Exhibit 13.1
[PORTIONS OF 2004 ANNUAL REPORT TO SHAREHOLDERS]
2004 Annual Report
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Table of Contents
Financial Highlights..........................................................1
Letter to Stockholders........................................................2
Independent Auditor's Report..................................................3
Consolidated Balance Sheets...................................................4
Consolidated Statements of Income.............................................5
Consolidated Statements of Stockholders' Equity...............................6
Consolidated Statements of Cash Flows.........................................7
Notes to Consolidated Financial Statements....................................8
Management's Discussion and Analysis.........................................28
Bank Staff...................................................................46
Board of Directors and Officers..............................................47
Stockholder Information.......................................Inside Back Cover
1
Financial Highlights(1)
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2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
Summary of Operations
Interest income $ 14,656 $ 13,842 $ 14,280 $ 13,717 $ 13,153
Interest expense 4,474 5,637 6,640 7,204 6,785
----------- ----------- ----------- ----------- -----------
Net interest income 10,182 8,205 7,640 6,513 6,368
Provision for credit losses 390 410 441 280 280
Other income 1,607 2,662 1,021 589 435
Other expense 6,943 5,812 4,720 4,092 3,772
Income taxes 1,215 1,306 964 790 687
----------- ----------- ----------- ----------- -----------
Net income $ 3,241 $ 3,339 $ 2,536 $ 1,940 $ 2,064
=========== =========== =========== =========== ===========
Per Share Data
Net income $ 1.89 $ 1.94 $ 1.48 $ 1.13 $ 1.20
Cash dividends declared .60 1.00 .46 .41 .37
Book value 15.23 14.31 13.51 12.27 11.42
Estimated market value(2) 32.00 32.00 32.00 29.00 32.00
Year-end Balance Sheet Summary
Loans, net $ 196,912 $ 176,155 $ 154,190 $ 140,898 $ 133,072
Investment securities 37,909 46,282 44,872 33,452 28,766
Total assets 270,215 263,865 241,283 201,469 180,318
Deposits 231,059 228,219 206,909 179,323 159,590
Stockholders' equity 26,177 24,601 23,230 21,086 19,638
Selected Ratios
Return on average assets 1.23% 1.32% 1.13% 1.02% 1.18%
Return on average equity 12.56% 13.66% 11.40% 9.44% 10.95%
Average equity to average assets 9.76% 9.66% 9.88% 10.85% 10.75%
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1 In thousands of dollars, except per share data.
2 Provided at the trade date nearest year end.
2
Dear Stockholders:
It is our pleasure to present our Annual Financial Report to you.
We ended the year with total assets of $270,214,881, resulting in an increase of
$6,349,953 or 2.41% over the previous year. Our return on assets was 1.23% and
the return on equity was 12.56% as compared to 1.32% and 13.66% for the previous
year. Net earnings were $3,241,468, a decrease of $97,091 or 2.91% compared to
the previous year. Our deposits increased $2,840,196 or 1.24% and net loans
increased $20,757,141 or 11.78%. Please refer to our financial highlights page
and accompanying statements for additional information.
The book value of our stock at year-end was $15.23 and stock trades nearest
year-end were executed at $32.00 per share. Dividends for the year were $0.60
per share.
I am very pleased with our accomplishments in 2004. We opened our new Hillsville
Branch on December 17 and we continue to be extremely grateful for the warm
reception we have received from the Hillsville community. We continued our
efforts to enhance the products and services offered to all our customers
through the addition of ATM machines at our Elk Creek and Troutdale Branches and
through the introduction of home equity lines of credit. We intend to further
these efforts in 2005 as well, with the introduction of an overdraft protection
plan and internet banking with on-line bill paying.
Your bank has grown considerably in recent years and we are very excited about
the future of The Grayson National Bank. We continue to be blessed with great
personnel throughout our organization. I wish to thank our employees for their
dedicated service to the bank, our shareholders and most of all, our customers.
As always, we appreciate your support, welcome your comments and the opportunity
to serve you.
Sincerely,
/s/ Jacky K. Anderson
Jacky K. Anderson
President & CEO
3
Independent Auditor's Report
Board of Directors and Stockholders
Grayson Bankshares, Inc.
Independence, Virginia
We have audited the consolidated balance sheets of Grayson Bankshares, Inc. and
subsidiary as of December 31, 2004 and 2003 and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Grayson Bankshares,
Inc. and subsidiary at December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
/s/ Larrowe & Company, PLC
Galax, Virginia
January 28, 2005
Consolidated Balance Sheets
December 31, 2004 and 2003
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Assets 2004 2003
------------- -------------
Cash and due from banks $ 10,032,399 $ 11,748,140
Federal funds sold 8,833,069 15,305,544
Investment securities available for sale 33,786,785 41,239,131
Investment securities held to maturity
(fair value approximately $2,973,676
in 2004, and $3,997,347 in 2003) 2,975,455 3,960,887
Restricted equity securities 1,147,050 1,081,750
Loans, net of allowance for loan losses of $2,609,759
in 2004 and $2,395,387 in 2003 196,911,871 176,154,730
Cash value of life insurance 4,925,722 4,677,731
Foreclosed assets 65,000 15,000
Property and equipment, net 7,316,750 6,228,192
Accrued income 1,833,728 1,891,116
Other assets 2,387,052 1,562,707
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$ 270,214,881 $ 263,864,928
============= =============
Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest-bearing $ 31,569,179 $ 26,708,360
Interest-bearing 199,490,165 201,510,788
------------- -------------
Total deposits 231,059,344 228,219,148
Short-term debt 2,000,000 --
Long-term debt 10,000,000 10,000,000
Accrued interest payable 253,652 264,640
Other liabilities 724,839 780,344
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244,037,835 239,264,132
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Commitments and contingencies
Stockholders' equity
Preferred stock, $25 par value; 500,000
shares authorized; none issued -- --
Common stock, $1.25 par value; 5,000,000 shares
authorized; 1,718,968 shares issued
in 2004 and 2003, respectively 2,148,710 2,148,710
Surplus 521,625 521,625
Retained earnings 23,797,289 21,587,202
Accumulated other comprehensive income (290,578) 343,259
26,177,046 24,600,796
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$ 270,214,881 $ 263,864,928
============= =============
See Notes to Consolidated Financial Statements
5
Consolidated Statements of Income
Years ended December 31, 2004, 2003 and 2002
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2004 2003 2002
----------- ----------- -----------
Interest income:
Loans and fees on loans $12,787,560 $11,595,816 $11,798,933
Federal funds sold 139,300 245,760 239,255
Investment securities:
Taxable 1,287,584 1,545,643 1,803,674
Exempt from federal income tax 441,532 454,938 438,515
----------- ----------- -----------
