 1,940 2,200 7,831
Income tax expense................. 262 292 271 138 963
Net income......................... 604 759 544 631 2,538
Per Common Share:
Basic earnings.................. 0.19 0.25 0.17 0.20 0.81
Diluted earnings................ 0.17 0.23 0.16 0.19 0.75
69
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the Company's disclosure controls and procedures as of the end of the
fiscal year covered by this Report on Form 10-K and have concluded that the
Company's disclosure controls and procedures are effective. During the fourth
quarter of 2003, there were no changes in the Company's internal control over
financial reporting that have materially affected, or that are reasonably likely
to materially affect, the Company's internal control over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information appearing under the headings "Election of Directors,"
"Executive Officers," "Section 16(a) Beneficial Ownership Reporting Compliance"
and "Corporate Governance and Board Matters" in the Proxy Statement (the "2004
Proxy Statement") relating to the Company's 2004 annual meeting of shareholders
is incorporated herein by reference. The Company has adopted a code of ethics
that applies to the Company's chief executive officer and senior financial
officers, a copy of which is attached to this Form 10-K as Exhibit 14.
ITEM 11. EXECUTIVE COMPENSATION
The information appearing under the heading "Compensation of Executive
Officers and Directors" in the 2004 Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information appearing under the heading "Ownership of Common Stock" in
the 2004 Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information appearing under the caption "Related Party Transactions" in
the 2004 Proxy Statement is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information appearing under the caption "Independent Public
Accountants" in the 2004 Proxy Statement is incorporated herein by reference.
70
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
The following consolidated financial statements are located in Item 8
of this Report:
Independent Auditors' Report Consolidated Statements of Financial
Condition as of December 31, 2003 and 2002 Consolidated Statements of
Income for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows
for the Years Ended December 31, 2003, 2002 and 2001 Notes to
Consolidated Financial Statements Quarterly Results (Unaudited)
2. Financial Statement Schedules.
Schedules to the consolidated financial statements are omitted, as the
required information is not applicable.
3. Exhibits.
The following exhibits are filed or incorporated by reference as part
of this Report:
Exhibit Number Description of Exhibit
- ----------------------------- --------------------------------------------
3.1 Articles of Incorporation of the Company, as
Restated (included as Exhibit 3.1 to the
Company's Quarterly Report on Form 10-Q,
dated August 15, 2003 (File No. 000-21383),
previously filed with the Commission and
incorporated herein by reference).
3.2 Bylaws of the Company, as Restated (included
as Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q, dated August 15, 2003
(File No. 000-21383), previously filed with
the Commission and incorporated herein by
reference).
10.1 1997 Directors' Non-Qualified Stock Option
Plan (included as Exhibit 10.1 to the
Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1996
(File No. 000-21383) and incorporated herein
by reference).*
10.2 1997 Employee Incentive Stock Incentive Plan
(included as Exhibit 10.2 to the Company's
Annual Report on Form 10-K for the fiscal
year ended December 31, 1996 (File No.
000-21383) and incorporated herein by
reference).*
10.3 Adoption Agreement for the Appalachian
Bancshares, Inc. Employees' Savings & Profit
Sharing Plan (the "Plan") (filed as
Exhibit 10.1 to the Plan's Annual Report
on Form 11-K for the fiscal year ended
December 31, 2001 (File No. 001-15571)
and incorporated herein by reference).
71
Exhibit Number Description of Exhibit
- ----------------------------- --------------------------------------------
10.4 Pentegra Services, Inc. Employees' Savings &
Profit Sharing Plan Basic Plan Document, and
the following related documents: Trust
Agreement by and between Appalachian
Bancshares, Inc. and the Bank of New York;
Custody Agreement by and between Tracy R.
Newton, Kent W. Sanford and Joseph Hensley,
as Trustee on behalf of the Appalachian
Bancshares, Inc. Employees' Savings & Profit
Sharing Plan, and the Bank of New York (with
Letter Notification to the Bank of New York
providing an updated list of members of the
Administrative Committee); and the Internal
Revenue Service Favorable Approval Letter of
the Pentegra Services, Inc. Prototype
Non-Standardized Profit Sharing Plan (filed
as Exhibit 10.2 to the Plan's Annual Report
on Form 11-K for the fiscal year ended
December 31, 2001 (File No. 001-15571) and
incorporated herein by reference).
10.5 Form of Deferred Fee Agreement between
Gilmer County Bank and certain directors
and executive officers, with addendum
(filed as Exhibit 10.6 to the Company's
Quarterly Report on Form 10-QSB for the
period ended June 30, 1997 (File No.
000-21383) and incorporated herein by
reference).
