SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended: September 30, 1998 Commission file number: 33-42286
HENDERSON CITIZENS BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
TEXAS 6712 75-2371232
- -------------------------- --------------------------- ---------------------
(State or other (Primary Standard (IRS Employer
jurisdiction of Industrial Classification Identification No.)
incorporation Code Number)
or organization)
201 WEST MAIN STREET, P.O. BOX 1009
HENDERSON, TEXAS 75653
(903) 657-8521
(Address, including ZIP code, and telephone number, including
area code, of registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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.
X Yes No
----------- ------
At September 30, 1998, 2,016,874 shares of Common Stock, $5.00 par value, were
outstanding.
1
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
September 30, 1998 and December 31, 1997
(dollars in thousands, except share amounts)
1998 1997
Assets -------------- --------------
------
Cash and due from banks $ 7,381 8,886
Interest-bearing deposits with
other financial institutions 7,885 8,212
Federal funds sold 6,245 5,040
Securities:
Held-to-maturity, approximate market value of $66,125
in 1998 and $69,598 in 1997 64,955 69,233
Available-for-sale 133,258 148,740
-------------- --------------
198,213 217,973
Loans, net 120,040 106,061
Premises and equipment, net 5,549 5,209
Accrued interest receivable 3,165 3,311
Other assets 3,414 3,801
-------------- --------------
$ 351,892 358,493
============== ==============
Liabilities and Stockholders' Equity
------------------------------------
Deposits:
Demand - noninterest-bearing 37,557 32,860
Interest-bearing transaction accounts 70,743 79,810
Money market and savings 43,811 46,206
Certificates of deposit and other time deposits 161,948 163,231
-------------- --------------
Total deposits 314,059 322,107
Accrued interest payable 1,083 1,105
Notes payable 444 844
Other liabilities 909 1,708
-------------- --------------
316,495 325,764
Stockholders' equity:
Preferred stock, $5 par value; 2,000,000 shares authorized
none issued or outstanding -- --
Common stock, $5 par value; 10,000,000 shares authorized,
2,160,000 issued 10,800 10,800
Surplus 5,400 5,400
Retained earnings 20,663 18,875
Accumulated other comprehensive income 554 (335)
-------------- --------------
37,417 34,740
Less treasury stock, 143,126 shares in 1998 and 142,506 shares
in 1997, at cost (2,020) (2,011)
-------------- --------------
Total stockholders' equity 35,397 32,729
Commitments and contingencies
-------------- --------------
$ 351,892 358,493
============== ==============
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
2
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
(dollars in thousands, except per share amounts)
Three months Nine months
ended September 30, ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
------------- -------------- ------------- -------------
Interest income:
Loans $ 2,470 2,163 7,128 6,387
Securities
Taxable - available-for-sale 2,032 2,204 6,359 6,734
Taxable - held-to-maturity 409 623 1,407 1,949
Tax-exempt 436 468 1,179 1,367
Federal funds sold 60 33 251 119
Interest-bearing deposits with other financial 109 55 420 213
institutions
------------- -------------- ------------- -------------
Total interest income 5,516 5,546 16,744 16,769
------------- -------------- ------------- -------------
Interest expense:
Deposits:
Transaction accounts 449 453 1,414 1,443
Money market and savings 309 316 951 955
Certificates of deposit and other time deposits 2,069 2,073 6,259 6,265
Other 10 14 25 40
------------- -------------- ------------- -------------
Total interest expense 2,837 2,856 8,649 8,703
------------- -------------- ------------- -------------
Net interest income 2,679 2,690 8,095 8,066
Provision for loan losses 165 83 458 253
------------- -------------- ------------- -------------
Net interest income after provision for loan
losses 2,514 2,607 7,637 7,813
------------- -------------- ------------- -------------
Other income:
Gains (losses) on securities transactions, net 216 27 282 (37)
Income from fiduciary activities 197 156 602 444
Service charges, commissions, and fees 802 509 2,209 1,401
Other 134 91 421 249
------------- -------------- ------------- -------------
Total other income 1,349 783 3,514 2,057
------------- -------------- ------------- -------------
Other expenses:
Salaries and employee benefits 1,448 1,339 4,374 4,005
Occupancy and equipment 362 266 1,000 752
Regulatory assessments 38 33 102 93
Other 745 648 2,175 1,883
------------- -------------- ------------- -------------
Total other expenses 2,593 2,286 7,651 6,733
------------- -------------- ------------- -------------
Income before income taxes 1,270 1,104 3,500 3,137
Income tax expense 262 252 744 714
------------- -------------- ------------- -------------
Net income $ 1,008 852 2,756 2,423
============= ============== ============= =============
Basic net income per common share $ .50 0.40 1.37 1.14
============= ============== ============= =============
Average number of shares outstanding 2,017,198 2,115,871 2,017,390 2,122,551
============= ============== ============= =============
See accompanying notes to consolidated financial statements.