14,655,976 13,842,157 14,280,377
----------- ----------- -----------
Interest expense:
Deposits 3,954,159 5,123,483 6,197,872
Interest on borrowings 519,247 513,639 442,067
----------- ----------- -----------
4,473,406 5,637,122 6,639,939
----------- ----------- -----------
Net interest income 10,182,570 8,205,035 7,640,438
Provision for loan losses 390,000 410,000 441,000
----------- ----------- -----------
Net interest income after
provision for loan losses 9,792,570 7,795,035 7,199,438
----------- ----------- -----------
Noninterest income:
Service charges on deposit accounts 549,871 429,135 354,644
Other service charges and fees 506,513 534,537 437,263
Net realized gains on securities 63,004 919,710 3,735
Other income 487,874 778,266 225,659
----------- ----------- -----------
1,607,262 2,661,648 1,021,301
----------- ----------- -----------
Noninterest expense:
Salaries and employee benefits 4,354,566 3,687,447 2,985,573
Occupancy expense 224,656 180,119 127,153
Equipment expense 638,069 501,658 391,390
Foreclosure expense 14,567 -- --
Other expense 1,711,381 1,443,365 1,216,061
----------- ----------- -----------
6,943,239 5,812,589 4,720,177
----------- ----------- -----------
Income before income taxes 4,456,593 4,644,094 3,500,562
Income tax expense 1,215,125 1,305,535 964,103
----------- ----------- -----------
Net income $ 3,241,468 $ 3,338,559 $ 2,536,459
=========== =========== ===========
Basic earnings per share $ 1.89 $ 1.94 $ 1.48
=========== =========== ===========
Weighted average shares outstanding 1,718,968 1,718,968 1,718,968
=========== =========== ===========
See Notes to Consolidated Financial Statements
6
Consolidated Statements of Stockholders' Equity
Years ended December 31, 2004, 2003 and 2002
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Accumulated
Common Stock Other
------------------ Retained Comprehensive
Shares Amount Surplus Earnings Income (Loss) Total
------ ------ ------- -------- ------------- -----
Balance, December 31, 2001 1,718,968 $ 2,148,710 $ 521,625 $ 18,221,877 $ 193,561 $ 21,085,773
Comprehensive income
Net income - - - 2,536,459 - 2,536,459
Net change in unrealized
gain (loss) on investment
securities available for sale,
net of taxes of $203,765 - - - - 400,475 400,475
Reclassification adjustment,
net of income taxes of $1,270 - - - - (2,465) (2,465)
-------------
Total comprehensive income 2,934,469
Dividends paid
($.46 per share) - - - (790,725) - (790,725)
--------- ----------- ---------- ------------- ------------- --------------
Balance, December 31, 2002 1,718,968 2,148,710 521,625 19,967,611 591,571 23,229,517
Comprehensive income
Net income - - - 3,338,559 - 3,338,559
Net change in unrealized
gain (loss) on investment
securities available for sale,
net of taxes of $184,783 - - - - 358,697 358,697
Reclassification adjustment,
net of income taxes of $312,701 - - - - (607,009) (607,009)
-------------
Total comprehensive income 3,090,247
Dividends paid
($1.00 per share) - - - (1,718,968) - (1,718,968)
--- ---- --------- ----------- ---------- ------------- ------------- --------------
Balance, December 31, 2003 1,718,968 2,148,710 521,625 21,587,202 343,259 24,600,796
Comprehensive income
Net income - - - 3,241,468 - 3,241,468
Net change in unrealized
gain (loss) on investment
securities available for sale,
net of taxes of ($305,101) - - - - (592,254) (592,254)
Reclassification adjustment,
net of income taxes of ($21,421) - - - - (41,583) (41,583)
-------------
Total comprehensive income 2,607,631
Dividends paid
($.60 per share) - - - (1,031,381) - (1,031,381)
--- ---- --------- ----------- ---------- ------------- ------------- --------------
Balance, December 31, 2004 1,718,968 $ 2,148,710 $ 521,625 $ 23,797,289 $ (290,578) $ 26,177,046
=== ==== ========= =========== ========== ============= ============= ==============
See Notes to Consolidated Financial Statements
7
Consolidated Statements of Cash Flows
Years ended December 31, 2004, 2003 and 2002
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2004 2003 2002
---------------- --------------- ----------------
Cash flows from operating activities
Net income $ 3,241,468 $ 3,338,559 $ 2,536,459
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization 566,587 409,525 319,320
Provision for loan losses 390,000 410,000 441,000
Deferred income taxes 187,110 (40,580) (108,478)
Net realized gains on securities (63,004) (919,710) (3,735)
Accretion of discount on securities, net of
amortization of premiums 221,135 248,727 131,135
Deferred compensation 8,304 11,475 7,594
Changes in assets and liabilities:
Cash value of life insurance (247,991) (254,313) (224,834)
Accrued income 57,388 (92,210) (85,262)
Other assets (684,933) (527,830) (21,343)
Accrued interest payable (10,988) (64,335) 61,177
Other liabilities (63,809) (46,704) 15,392
---------------- --------------- ----------------
Net cash provided by operating activities 3,601,267 2,472,604 3,068,425
---------------- --------------- ----------------
Cash flows from investing activities
Net (increase) decrease in federal funds sold 6,472,475 4,434,684 (7,104,182)
Activity in available for sale securities:
Purchases (16,552,392) (23,342,538) (20,833,587)
Sales 18,782,690 11,964,172 1,542,321
Maturities 4,083,990 10,547,217 5,651,348
Activity in held to maturity securities:
Purchases - (2,215,694) (92,825)
Maturities 1,005,000 2,168,103 2,808,090
Purchases of restricted equity securities (65,300) (236,300) (19,700)
Net increase in loans (21,147,141) (22,374,725) (13,733,164)
Net increase in foreclosed assets (50,000) (15,000) -
Purchases of property and equipment, net of sales (1,655,145) (2,511,483) (1,531,556)
Purchase of bank-owned life insurance - - (4,000,000)
---------------- --------------- ----------------
Net cash used in investing activities (9,125,823) (21,581,564) (37,313,255)
---------------- --------------- ----------------
Cash flows from financing activities
Net increase in deposits 2,840,196 21,310,624 27,585,542
Dividends paid (1,031,381) (1,718,968) (790,725)
Net increase in short-term debt 2,000,000 - -
Net increase in long-term debt - - 10,000,000
Net cash provided by financing activities 3,808,815 19,591,656 36,794,817
Net increase (decrease) in cash and cash equivalents (1,715,741) 482,696 2,549,987
Cash and cash equivalents, beginning 11,748,140 11,265,444 8,715,457
---------------- --------------- ----------------
Cash and cash equivalents, ending $ 10,032,399 $ 11,748,140 $ 11,265,444
================ =============== ================
Supplemental disclosure of cash flow information
Interest paid $ 4,484,394 $ 5,701,457 $ 6,578,762
================ =============== ================
Taxes paid $ 993,467 $ 1,443,179 $ 1,028,309
================ =============== ================
Supplemental disclosure of noncash investing activities
Effect on equity of change in net unrealized gain $ (633,837) $ (248,312) $ 398,010
================ =============== ================
See Notes to Consolidated Financial Statements
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8
Note 1. Organization and Summary of Significant Accounting Policies
Organization
Grayson Bankshares, Inc. (the Company) was incorporated as a Virginia
corporation on February 3, 1992 to acquire the stock of The Grayson National
Bank (the Bank). The Bank was acquired by the Company on July 1, 1992.