10.6 Loan and Stock Pledge Agreement, dated as of
April 3, 2002, between the Company and
Crescent Bank and Trust Company (filed as
Exhibit 10.1 to the Company's Quarterly
Report on Form 10-QSB for the period ended
September 30, 2002 (File No. 001-15571) and
incorporated herein by reference).
10.7 Promissory Note, dated April 3, 2002, issued
by the Company to Crescent Bank and Trust
Company (filed as Exhibit 10.2 to the
Company's Quarterly Report on Form 10-QSB
for the period ended September 30, 2002
(File No. 001-15571) and incorporated herein
by reference).
10.8 Form of Data Processing Agreement by and
between Appalachian Community Bank and
Fiserv Solutions, Inc., effective as of July
26, 2002 (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-QSB
for the period ended September 30, 2002
(File No. 001-15571) and incorporated herein
by reference).
10.9 2003 Stock Option Plan (included as Exhibit
10.1 to the Company's Quarterly Report on
Form 10-Q for the period ended June 30,
2003 (File No. 000-21383) and incorporated
herein by reference).*
11 Statement re: Computation of Per Share
Earnings
12 Statement re: Computation of Ratios
14 Code of Ethics for CEO and Senior Financial
Officers
21 Subsidiaries of the Registrant
72
Exhibit Number Description of Exhibit
- ----------------------------- -------------------------------------------
23 Consent of Schauer, Taylor, Cox, Vise,
Morgan & Fowler, P.C.
31.1 Certification of President and Chief
Executive Officer Pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer
Pursuant to Section 302 of Sarbanes-Oxley
Act of 2002.
32 Certifications Pursuant to Section 906 of
arbanes-Oxley Act of 2002.
o The referenced exhibit is a compensatory contract, plan or arrangement.
(b) A current report on Form 8-K dated October 23, 2003, was filed with the
Securities and Exchange Commission under Items 5 ("Other Events") and 7
("Financial Statements and Exhibits") of such form, involving the Company's
issuance of a press release announcing an increase in the regulatory
capital of the Company, resulting from the issuance and sale, on August 28,
2003, of $6,000,000 of Appalachian Capital Trust I preferred securities.
A current report on Form 8-K dated November 4, 2003, was filed with the
Securities and Exchange Commission under Items 7 ("Financial Statements and
Exhibits") and 12 ("Results of Operation and Financial Condition") of such
form, involving the Company's issuance of a press release dated November 4,
2003, reporting the unaudited results of operations and earnings for the
three months and nine months ended September 30, 2003.
A current report on Form 8-K dated November 10, 2003, was filed with the
Securities and Exchange Commission under Items 7 ("Financial Statements and
Exhibits") and 12 ("Results of Operation and Financial Condition") of such
form, involving the Company's issuance of a press release dated November
10, 2003, announcing a restatement of the earnings-per-share data included
in its report of unaudited results of operations and earnings for the three
months and nine months ended September 30, 2003, as previously reported on
November 4, 2003.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 29th day of
March, 2003.
APPALACHIAN BANCSHARES, INC.
By: /s/ Tracy R. Newton
------------------------------------------
Tracy R. Newton
President and Chief Executive Officer
By: /s/ Darren M. Cantlay
------------------------------------------
Darren M. Cantlay
Chief Financial Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/s/ Tracy R. Newton Date: March 29, 2004
- --------------------------------------------
Tracy R. Newton, President, Chief
Executive Officer and Director
/s/ Alan S. Dover Date: March 29, 2004
- --------------------------------------------
Alan S. Dover, Director
/s/ Charles A. Edmondson Date: March 29, 2004
- --------------------------------------------
Charles A. Edmondson, Director
/s/ Roger E. Futch Date: March 29, 2004
- --------------------------------------------
Roger E. Futch, Director
/s/ Joseph C. Hensley Date: March 29, 2004
- --------------------------------------------
Joseph C. Hensley, Director
/s/ Frank E. Jones Date: March 29, 2004
- --------------------------------------------
Frank E. Jones, Director
/s/ J. Ronald Knight Date: March 29, 2004
- --------------------------------------------
J. Ronald Knight, Director
/s/ P. Joe Sisson Date: March 29, 2004
- --------------------------------------------
P. Joe Sisson, Director
/s/ Kenneth D. Warren Date: March 29, 2004
- --------------------------------------------
Kenneth D. Warren, Director
74
EXHIBIT INDEX
The following exhibits are filed as part of this report (in addition to
those exhibits listed in Item 15 which are filed as a part of this report and
incorporated by reference):
Exhibit Number Description of Exhibit Page
- ------------------------------ ------------------------------------------------------------ ----------------
11 Statement re: Computation of Per Share Earnings 76
12 Statement re: Computation of Ratios 77
14 Code of Ethics for CEO and Senior Financial Officers 78
21 Subsidiaries of the Registrant 79
23 Consent of Schauer, Taylor, Cox, Vise, Morgan & Fowler, P.C. 80
31.1 Certification of President and Chief Executive Officer
Pursuant to Section 302 of Sarbanes-Oxley Act of 2002. 81
31.2 Certification of Chief Financial Officer Pursuant to
Section 302 of Sarbanes-Oxley Act of 2002. 82
32 Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002. 83
75
EXHIBIT 11 - STATEMENTS RE: COMPUTATION OF PER SHARE EARNINGS
Appalachian Bancshares, Inc.