3
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(unaudited)
Nine months ended September 30, 1998 and 1997
(dollars in thousands, except share and per share amounts)
Accumulated
Other
Comprehensive
Income
-------------------
Net Unrealized
Gains (Losses)
on Securities Total
Preferred Common Retained Available Treasury Stockholders'
Stock Stock Surplus Earnings For Sale Stock Equity
----------- -------- --------- -------- ------------------- ---------- -------------
Balances at December 31, 1996 $ -- 10,800 5,400 16,825 (703) (334) 31,988
Net income -- -- -- 2,423 -- -- 2,423
Net change in unrealized
losses on securities
available for sale -- -- -- -- 261 -- 261
Cash dividends ($.48 per
share) -- -- -- (1,017) -- -- (1,017)
Purchase of 14,620 shares of
treasury stock -- -- -- -- -- (177) (177)
----------- -------- --------- -------- ---------------- ---------- -------------
Balances at September 30, 1997 $ -- 10,800 5,400 18,231 (442) (511) 33,478
=========== ======== ========= ======== ================ ========== =============
Balances at December 31, 1997 $ -- 10,800 5,400 18,875 (335) (2,011) 32,729
Net income -- -- -- 2,756 -- -- 2,756
Net change in unrealized gains
on securities available for
sale -- -- -- -- 889 -- 889
Cash dividends ($.48 per
share) -- -- -- (968) -- -- (968)
Purchase of 620 shares of
treasury stock -- -- -- -- -- (9) (9)
----------- -------- --------- -------- ---------------- ---------- -------------
Balances at September 30, 1998 $ -- 10,800 5,400 20,663 554 (2,020) 35,397
=========== ======== ========= ======== ================ ========== =============
See accompanying notes to consolidated financial statements.
4
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
(unaudited)
Nine months ended September 30, 1998 and 1997
(dollars in thousands)
1998 1997
-------------- --------------
Operating activities:
Net income $ 2,756 2,423
Adjustments to reconcile net income to net cash
provided by operating activities:
Net amortization of premium on securities 327 273
Net (gains) losses on securities transactions, net (282) 37
Provision for loan losses 458 253
Depreciation and amortization 783 453
Decrease in accrued interest receivable 146 115
Increase in other assets (98) (543)
Increase (decrease) in accrued interest payable (22) 188
Decrease in other liabilities (762) (712)
-------------- --------------
Net cash provided by operating activities 3,306 2,487
-------------- --------------
Investing activities:
Proceeds from maturities and paydowns of held-to-maturity securities 19,458 16,425
Purchases of held-to-maturity securities (15,390) (6,126)
Proceeds from sales of available-for-sale securities 31,323 20,823
Proceeds from maturities and paydowns of available-for-sale securities 36,511 8,368
Purchases of available-for-sale securities ( 50,839) (24,692)
Net increase in loans (14,437) (3,840)
Purchases of bank premises and equipment (811) (1,693)
-------------- --------------
Net cash provided by investing activities 5,815 9,265
-------------- --------------
Financing activities:
Net decrease in deposits (8,048) (11,272)
Payment on notes payable (400) (667)
Cash dividends paid (1,291) (1,017)
Purchase of treasury stock (9) (177)
-------------- --------------
Net cash used in financing activities (9,748) (13,133)
-------------- --------------
Decrease in cash and cash equivalents (627) (1,381)
Cash and cash equivalents at beginning of period 22,138 17,455
-------------- --------------
Cash and cash equivalents at end of period $ 21,511 16,074
============== ==============
Supplemental disclosures of cash flow activities:
Income taxes paid, net of refunds $ 970 865
============== ==============
Interest paid $ 8,671 8,515
============== ==============
See accompanying notes to consolidated financial statements.