The Grayson National Bank was organized under the laws of the United States in
1900 and currently serves Grayson County, Virginia and surrounding areas through
eight banking offices. As an FDIC insured, National Banking Association, the
Bank is subject to regulation by the Comptroller of the Currency. The Company is
regulated by the Federal Reserve.
The accounting and reporting policies of the Company and the Bank follow
generally accepted accounting principles and general practices within the
financial services industry. Following is a summary of the more significant
policies.
Critical accounting policies
The notes to our audited consolidated financial statements for the year ended
December 31, 2004 included herein, contain a summary of our significant
accounting policies. We believe our policies with respect to the methodology for
our determination of the allowance for loan losses, and asset impairment
judgments involve a higher degree of complexity and require management to make
difficult and subjective judgments which often require assumptions or estimates
about highly uncertain matters. Changes in these judgments, assumptions or
estimates could cause reported results to differ materially. These critical
policies and their application are periodically reviewed with the Audit
Committee and our Board of Directors.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
the Bank, which is wholly owned. All significant, intercompany transactions and
balances have been eliminated in consolidation.
Business Segments
The Company reports its activities as a single business segment. In determining
the appropriateness of segment definition, the Company considers components of
the business about which financial information is available and regularly
evaluated relative to resource allocation and performance assessment.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles 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.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowances for loan and
foreclosed real estate losses, management obtains independent appraisals for
significant properties.
Substantially all of the Bank's loan portfolio consists of loans in its market
area. Accordingly, the ultimate collectibility of a substantial portion of the
Bank's loan portfolio and the recovery of a substantial portion of the carrying
amount of foreclosed real estate are susceptible to changes in local market
conditions. The regional economy is diverse, but influenced to an extent by the
manufacturing and agricultural segments.
9
Note 1. Organization and Summary of Significant Accounting Policies, continued
Use of Estimates, continued
While management uses available information to recognize loan and foreclosed
real estate losses, future additions to the allowances may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as a
part of their routine examination process, periodically review the Bank's
allowances for loan and foreclosed real estate losses. Such agencies may require
the Bank to recognize additions to the allowances based on their judgments about
information available to them at the time of their examinations. Because of
these factors, it is reasonably possible that the allowances for loan and
foreclosed real estate losses may change materially in the near term.
Cash and Cash Equivalents
For the purpose of presentation in the consolidated statements of cash flows,
cash and cash equivalents are defined as those amounts included in the balance
sheet caption "cash and due from banks."
Trading Securities
The Company does not hold securities for short-term resale and therefore does
not maintain a trading securities portfolio.
Securities Held to Maturity
Bonds, notes, and debentures for which the Company has the positive intent and
ability to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest method over
the period to maturity or to call dates.
Securities Available for Sale
Available for sale securities are reported at fair value and consist of bonds,
notes, debentures, and certain equity securities not classified as trading
securities or as held to maturity securities.
Unrealized holding gains and losses, net of tax, on available for sale
securities are reported as a net amount in a separate component of shareholders'
equity. Realized gains and losses on the sale of available for sale securities
are determined using the specific-identification method. Premiums and discounts
are recognized in interest income using the interest method over the period to
maturity or to call dates.
Declines in the fair value of individual held to maturity and available for sale
securities below cost that are other than temporary are reflected as write-downs
of the individual securities to fair value. Related write-downs are included in
earnings as realized losses.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance by charges to
income. The Company had no loans held for sale at December 31, 2004 or during
the three year period then ended.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal amount adjusted for any charge-offs and the allowance for
loan losses. Loan origination fees and costs, are not capitalized and recognized
as an adjustment to the yield on the related loan as such deferrals are not
material to the Company's financial position or results of operations.
10
Note 1. Organization and Summary of Significant Accounting Policies, continued
Loans Receivable, continued
Interest is accrued and credited to income based on the principal amount
outstanding. The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received. When facts and circumstances indicate the borrower has
regained the ability to meet the required payments, the loan is returned to
accrual status. Past due status of loans is determined based on contractual
terms.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management believes the uncollectability
of a loan balance, or portion there of, is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and events, it
is probable that the Bank will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for all loans by either the present value of
expected future cash flows discounted at the loan's effective interest rate, the
loan's obtainable market price, or the fair value of the collateral if the loan
is collateral dependent.