Computation of Net Income Per Common Share
The following tabulation presents the calculation of basic and diluted
earnings per common share for the years ended December 31, 2003, 2002 and 2001.
All share amounts have been retroactively adjusted to give effect to the ten
percent stock dividend issued in July 2003.
2003 2002 2001
---------------- --------------- ---------------
Basic Earnings Per Share:
Net income................................................ $ 3,086,580 $ 2,668,008 $ 2,538,098
================ =============== ===============
Earnings on common shares................................. $ 3,086,580 $ 2,668,008 $ 2,538,098
================ =============== ===============
Weighted average common shares outstanding - basic........ 3,609,728 3,277,787 3,145,651
================ =============== ===============
Basic earnings per common share........................... $ 0.86 $ 0.81 $ 0.81
================ =============== ===============
Diluted Earnings Per Share:
Net income................................................ $ 3,086,580 $ 2,668,008 $ 2,538,098
================ =============== ===============
Weighted average common shares
outstanding............................................. 3,609,728 3,277,787 3,145,651
Net effect of the assumed exercise of stock
options - based on the treasury stock method
using average market price for the year................. 199,897 230,232 243,753
---------------- --------------- ---------------
Weighted average common shares outstanding -
diluted................................................. 3,809,625 3,508,019 3,389,404
================ =============== ===============
Diluted earnings per common share......................... $ 0.81 $ 0.76 $ 0.75
================ =============== ===============
76
EXHIBIT 12 - STATEMENTS RE: COMPUTATION OF RATIOS
Appalachian Bancshares, Inc.
Computation of Ratio of Earnings to Fixed Charges
Year Ended December 31,
-------------------------------------------------
2003 2002 2001
-------------- ------------- --------------
(Dollars in thousands)
Pretax income................................................. $ 4,340 $ 3,674 $ 3,501
Add fixed charges:
Interest on deposits....................................... 6,959 9,353 11,295
Interest on borrowings..................................... 1,297 2,073 2,380
Portion of rental expense representing interest expense.... 27 23 17
-------------- ------------- --------------
Total fixed charges...................................... 8,283 11,449 13,692
-------------- ------------- --------------
Income before fixed charges................................... $ 12,623 $ 15,123 $ 17,193
============== ============= ==============
Pretax income................................................. $ 4,340 $ 3,674 $ 3,501
Add fixed charges (excluding interest on deposits):
Interest on borrowings..................................... 1,297 2,073 2,380
Portion of rental expense representing interest expense.... 27 23 17
-------------- ------------- --------------
Total fixed charges...................................... 1,324 2,096 2,397
-------------- ------------- --------------
Income before fixed charges (excluding interest on
deposits).................................................. $ 5,664 $ 5,770 $ 5,898
============== ============= ==============
Ratio of Earnings to Fixed Charges
Including interest on deposits............................. 1.52 1.32 1.26
Excluding interest on deposits............................. 4.28 2.75 2.46
77
Exhibit 14 - Code of ethics for ceo and senior financial officers
APPALACHIAN BANCSHARES, INC.
Code of Ethics
For
Chief Executive Officer and Senior Financial Officers
The Company has a Code of Conduct applicable to all officers and certain
other designated employees of the Company. The Chief Executive Officer and all
senior financial officers, including the Chief Financial Officer, Corporate
Controller and senior accounting personnel identified by the Chief Financial
Officer (the "senior financial officers") are bound by the provisions set forth
in the Code of Conduct relating to ethical conduct, conflicts of interest and
compliance with law. In addition to the Code of Conduct, the Chief Executive
Officer and senior financial officers are subject to the following additional
specific policies:
1. The Chief Executive Officer and all senior financial officers are
responsible for full, fair, accurate, timely and understandable disclosure
in the periodic reports required to be filed by the Company with the SEC.