5
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1998
(1) BASIS OF PRESENTATION
---------------------
The accompanying consolidated financial statements are unaudited, but
include all adjustments, consisting of normal recurring accruals, which
management considers necessary for a fair presentation of the financial
position, results of operations, and cash flows.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to Securities and
Exchange Commission rules and regulations. The consolidated financial
statements and footnotes included herein should be read in conjunction
with the Company's annual consolidated financial statements as of
December 31, 1997 and 1996, and for each of the years in the three year
period ended December 31, 1997 included in the Company's Form 10-K.
(2) SECURITIES
----------
The amortized cost (carrying value) and approximate market values of
securities held-to-maturity at September 30, 1998, are summarized as
follows (in thousands of dollars):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------- ------------- -------------- --------------
U.S. Treasury $ 7,020 20 -- 7,040
U.S. Government agencies 3,083 20 -- 3,103
State and municipal 40,563 1,001 (20) 41,544
Mortgage-backed securities
and collateralized mortgage
obligations 14,289 151 (2) 14,438
------------- ------------- -------------- --------------
$ 64,955 1,192 (22) 66,125
------------- ------------- -------------- --------------
The amortized cost and approximate market values (carrying value) of
securities available- for-sale at September 30, 1998, are summarized as
follows (in thousands of dollars):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------- ------------- -------------- --------------
U.S. Treasury $ 49,673 825 -- 50,498
U.S. Government agencies 17,465 80 (1) 17,544
Mortgage-backed securities
and collateralized mortgage
obligations 64,913 279 (343) 64,849
Other 367 -- -- 367
------------- ------------- -------------- --------------
$ 132,418 1,184 (344) 133,258
------------- ------------- -------------- --------------
6
HENDERSON CITIZENS BANCSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1998
(3) LOANS AND ALLOWANCE FOR LOAN LOSSES
-----------------------------------
The composition of the Company's loan portfolio is as follows (in thousands
of dollars):
September 30, December 31,
1998 1997
------------------ -----------------
Commercial and industrial $ 30,848 28,195
Real estate mortgage 60,717 49,979
Installment and other 30,473 29,832
------------------ -----------------
Total 122,038 108,006
Less:
Allowance for loan losses (1,535) (1,249)
Unearned discount (463) (696)
------------------ -----------------
Loans, net $ 120,040 106,061
================== =================
Changes in the allowance for loan losses for the nine months ended
September 30, 1998 and 1997 are summarized as follows (in thousands of
dollars):
1998 1997
------------------ -----------------
Balance, January 1 $ 1,249 1,146
Provision charged to operating expense 458 253
Loans charged off (328) (261)
Recoveries on loans 156 88
------------------ -----------------
Balance, September 30 $ 1,535 1,226
================== =================
(4) TOTAL COMPREHENSIVE INCOME
--------------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income". SFAS 130 requires that an entity include in total comprehensive
income certain amounts that were previously recorded directly in
stockholders' equity. For the nine-month periods ended September 30, 1998
and 1997, other comprehensive income amounts included in total
comprehensive income consisted only of net unrealized gains (losses) on
securities available for sale, net of income taxes. Total comprehensive
income for the nine-month periods ended September 30, 1998 and 1997, were
$3,645,000 and $2,684,000, respectively and for the three-month periods
ended September 30, 1998 and 1997, were $1,493,000 and 1,234,000,
respectively.
7
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF HENDERSON CITIZENS BANCSHARES, INC.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
The following discussion and analysis of the financial condition and results of
operations of the Company and its primary bank subsidiary, Citizens National
Bank, Henderson, Texas, should be read in conjunction with the consolidated
financial statements and the notes thereto, and other financial and statistical
information appearing elsewhere in this report.