Property and Equipment
Land is carried at cost. Bank premises, furniture and equipment, and leasehold
improvements are carried at cost, less accumulated depreciation and amortization
computed principally by the straight-line method over the following estimated
useful lives:
Years
-----
Buildings and improvements 10-40
Furniture and equipment 5-12
Foreclosed Assets
Real estate properties acquired through, or in lieu of, loan foreclosure are to
be sold and are initially recorded at fair value less anticipated cost to sell
at the date of foreclosure establishing a new cost basis. After foreclosure,
valuations are periodically performed by management and the real estate is
carried at the lower of carrying amount or fair value less cost to sell. Revenue
and expenses from operations and changes in the valuation allowance are included
in loss on foreclosed real estate. The historical average holding period for
such properties is less than six months.
11
Note 1. Organization and Summary of Significant Accounting Policies, continued
Pension Plan
The Bank maintains a noncontributory defined benefit pension plan covering all
employees who meet eligibility requirements. To be eligible, an employee must be
21 years of age and have completed one year of service. Plan benefits are based
on final average compensation and years of service. The funding policy is to
contribute the maximum deductible for federal income tax purposes.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the
assets has been surrendered. Control over transferred assets is deemed to be
surrendered when (1) the assets have been isolated from the Bank, (2) the
transferee obtains the right (free of conditions that constrain it from taking
advantage of that right) to pledge or exchange the transferred assets, and (3)
the Bank does not maintain effective control over the transferred assets through
an agreement to repurchase them before their maturity.
Income Taxes
Provision for income taxes is based on amounts reported in the statements of
income (after exclusion of non-taxable income such as interest on state and
municipal securities) and consists of taxes currently due plus deferred taxes on
temporary differences in the recognition of income and expense for tax and
financial statement purposes. Deferred tax assets and liabilities are included
in the financial statements at currently enacted 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 taxes
assets and liabilities are adjusted through the provision for income taxes.
Deferred income tax liability relating to unrealized appreciation (or the
deferred tax asset in the case of unrealized depreciation) on investment
securities available for sale is recorded in other liabilities (assets). Such
unrealized appreciation or depreciation is recorded as an adjustment to equity
in the financial statements and not included in income determination until
realized. Accordingly, the resulting deferred income tax liability or asset is
also recorded as an adjustment to equity.
Basic Earnings per Share
Basic earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding during
the period, after giving retroactive effect to stock splits and dividends.
Diluted Earnings per Share
The computation of diluted earnings per share is similar to the computation of
basic earnings per share except that the denominator is increased to include the
number of additional common shares that would have been outstanding if dilutive
potential common shares had been issued. The numerator is adjusted for any
changes in income or loss that would result from the assumed conversion of those
potential common shares. For the years presented, the Company has no potentially
dilutive securities outstanding.
Comprehensive Income
Annual comprehensive income reflects the change in the Company's equity during
the year arising from transactions and events other than investments by and
distributions to shareholders. It consists of net income plus certain other
changes in assets and liabilities that are reported as separate components of
shareholders' equity rather than as income or expense.
12
Note 1. Organization and Summary of Significant Accounting Policies, continued
Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Company has entered into commitments to
extend credit, including commitments under line of credit arrangements,
commercial letters of credit, and standby letters of credit. Such financial
instruments are recorded when they are funded.
Derivative Financial Instruments and Change in Accounting Principle
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." This Statement requires that all derivatives be recognized as
assets or liabilities in the balance sheet and measured at fair value.
Interest Rate Swap Agreements
For asset/liability management purposes, the Corporation uses interest rate swap
agreements to hedge various exposures or to modify interest rate characteristics
of various balance sheet accounts. Such derivatives are used as part of the
asset/liability management process and are linked to specific assets or
liabilities, and have high correlation between the contract and the underlying
item being hedged, both at inception and throughout the hedge period.
The Company utilizes interest rate swap agreements to convert a portion of its
variable-rate debt to fixed rate (cash flow hedge), and to convert a portion of
its fixed-rate loans to a variable rate (fair value hedge). Interest rate swaps
are contracts in which a series of interest rate flows are exchanged over a
prescribed period. The notional amount on which the interest payments are based
is not exchanged.
Under SFAS No. 133, the gain or loss on all derivatives designated and
qualifying as a fair value hedging instrument, as well as the offsetting gain or
loss on the hedged item attributable to the risk being hedged, is recognized
currently in earnings in the same accounting period. The effective portion of
the gain or loss on a derivative designated and qualifying as a cash flow
hedging instrument is initially reported as a component of other comprehensive
income and subsequently reclassified into earnings in the same period or periods
during which the hedged transaction affects earnings. The ineffective portion of
the gain or loss on the derivative instrument, if any, is recognized currently
in earnings.
Interest rate derivative financial instruments receive hedge accounting
treatment only if they are designated as a hedge and are expected to be, and
are, effective in substantially reducing interest rate risk arising from the
assets and liabilities identified as exposing the Company to risk. Those
derivative financial instruments that do not meet the hedging criteria discussed
below would be classified as trading activities and would be recorded at fair
value with changes in fair value recorded in income. Derivative hedge contracts
must meet specific effectiveness tests (i.e., over time the change in their fair
values due to the designated hedge risk must be within 80 to 125 percent of the
opposite change in the fair values of the hedged assets or liabilities). Changes
in fair value of the derivative financial instruments must be effective at
offsetting changes in the fair value of the hedged items due to the designated
hedge risk during the term of the hedge. Further, if the underlying financial
instrument differs from the hedged asset or liability, there must be a clear
economic relationship between the prices of the two financial instruments. If
periodic assessment indicated derivatives no longer provide an effective hedge,
the derivatives contracts would be closed out and settled or classified as a
trading activity.
Beginning January 1, 2001, in accordance with SFAS No. 133, hedges of
variable-rate debt are accounted for as cash flow hedges, with changes in fair
value recorded in derivative assets or liabilities and other comprehensive
income. The net settlement (upon close out or termination) that offsets changes
in the value of the hedged debt is deferred and amortized into net interest
income over the life of the hedged debt. Hedges of fixed-rate loans are
accounted for as fair value hedges, with changes in fair value recorded in
derivative assets or liabilities and loan interest income. The net settlement
(upon close out or termination) that offsets changes in the value of the loans
adjusts the basis of the loans and is deferred and amortized to loan interest
income over the life of the loans. The portion, if any, of the net settlement
amount that did not offset changes in the value of the hedged asset or liability
is recognized immediately in non-interest income.