Accordingly, it is the responsibility of the Chief Executive Officer and
each senior financial officer to promptly bring to the attention of the
Chief Financial Officer and the Chairman of the Audit Committee any
material information of which he or she may become aware that affects the
disclosures made by the Company in its public filings or otherwise assist
the Chief Financial Officer and the Chairman of the Audit Committee in
assuring that the Company fulfills its responsibilities in preparation of
such disclosures.
2. The Chief Executive Officer and each senior financial officer shall
promptly bring to the attention of the Chief Financial Officer and the
Chairman of the Audit Committee any information he or she may have
concerning (a) significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability to
record, process, summarize and report financial data or (b) any fraud,
whether or not material, that involves management or other employees who
have a significant role in the Company's financial reporting, disclosures
or internal controls.
3. The Chief Executive Officer and each senior financial officer shall
promptly bring to the attention of the Chief Financial Officer or the
Chairman of the Audit Committee any information he or she may have
concerning any violation of the Company's Code of Conduct, including any
actual or apparent conflicts of interest between personal and professional
relationships, involving any management or other employees who have a
significant role in the Company's financial reporting, disclosures or
internal controls.
4. The Chief Executive Officer and each senior financial officer shall
promptly bring to the attention of the Chief Financial Officer or the
Chairman of the Audit Committee any information he or she may have
concerning evidence of a material violation of the securities laws or other
laws, rules or regulations applicable to the Company and the operation of
its business, by the Company or any agent thereof, or of violation of the
Code of Conduct or of these additional policies.
5. The Board of Directors shall determine, or designate appropriate persons to
determine, appropriate actions to be taken in the event of violations of
the Code of Conduct or of these additional policies by the Chief Executive
Officer and the Company's senior financial officers. Such action shall be
reasonably designed to deter wrongdoing and to promote accountability for
adherence to the Code of Conduct and to these additional procedures, and
shall include written notices to the individual involved that the Board has
determined that there has been a violation, censure by the Board, demotion
or re-assignment of the individual involved, suspension with or without pay
or benefits (as determined by the Board) or termination of the individual's
employment. In determining what action is appropriate in a particular case,
the Board of Directors or such designee shall take into account all
relevant information, including the nature and severity of the violation,
whether the violation was a single occurrence or repeated occurrences,
whether the violation appears to have been intentional or inadvertent,
whether the individual in question had been advised prior to the violation
as to the proper course of action, and whether or not the individual in
question had committed other violations in the past.
78
EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT
Subsidiaries - Direct/wholly-owned State of Incorporation
- ---------------------------------- ----------------------
Appalachian Capital Trust I Delaware
Appalachian Community Bank Georgia
Also doing business under the registered trade name "Gilmer County Bank"
Subsidiaries - Indirect/wholly-owned by Appalachian Community Bank
- ------------------------------------------------------------------
Appalachian Information Management, Inc. Georgia
79
EXHIBIT 23 - CONSENT OF SCHAUER TAYLOR COX VISE MORGAN & FOWLER, P.C.
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report included in this Form 10-K, into the Company's previously filed
Registration Statements on Form S-8.
/s/ Schauer Taylor Cox Vise Morgan & Fowler, P.C.
Schauer Taylor Cox Vise Morgan & FOWLER, P.C.
Birmingham, Alabama
March 29, 2004
80
EXHIBIT 31.1
CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER
I, Tracy R. Newton, certify that:
1. I have reviewed this Annual Report on form 10-K of Appalachian Bancshares,
Inc.;
2. 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;
3. 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;
4. The registrant's other certifying officers 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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we 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]
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control 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.
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal controls 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: March 29, 2004
/s/ Tracy R. Newton
-------------------------------------
Tracy R. Newton
President and Chief Executive Officer
81
EXHIBIT 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Darren M. Cantlay, certify that:
1. I have reviewed this Annual Report on form 10-K of Appalachian Bancshares,
Inc.;
2. 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;
3. 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;
4. The registrant's other certifying officers 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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we 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]
c) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal
control 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.
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal controls 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: March 29, 2004
/s/ Darren M. Cantlay
-------------------------------------
Darren M. Cantlay
Chief Financial Officer
82
EXHIBIT 32
CERTIFICATIONS 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 Annual Report of Appalachian Bancshares, Inc. (the
"Company") on Form 10-K for the year ended December 31, 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 M. 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) 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.
By:
/s/ Tracy R. Newton
-------------------------------------
Tracy R. Newton
President and Chief Executive Officer
March 29, 2004
/s/ Darren M. Cantlay
-------------------------------------
Darren M. Cantlay
Chief Financial Officer
March 29, 2004
83