Results of Operations
- ---------------------
Net income for the first nine months of 1998 increased to $2,756,000 compared to
$2,423,000 for the same period in 1997. The increase was primarily caused by an
increase in non-interest income. During the first nine months of 1998, net
interest income increased slightly due to increased loan demand although loan
and deposit interest rates generally remained unchanged. The Company made a
provision of $458,000 to the allowance for loan losses during the first nine
months of 1998. A provision of $253,000 was made for loan losses during the
same period in 1997. The Company experienced a gain on securities transactions
totaling approximately $282,000 in the first nine months of 1998 compared to
losses of $37,000 in the first nine months of 1997. Other income, excluding
gains on securities transactions, for the first nine months of 1998 was
$3,232,000 compared to $2,094,000 for the same period in 1997 due primarily to
an increase in insufficient funds fee income as a result of the initiation of a
new deposit program in March 1998 and the establishment of a trust office in
Corsicana, Texas in March 1997. Total other expenses for the first nine months
of 1998 were $7,651,000 compared to $6,733,000 for the same period in 1997.
Income tax expense for the first nine months of 1998 and 1997 was $744,000 and
$714,000, respectively.
PROPOSED ACQUISITION
- --------------------
In May 1998, the Company agreed to acquire certain assets and assume certain
liabilities of Jefferson National Bank, Jefferson, Texas, for a purchase price
of $6,150,200. The acquisition of Jefferson National Bank will result in an
increase in total assets of the Company of approximately $32,977,000, total
loans of approximately $7,779,000, and total deposits of approximately
$29,599,000, and will be accounted for using the purchase method of accounting.
It is anticipated that the proposed acquisition will be completed, subject to
regulatory approvals, during the fourth quarter of 1998, although no assurance
can be given that the acquisition will be completed or that such timetable will
be met. The acquisition is expected to be funded through internal sources.
MERGER OF FIRST STATE BANK WASKOM
- ---------------------------------
The sole banking office of First State Bank, Waskom, Texas, previously a wholly
owned subsidiary but separate bank charter, is now being operated as a full-
service branch of Citizens National Bank since completion of the merger on July
23, 1998. It is not anticipated that the merger will result in any diminution
of products and services currently available to customers of First State Bank or
Citizens National Bank. It is anticipated, however, that the merger will
generate certain operational efficiencies by operating under one bank charter
rather than two separate charters regulated by different regulatory authorities.
NET INTEREST INCOME
- -------------------
For the nine months ended September 30, 1998, net interest income was $8,095,000
compared to $8,066,000 for the first nine months of 1997. The slight increase is
primarily the result of continued loan growth. Loan and deposit interest rates
generally remained unchanged.
Net interest income for the three-month period ended September 30, 1998 was
relatively unchanged at $2,679,000 compared to $2,690,000 in 1997.
PROVISION FOR LOAN LOSSES
- -------------------------
During the first nine months of 1998, the Company increased its allowance for
loan losses through a provision of $458,000. The Company increased its allowance
for loan losses during the same period of 1997 by $253,000. The increase is
primarily due to an estimate for potential overdraft charge-offs that may result
from the insufficient funds fee program initiated in March 1998.
8
The Company experienced net charge-offs of $172,000 in the first nine months of
1998 compared to net charge-offs of $173,000 in the same period in 1997.
For the three-month period ended September 30, 1998, the Company increased its
allowance through a provision of $165,000. The Company increased its allowance
for loan losses during the same period in 1997 by $83,000.
See additional information related to the Company's loan operations in the
Allowance for Loan Loss section below.
OTHER INCOME AND EXPENSES
- -------------------------
Non-interest income, excluding securities gains/losses, was $3,232,000 for the
first nine months of 1998 as compared to $2,094,000 in the first nine months of
1997. This increase is due to increases in service charges primarily through the
initiation of an insufficient funds fee program in March 1998, as well as an
increase in trust revenues due to the establishment of a trust office in
Corsicana, Texas in March 1997. The Company experienced net gains on securities
transactions for the first nine months of 1998 of $282,000 compared to net
losses on securities transactions for the first nine months of 1997 of $37,000.
Other expenses for the nine-month period ended September 30, 1998 were
$7,651,000 compared to $6,733,000 during the same period in 1997. The increase
in other expenses is due to increases in general salaries and benefits, and
occupancy and equipment due to remodeling of the main bank facility in
Henderson, Texas.
For the three months ended September 30, 1998, non-interest income, excluding
securities losses was $1,133,000 compared to $756,000 for the same period in
1997, with the majority of the increase due to insufficient funds fee income.