13
Note 1. Organization and Summary of Significant Accounting Policies, continued
Interest Rate Swap Agreements, continued
Cash flow resulting from the derivative financial instruments that are accounted
for as hedges of assets and liabilities are classified in the cash flow
statement in the same category as the cash flows of the items being hedged.
Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate their fair values.
Interest-bearing deposits with banks: Fair values for time deposits are
estimated using a discounted cash flow analysis that applies interest rates
currently being offered on certificates to a schedule of aggregated contractual
maturities on such time deposits.
Available-for-sale and held-to-maturity securities: Fair values for securities,
excluding restricted equity securities, are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments. The carrying values of
restricted equity securities approximate fair values.
Loans receivable: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying amounts.
The fair values for other loans are estimated using discounted cash flow
analysis, based on interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. Loan fair value estimates include
judgments regarding future expected loss experience and risk characteristics.
Fair values for impaired loans are estimated using discounted cash flow analysis
or underlying collateral values, where applicable. The carrying amount of
accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values disclosed for demand and savings deposits
are, by definition, equal to the amount payable on demand at the reporting date.
The fair values for certificates of deposit are estimated using a discounted
cash flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated contractual maturities on such time
deposits. The carrying amount of accrued interest payable approximates fair
value.
Short-term debt: The carrying amounts of short-term debt approximate their fair
values.
Long-term debt: The fair value of long-term debt is estimated using a discounted
cash flow calculation that applies interest rates currently available on similar
instruments.
Other liabilities: For fixed-rate loan commitments, fair value considers the
difference between current levels of interest rates and the committed rates. The
carrying amounts of other liabilities approximates fair value.
14
Note 1. Organization and Summary of Significant Accounting Policies, continued
Fair Value of Financial Instruments, continued
Derivatives: The fair value of derivatives is determined by comparing current
market prices for similar contracts with contracts entered by the Company.
Reclassification
Certain reclassifications have been made to the prior years' financial
statements to place them on a comparable basis with the current presentation.
Net income and stockholders' equity previously reported were not affected by
these reclassifications.
Advertising Expense
The Company expenses advertising costs as they are incurred. Advertising expense
for the years presented are not material.
Note 2. Restrictions on Cash
To comply with banking regulations, the Bank is required to maintain certain
average cash reserve balances. The daily average cash reserve requirement was
approximately $1,010,000 and $797,000 for the periods including December 31,
2004 and 2003, respectively.
Note 3. Investment Securities
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at December 31 follow:
Amortized Unrealized Unrealized Fair
2004 Cost Gains Losses Value
- ---- --------------- ---------------- --------------- --------------
Available for sale:
U.S. Government agency securities $ 17,173,436 $ 6,798 $ 653,282 $ 16,526,952
Mortgage-backed securities 5,343,481 49,460 13,541 5,379,400
State and municipal securities 7,855,015 138,263 36,427 7,956,851
Corporate securities 3,855,121 70,211 1,750 3,923,582
--------------- ---------------- --------------- --------------
$ 34,227,053 $ 264,732 $ 705,000 $ 33,786,785
=============== ================ =============== ==============
Held to maturity:
State and municipal securities $ 2,975,455 $ 43,198 $ 44,977 $ 2,973,676
=============== ================ =============== ==============
2003
Available for sale:
U.S. Government agency securities $ 14,157,022 $ 66,517 $ 251,086 $ 13,972,453
Mortgage-backed securities 2,813,419 74,623 - 2,888,042
State and municipal securities 11,842,245 399,916 28,093 12,214,068
Corporate securities 11,906,355 297,818 39,605 12,164,568
--------------- ---------------- --------------- --------------
$ 40,719,041 $ 838,874 $ 318,784 $ 41,239,131
=============== ================ =============== ==============
Held to maturity:
State and municipal securities $ 3,960,887 $ 69,110 $ 32,650 $ 3,997,347
=============== ================ =============== ==============
There were no securities transferred between the available for sale and held to
maturity portfolios during 2004, 2003 or 2002.
15
Note 3. Investment Securities, continued
Restricted equity securities were $1,147,050 and $1,081,750 at December 31, 2004
and 2003, respectively. Restricted equity securities consist of investments in
stock of the Federal Home Loan Bank of Atlanta ("FHLB"), Community Bankers Bank,
and the Federal Reserve Bank of Richmond, all of which are carried at cost. All
of these entities are upstream correspondents of the Bank. The FHLB requires
financial institutions to make equity investments in the FHLB in order to borrow
money. The Bank is required to hold that stock so long as it borrows from the
FHLB. The Federal Reserve requires Banks to purchase stock as a condition for
membership in the Federal Reserve system. The Bank's stock in The Bankers Bank
is restricted only in the fact that the stock may only be repurchased by The
Bankers Bank.
The following table details unrealized losses and related fair values in the
Bank's held to maturity and available for sale investment securities portfolios.
This information is aggregated by the length of time that individual securities
have been in a continuous unrealized loss position as of December 31, 2004.
Less Than 12 Months 12 Months or More Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ---------- ----------- ---------- ----------- -----------
U.S. Government agency securities $13,466,631 $ 156,223 $ 1,731,700 $ 510,600 $15,198,331 $ 666,823
State and municipal securities 3,894,918 48,065 637,222 33,339 4,532,140 81,404
Other securities 198,250 1,750 - - 198,250 1,750
----------- ---------- ----------- ---------- ----------- -----------
Total temporarily impaired securities $17,559,799 $ 206,038 $ 2,368,922 $ 543,939 $19,928,721 $ 749,977
=========== ========== =========== ========== =========== ===========
Management considers the nature of the investment, the underlying causes of the
decline in market value, the severity and duration of the decline in market
value and other evidence, on a security by security basis, in determining if the
decline in market value is other than temporary. Management believes all
unrealized losses presented in the table above to be temporary in nature.
Investment securities with amortized cost of approximately $2,582,000 and
$1,628,000 at December 31, 2004 and 2003, respectively, were pledged as
collateral on public deposits and for other purposes as required or permitted by
law.
Gross realized gains and losses for the years ended December 31, 2004, 2003 and
2002 are as follows:
2004 2003 2002
-------- -------- --------
Realized gains $189,668 $919,710 $ 59,037
Realized losses 126,664 -- (55,302)
-------- -------- --------
$ 63,004 $919,710 $ 3,735
======== ======== ========
The scheduled maturities of securities available for sale and securities held to
maturity at December 31, 2004, were as follows:
Available for Sale Held to Maturity
--------------------------------- ---------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------------- ---------------- --------------- ----------------
Due in one year or less $ 2,118,524 $ 2,157,184 $ 25,000 $ 25,010
Due after one year through five years 3,047,596 3,147,974 - -
Due after five years through ten years 10,470,638 10,520,500 1,279,635 1,301,653
Due after ten years 18,590,295 17,961,127 1,670,820 1,647,013
--------------- ---------------- --------------- ----------------
$ 34,227,053 $ 33,786,785 $ 2,975,455 $ 2,973,676
=============== ================ =============== ================
Maturities of mortgage backed securities are based on contractual amounts.
Actual maturity will vary as loans underlying the securities are prepaid.
16
Note 4. Loans Receivable
The major components of loans in the consolidated balance sheets at December 31,
2004 and 2003 are as follows (in thousands):
2004 2003
--------- ---------
Commercial $ 17,603 $ 15,093
Real estate:
Construction and land development 19,454 14,530
Residential, 1-4 families 94,655 83,824
Residential, 5 or more families 692 321
Farmland 18,387 15,640
Nonfarm, nonresidential 31,485 31,902
Agricultural 2,891 3,152
Consumer 13,657 13,040
Other 698 1,048
--------- ---------
199,522 178,550
Allowance for loan losses (2,610) (2,395)
--------- ---------
$ 196,912 $ 176,155
========= =========
Note 5. Allowance for Loan Losses
An analysis of the allowance for loan losses as of December 31 follows:
2004 2003 2002
----------- ----------- -----------
Balance, beginning $ 2,395,387 $ 2,189,028 $ 1,821,966
Provision charged to expense 390,000 410,000 441,000
Recoveries of amounts charged off 100,861 103,782 190,065
Amounts charged off (276,489) (307,423) (264,003)
----------- ----------- -----------
Balance, ending $ 2,609,759 $ 2,395,387 $ 2,189,028
=========== =========== ===========
The following is a summary of information pertaining to impaired loans at
December 31:
2004 2003
---------- ----------
Impaired loans without a valuation allowance $ 881,753 $3,118,002
Impaired loans with a valuation allowance 478,712 641,779
---------- ----------
Total impaired loans $1,360,465 $3,759,781
========== ==========
Valuation allowance related to impaired loans $ 72,162 $ 144,629
========== ==========
Nonaccrual loans and loans past due 90 days or more at December 31, 2004 were
approximately $690,000 and $635,000, respectively. At December 31, 2003, those
amounts were approximately $1,435,000 and $2,119,000, respectively.
Substantially all of these loans are included in impaired loans for both years.
17
Note 5. Allowance for Loan Losses, continued
The average annual recorded investment in impaired loans and interest income
recognized on impaired loans for the years ended December 31, 2004, 2003 and
2002 (all approximate) is summarized below:
2004 2003 2002
---------------- --------------- ----------------
Average investment in impaired loans $ 2,091,011 $ 2,116,478 $ 1,496,239
================ =============== ================
Interest income recognized on impaired loans $ 55,157 $ 193,635 $ 154,810
================ =============== ================
Interest income recognized on a cash basis on impaired loans $ 48,973 $ 109,711 $ 82,391
================ =============== ================
No additional funds are committed to be advanced in connection with impaired
loans.
Note 6. Property and Equipment
Components of property and equipment and total accumulated depreciation at
December 31, 2004 and 2003, are as follows:
2004 2003
------------ ------------
Land $ 1,311,314 $ 1,226,339
Buildings and improvements 4,876,164 3,920,221
Furniture and equipment 4,329,694 3,715,468
------------ ------------
10,517,172 8,862,028
Less accumulated depreciation (3,200,422) (2,633,836)
------------ ------------
$ 7,316,750 $ 6,228,192
============ ============
Note 7. Cash Value of Life Insurance
The Bank is owner and beneficiary of life insurance policies on certain
employees and directors. Policy cash values totaled $4,925,722 and $4,677,731 at
December 31, 2004 and 2003, respectively.
Note 8. Deposits
The aggregate amount of time deposits in denominations of $100,000 or more at
December 31, 2004 and 2003 was $36,668,682 and $34,695,733, respectively. At
December 31, 2004, the scheduled maturities of time deposits are as follows:
Three months or less $ 26,783,085
Over three months through twelve months 66,775,438
Over one year through three years 26,573,676
Over three years 6,515,957
---------------
$ 126,648,156
===============
Note 9. Short-Term Debt
The Bank has established unsecured lines of credit with correspondent banks
totaling approximately $9,000,000 and a secured line of credit with the Federal
Home Loan Bank of Atlanta of approximately $30,336,000. At December 31, 2004 the
amount outstanding under the line of credit with the Federal Home Loan Bank of
Atlanta was $2,000,000. The interest rate on this advance varies daily based
upon the federal funds rate plus approximately 25 basis points. The rate on
December 31, 2004 was 2.44%. The weighted average rate was 2.33% and the highest
amount outstanding at any month-end was $5,000,000 during 2004. There were no
amounts outstanding under these agreements during the years ended December 31,
2003 and 2002.
18
Note 10. Long-Term Debt
The Bank's long-term debt consists of $10,000,000 borrowed from the Federal Home
Loan Bank of Atlanta. The loan matures on January 17, 2012 and is secured by
substantially all first mortgage one-to-four family residential loans. Interest
on the loan is fixed at 4.56% until January 17, 2007 at which time the interest
rate is convertible, at the option of the Federal Home Loan Bank, to a variable
rate equal to the three-month LIBOR rate. If converted, the Bank has the option
to prepay the debt without penalty.