The Company experienced net gains on securities transactions in the three months
ended September 30, 1998 of approximately $216,000 compared to net gains on
securities transactions of $27,000 for the three months ended September 30,
1997.
INCOME TAXES
- ------------
Income tax expense for the first nine months of 1998 was $744,000, compared to
$714,000 in the same period in 1997. The effective tax rate for the first nine
months of 1998 and 1997, respectively, was 21.3% and 22.8%. This effective rate
is less than the statutory rate primarily because of tax-free income provided
from state and municipal bonds, leases and obligations. As these tax-free
investments, leases, and obligations mature and are replaced, the effective
income tax rate is expected to increase.
Income tax expense for the three-month periods ended September 30, 1998 and
September 30, 1997 were $262,000 and $252,000 respectively.
FINANCIAL CONDITION
- -------------------
The Company's total assets at September 30, 1998 of $351,892,000 decreased from
the total assets at December 31, 1997 of $358,493,000. Total deposits were
$314,059,000 at September 30, 1998, compared to the December 31, 1997 total of
$322,107,000. These slight decreases are primarily seasonal fluctuations. The
Company's loan portfolio grew 13.2% to $120,040,000 at September 30, 1998, up
from $106,061,000 at December 31, 1997, due to a significant increase in real
estate loans. The increase in real estate loans was primarily due to the
availability of home equity loans combined with the addition of a loan
production office in Corsicana, Texas.
Equity capital of the Company, excluding unrealized gains or losses on
securities available for sale, as a percentage of total assets was 9.9% at
September 30, 1998, compared to 9.2% at December 31, 1997. The risk-based Tier
I and Tier II capital ratios and the leverage ratio of Citizens National Bank
amounted to 23.2%, 24.3%, and 9.7%, respectively at September 30, 1998 compared
to 23.7%, 24.7%, and 9.1%, respectively, at December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At September 30, 1998, the Company's cash and cash equivalents of $21,511,000
decreased slightly from the December 31, 1997 amount of $22,138,000. The
Company's stockholders' equity at September 30, 1998, of $35,397,000 remains at
a level considered to be adequate by management. Profits in excess of dividends
paid to shareholders are reflected in the increase in undivided profits from
1997.
9
ALLOWANCE FOR LOAN LOSSES
- -------------------------
The allowance for loan losses at September 30, 1998 and December 31, 1997 was
1.26% and 1.16% of outstanding loans, respectively. By its nature, the process
through which management determines the appropriate level of the allowance
requires considerable judgment. The determination of the necessary allowance,
and correspondingly the provision for loan losses, involves assumptions about
projections of national and local economic conditions, the composition of the
loan portfolio, and prior loss experience, in addition to other considerations.
As a result, no assurance can be given that future losses will not vary from the
current estimates. However, management believes that the allowance at September
30, 1998 is adequate to cover losses inherent in its loan portfolio. A
migration analysis and an internal classification system for loans also helps
identify potential problems, if any, that are not identified otherwise. From
these analyses, management determines which loans are potential candidates for
nonaccrual status, including impaired loan status, or charge-off. Management
continually reviews loans and classifies them consistent with the Comptroller's
guidelines to help ensure that an adequate allowance is maintained.
The allocation of the allowance for loan losses is based upon the inherent risks
in the various components of the loan portfolio. Amounts allocated to each
component are determined based on management's evaluations of concentrations of
credit risks, current and anticipated economic conditions, historical analyses,
and classification and estimated loss exposure assigned to specific credits.