Note 11. Financial Instruments
Fair Values
The estimated fair values of the Company's financial instruments are as follows
(dollars in thousands):
December 31, 2004 December 31, 2003
--------------------------------- ---------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------- ---------------- --------------- ----------------
Financial assets
Cash and cash equivalents $ 10,032 $ 10,032 $ 11,748 $ 11,748
Federal funds sold 8,833 8,833 15,306 15,306
Securities, available for sale 33,787 33,787 41,239 41,239
Securities, held to maturity 2,975 2,974 3,961 3,997
Restricted equity securities 1,147 1,147 1,082 1,082
Loans, net of allowance for credit losses 196,912 197,084 176,155 175,327
Financial liabilities
Deposits 231,059 230,675 228,219 228,845
Short-term debt 2,000 2,000 - -
Long-term debt 10,000 10,157 10,000 10,312
Off-balance-sheet assets (liabilities)
Commitments to extend credit and
standby letters of credit - - - -
Derivate financial instruments - - - -
Interest Swap Agreement
During 2004, in order to better manage interest rate risk, the Bank entered into
an agreement whereby the interest expense on variable rate debt totaling
$5,000,000 was swapped for a fixed rate of interest expense. Due to a change in
long-term interest rates, the Bank terminated the swap agreement and repaid the
related debt during the year. As a result, the Bank recognized a gain of
approximately $203,750 that is included in other income for the year ended
December 31, 2004.
19
Note 12. Employee Benefit Plan
The Bank has a qualified noncontributory defined benefit pension plan which
covers substantially all of its employees. The benefits are primarily based on
years of service and earnings. The following is a summary of the plan's funded
status as of December 31, 2004 and 2003.
2004 2003
----------- -----------
Change in benefit obligation
Benefit obligation at beginning of year $ 3,708,775 $ 3,116,886
Service cost 221,173 173,885
Interest cost 241,070 218,182
Actuarial (gain) loss 684,106 460,742
Benefits paid (142,394) (260,920)
----------- -----------
Benefit obligation at end of year $ 4,712,730 $ 3,708,775
=========== ===========
Change in plan assets
Fair value of plan assets at beginning of year $ 2,086,716 $ 1,830,770
Actual return on plan assets 241,484 258,803
Employer contribution 1,018,751 258,063
Benefits paid (142,394) (260,920)
----------- -----------
Fair value of plan assets at end of year $ 3,204,557 $ 2,086,716
=========== ===========
Change in prepaid (accrued) benefit cost
Prepaid (accrued) benefit cost, beginning $ (109,357) $ (90,249)
Contributions 1,018,751 258,063
Pension cost (347,589) (277,171)
----------- -----------
Prepaid (accrued) benefit cost, ending $ 561,805 $ (109,357)
=========== ===========
Funded status $(1,508,173) $(1,622,059)
Unrecognized transitional net assets (168) (203)
Unrecognized prior service costs 50,322 60,386
Unrecognized net actuarial loss 2,019,824 1,452,519
----------- -----------
Prepaid (accrued) benefit cost $ 561,805 $ (109,357)
=========== ===========
Additional disclosure information
Accumulated benefit obligation $ 2,521,489 $ 2,034,649
Vested benefit obligation $ 1,894,769 $ 1,975,682
Discount rate 6.0% 6.5%
Expected return on plan assets 8.5% 8.5%
Rate of compensation increase 5.0% 5.0%
Average remaining service (years) 18 18
2004 2003 2002
--------- --------- ---------
Components of net periodic benefit cost
Service cost $ 221,173 $ 173,885 $ 132,227
Interest cost 241,070 218,182 185,457
Return on plan assets (241,484) (258,803) 116,096
Originating unrecognized asset gain (loss) 56,710 85,998 (279,703)
Recognized net actuarial (gain) loss 60,091 47,880 18,040
Amortization 10,029 10,029 10,029
--------- --------- ---------
Net periodic benefit cost $ 347,589 $ 277,171 $ 182,146
========= ========= =========
20
Note 12. Employee Benefit Plan, continued
Estimated Future Benefit Payments
Pension
Benefits
---- ---------------
2005 $ -
2006 18,074
2007 18,504
2008 61,575
2009 70,206
2010 - 2014 789,252
---- ---------------
$ 957,611
===============
Funding Policy
It is Bank policy to contribute the maximum tax-deductible amount each year as
determined by the plan administrator. Based on current information, it is
anticipated the 2004 contribution will be approximately $371,681 and pension
cost will be approximately $405,793.
Long-Term Rate of Return
The plan sponsor selects the expected long-term rate-of-return-on-assets
assumption in consultation with their investment advisors and actuary, and with
concurrence from their auditors. This rate is intended to reflect the average
rate of earnings expected to be earned on the funds invested or to be invested
to provide plan benefits. Historical performance is reviewed - especially with
respect to real rates of return (net of inflation) - for the major asset classes
held, or anticipated to be held by the trust, and for the trust itself. Undue
weight is not given to recent experience - that may not continue over the
measurement period - with higher significance placed on current forecasts of
future long-term economic conditions.
Because assets are held in a qualified trust, anticipated returns are not
reduced for taxes. Further - solely for this purpose the plan is assumed to
continue in force and not terminate during the period during which the assets
are invested. However, consideration is given to the potential impact of current
and future investment policy, cash flow into and out of the trust, and expenses
(both investment and non-investment) typically paid from plan assets (to the
extent such expenses are not explicitly estimated within periodic cost).
Asset Allocation
The pension plan's weighted-average asset allocations at September 30, 2004 and
2003 (the latest dates available), by asset category are as follows:
2004 2003
---- ----
Mutual funds - fixed income 41% 48%
Mutual funds - equity 55% 52%
Other 4% 0%
---- ----
Total 100% 100%
==== ====
21
Note 12. Employee Benefit Plan, continued
Asset Allocation, continued
The trust fund is sufficiently diversified to maintain a reasonable level of
risk without imprudently sacrificing return, with a targeted asset allocation of
50% fixed income and 50% equities. The Investment Manager selects investment
fund managers with demonstrated experience and expertise, and funds with
demonstrated historical performance, for the implementation of the Plan's
investment strategy. The Investment Manager will consider both actively and
passively managed investment strategies and will allocate funds across the asset
classes to develop an efficient investment structure.
It is the responsibility of the Trustee to administer the investments of the
Trust within reasonable costs, being careful to avoid sacrificing quality. These
costs include, but are not limited to, management and custodial fees, consulting
fees, transaction costs and other administrative costs chargeable to the Trust.