These reserve allocations are subject to change as various economic conditions
dictate. The following table is an analysis of the Allowance for Loan Losses.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
For the Nine Months Ended
September 30,
1998 1997
--------------- --------------
Balance at beginning of period $ 1,249 1,146
Charge-offs:
Commercial, financial, and agricultural 25 57
Real estate-mortgage -- 1
Installment loans to individuals 303 203
--------------- --------------
328 261
Recoveries:
Commercial, financial, and agricultural 54 41
Installment loans to individuals 102 47
--------------- --------------
156 88
--------------- --------------
Net charge-offs (172) (173)
--------------- --------------
Additions charged to operations 458 253
--------------- --------------
Balance at end of period $ 1,535 1,226
=============== ==============
Ratio of net charge-offs during
the period to average loans outstanding
during the period .14% .16%
=============== ==============
NON ACCRUAL, PAST DUE AND RESTRUCTURED LOANS
- --------------------------------------------
The Company's policy is to discontinue the accrual of interest income on loans
whenever it is determined that reasonable doubt exists with respect to timely
collectibility of interest and principal. Loans are placed on nonaccrual status
if either material deterioration occurs in the financial position of the
borrower, payment in full of interest or principal is not anticipated, payment
in full of interest or principal is past due 90 days or more unless well
secured, payment in full of interest or principal on a loan is past due 180 days
or more, regardless of collateral, or the loan in whole or in part is classified
as doubtful. A loan may remain on accrual status if it is in the process of
collection and is either guaranteed or well secured. When a loan is placed on
nonaccrual status, interest is no longer accrued or included in interest income
and previously accrued income is reversed.
10
The following is a summary of the Company's problem loans as of September 30,
1998 and 1997.
At September 30,
1998 1997
-------------- --------------
(dollars in thousands)
Nonaccrual loans $ 149 88
Restructured loans -- --
Other impaired loans -- --
Other real estate -- 150
-------------- --------------
Total non-performing loans 149 238
============== ==============
Loans past due 90+ days and still accruing 182 44
============== ==============
Other potential problem loans -- --
============== ==============
Income that would have been recorded in
accordance with original terms 7 6
Less income actually recorded -- --
-------------- --------------
Loss of income $ 7 6
============== ==============
CONCENTRATION OF CREDIT RISK
- ----------------------------
The Company grants real estate, commercial, and industrial loans to customers
primarily in Henderson, Texas, and surrounding areas of east Texas. Although the
Company has a diversified loan portfolio, a substantial portion (approximately
49.8% at September 30, 1998) of its loans are secured by real estate and its
ability to fully collect its loans is dependent upon the real estate market in
this region. The Company typically requires collateral sufficient in value to
cover the principal amount of the loan. Such collateral is evidenced by
mortgages on property held and readily accessible to the Company. See
additional information related to the composition of the Company's loan
portfolio included in note 3 to the consolidated financial statements.
NEW EMPLOYEE BENEFIT PLANS
- --------------------------
In June 1998, the Company established a non-qualified deferred compensation plan
and performance and retention plan for certain select management employees of
the Company. Contributions by the Company are at the discretion of the Board of
Directors and generally provide vesting over five years. As of September 30,
1998, no awards have been granted.
SECURITIES
- ----------
The Investment Committee, under the guidance of the Company's Investment Policy,
assesses the short and long-term needs of the Company after consideration of
loan demand, interest rate factors, and prevailing market conditions.
Recommendations for purchases and other transactions are then made considering
safety, liquidity, and maximization of return to the Company. Management
determines the proper classification of securities at the time of purchase.
Securities that management does not intend to hold to maturity or that might be
sold under certain circumstances are classified as available for sale. If
management has the intent and the Company has the ability at the time of
purchase to hold the securities until maturity, the securities will be
classified as held to maturity.
The management strategy for securities is to maintain a very high quality
portfolio with generally short duration. The quality of the portfolio is
maintained with 79% of the total comprised of U.S. Treasury, federal agency
securities, and agency issued mortgage securities. Treasury holdings are
currently positioned in a ladder structure. Three-year treasury bonds are
purchased quarterly, held for two years, then sold with one year left to
maturity to take advantage of the slope in the yield curve. The collateralized
mortgage obligations (CMOs) and mortgage backed securities (MBS) held by the
company are backed by agency collateral which consists of loans issued by the
Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage
Corporation (FNMA), and the Government National Mortgage Association (GNMA) with
a blend of fixed and floating rate coupons.
11
Credit risk is minimized through agency backing, however, there are other risks
associated with MBS and CMOs. These other risks include prepayment, extension,
and interest rate risk. MBS are securities which represent an undivided
interest in a pool of mortgage loans. CMOs are structured obligations that are
derived from a pool of mortgage loans or agency mortgage backed securities.
CMOs in general have widely varying degrees of risk, which results from the
prepayment risk on the underlying mortgage loans and its effect on the cash
flows of the security.
Prepayment risk is the risk of borrowers paying off their loans sooner than
expected in a falling rate environment by either refinancing or curtailment.
Extension risk is the risk that the underlying pool of loans will not exhibit
the expected prepayment speeds thus resulting in a longer average life and
slower cash flows than anticipated at purchase. Interest rate risk is based on
the sensitivity of yields on assets that change in a different time period or in
a different proportion from that of current market interest rates. Changes in
average life due to prepayments and changes in interest rates in general will
cause the market value of MBS and CMOs to fluctuate.
The Company's MBS portfolio consists of fixed rate balloon maturity pools with
short stated final maturities and adjustable rate mortgage (ARM) pools with
coupons that reset annually and have longer maturities. Investments in CMOs
consist mainly of Planned Amortization Classes (PAC), Targeted Amortization
Classes (TAC), and sequential classes. Floating rate securities make up 75% of
the CMO portfolio. Support and liquidity classes with longer average lives and
floating rate coupons are a relatively small portion of the portfolio.
To maximize after-tax income, investments in tax-exempt municipal securities are
utilized but with somewhat longer maturities.
CORPORATE OBJECTIVES
- --------------------
It is the philosophy of the Company to continue to remain independent in
ownership, to foster its image as the community leader in banking, to increase
its market share through selected acquisitions and aggressive marketing, to
maintain a sound earning-asset portfolio, and to assess liquidity needs while
maximizing its profitability and return to its shareholders.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This Statement establishes accounting and reporting
standards for derivative instruments, including certain derivatives embedded in
other contracts, and for hedging activities. It requires that an entity
recognizes all derivatives as either assets or liabilities in the balance sheet
and measures those instruments at fair value. The Statement will be effective
for the Company in the fiscal year ending in 2000. Due to the level of use of
derivatives of the Company, the effect of implementation of this new
pronouncement is not expected to have a significant effect on the financial
position or results of operations of the Company.
In April 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position (SOP) 98-
5, "Reporting on the Costs of Start-Up Activities". SOP 98-5 requires that the
costs of start-up activities, including organizational costs, be expensed as
incurred. SOP 98-5, effective for fiscal years beginning after December 15,
1998, requires initial application to be recorded as of the beginning of the
fiscal year in which the SOP is first adopted and is reported as the cumulative
effect of a change in accounting principle. Although certain capitalized costs
will be effected, the effect of implementation of this new pronouncement is not
expected to have a significant effect on the financial condition or results of
operations of the Company.
YEAR 2000
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The Company recognizes that the arrival of the Year 2000 poses a unique
challenge to the ability of all systems to recognize the date change from
December 31, 1999 to January 1, 2000 and, like other companies, has assessed and
is repairing its computer applications and business processes to provide for
their continued functionality. Efforts to address and resolve this issue are
continuing, including a process of inventory, scoping and analysis,
modification, testing and certification, and implementation. An assessment of
the readiness of external entities with which the Company interfaces, such as
vendors, customers, payment systems, and others, is also ongoing. Currently,
the Company is in the process of developing a contingency plan should its
current Year 2000 plans not be successful and anticipates completion of this
plan in the fourth quarter of 1998.
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A major portion of the costs associated with correcting Year 2000 deficiencies
will be met from existing resources through a reprioritization of technology
development initiatives, with the remainder representing incremental costs. The
Company estimates that it will incur costs for testing of computer applications
and purchases of certain new hardware and software. Certain of these hardware
improvements would have been made regardless of the Year 2000 issues based on
the Company's history of technology upgrades. It is anticipated that the
Company will be Year 2000 compliant by early 1999. The Company does not expect
that the related overall costs of Year 2000 issues will have a significant
effect on the financial condition or results of operations of the Company.
Words or phrases when used in this Form 10-Q or other filings with the
Securities and Exchange Commission, such as "does not expect" and "anticipates",
or similar expressions are intended to identify "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
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Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information related to the market
risk of the Company since December 31, 1997.
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Part II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HENDERSON CITIZENS BANCSHARES, INC.
Date: November 9, 1998 By: /s/ Milton S. McGee, Jr.
---------------- ------------------------------
Milton S. McGee, Jr., CPA
President
Date: November 9, 1998 By: /s/ Rebecca G. Tanner
---------------- ----------------------------
Rebecca G. Tanner, CPA
Chief Accounting Officer
16