Note 13. Deferred Compensation and Life Insurance
Deferred compensation plans have been adopted for certain members of the Board
of Directors for future compensation upon retirement. Under plan provisions
aggregate annual payments ranging from $1,992 to $61,044 are payable for ten
years certain, generally beginning at age 65. Reduced benefits apply in cases of
early retirement or death prior to the benefit date, as defined. Liability
accrued for compensation deferred under the plan amounts to $535,336 and
$527,032 at December 31, 2004 and 2003, respectively. Expense charged against
income was $50,400, $53,571 and $55,456 in 2004, 2003 and 2002, respectively.
Charges to income are based on changes in present value of future cash payments,
discounted at 8%.
Note 14. Income Taxes
Current and Deferred Income Tax Components
The components of income tax expense (substantially all Federal) are as follows:
2004 2003 2002
----------- ----------- -----------
Current $ 1,028,015 $ 1,346,115 $ 1,072,581
Deferred 187,110 (40,580) (108,478)
----------- ----------- -----------
$ 1,215,125 $ 1,305,535 $ 964,103
=========== =========== ===========
Rate Reconciliation
A reconciliation of income tax expense computed at the statutory federal income
tax rate to income tax expense included in the statements of income follows:
2004 2003 2002
----------- ----------- -----------
Tax at statutory federal rate $ 1,515,242 $ 1,578,992 $ 1,190,191
Tax exempt interest income (251,545) (236,015) (195,153)
State income tax, net of federal benefit 8,840 12,716 11,951
Other (57,412) (50,158) (42,886)
----------- ----------- -----------
$ 1,215,125 $ 1,305,535 $ 964,103
=========== =========== ===========
22
Note 14. Income Taxes, continued
Deferred Income Tax Analysis
The significant components of net deferred tax assets (substantially all
Federal) at December 31, 2004 and 2003 are summarized as follows:
2004 2003
---------- ----------
Deferred tax assets
Allowance for loan losses $ 806,836 $ 726,874
Unearned credit life insurance 24,783 24,741
Deferred compensation and
accrued pension costs -- 216,372
Net unrealized losses on
securities available for sale 154,384 --
Other 34,216 36,240
---------- ----------
1,020,219 1,004,227
Deferred tax liabilities
Deferred compensation and
accrued pension costs 9,000 --
Net unrealized gains on
securities available for sale -- 176,830
Depreciation 158,637 115,734
Accretion of discount on investment securities 9,965 13,150
---------- ----------
177,602 305,714
---------- ----------
Net deferred tax asset $ 842,617 $ 698,513
========== ==========
Note 15. Commitments and Contingencies
Litigation
In the normal course of business the Bank is involved in various legal
proceedings. After consultation with legal counsel, management believes that any
liability resulting from such proceedings will not be material to the
consolidated financial statements.
Financial Instruments with Off-Balance-Sheet Risk
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. These instruments involve, to varying degrees, credit risk in excess
of the amount recognized in the consolidated balance sheets.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as for on-balance-sheet instruments. A summary of the Bank's
commitments at December 31, 2004 and 2003 is as follows:
2004 2003
----------- -----------
Commitments to extend credit $12,352,870 $ 8,267,932
Standby letters of credit -- --
----------- -----------
$12,352,870 $ 8,267,932
=========== ===========
23
Note 15. Commitments and Contingencies, continued
Financial Instruments with Off-Balance-Sheet Risk, continued
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation of the party. Collateral held varies, but may include accounts
receivable, inventory, property and equipment, residential real estate and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Bank deems necessary.
Concentrations of Credit Risk
Substantially all of the Bank's loans, commitments to extend credit, and standby
letters of credit have been granted to customers in the Bank's market area and
such customers are generally depositors of the Bank. Investments in state and
municipal securities involve governmental entities within and outside the Bank's
market area. The concentrations of credit by type of loan are set forth in Note
4. The distribution of commitments to extend credit approximates the
distribution of loans outstanding. Standby letters of credit are granted
primarily to commercial borrowers. The Bank's primary focus is toward small
business and consumer transactions, and accordingly, it does not have a
significant number of credits to any single borrower or group of related
borrowers in excess of $1,000,000. The Bank has cash and cash equivalents on
deposit with financial institutions which exceed federally insured limits.
Investment Purchase
During 2003, the Bank agreed to purchase an equity investment in a limited
liability company totaling $500,000. The Bank has paid $175,000 as of December
31, 2004 and expects to fund the remaining $325,000 during 2005.
Note 16. Regulatory Restrictions
Dividends
The Company's dividend payments are made from dividends received from the Bank.
Under applicable federal law, the Comptroller of the Currency restricts national
bank total dividend payments in any calendar year to net profits of that year,
as defined, combined with retained net profits for the two preceding years. The
Comptroller also has authority under the Financial Institutions Supervisory Act
to prohibit a national bank from engaging in an unsafe or unsound practice in
conducting its business. It is possible, under certain circumstances, the
Comptroller could assert that dividends or other payments would be an unsafe or
unsound practice.
24
Note 16. Regulatory Restrictions, continued
Intercompany Transactions
The Bank's legal lending limit on loans to the Company is governed by Federal
Reserve Act 23A, and differs from legal lending limits on loans to external
customers. Generally, a bank may lend up to 10% of its capital and surplus to
its Parent, if the loan is secured. If collateral is in the form of stocks,
bonds, debentures or similar obligations, it must have a market value when the
loan is made of at least 20% more than the amount of the loan, and if
obligations of a state or political subdivision or agency thereof, it must have
a market value of at least 10% more than the amount of the loan. If such loans
are secured by obligations of the United States or agencies thereof, or by
notes, drafts, bills of exchange or bankers' acceptances eligible for rediscount
or purchase by a Federal Reserve Bank, requirements for collateral in excess of
the loan amount do not apply. Under this definition, the legal lending limit for
the Bank on loans to the Company was approximately $2,461,000 at December 31,
2004. No 23A transactions were deemed to exist between the Company and the Bank
at December 31, 2004.
Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory (and possibly additional
discretionary) actions by regulators that, if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank's 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 Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital to risk-weighted assets, and of Tier I
capital to average assets, as all those terms are defined in the regulations.
Management believes, as of December 31, 2004, that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 2004, the most recent notification from the Office of the
Comptroller of the Currency categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the following table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
25
Note 16. Regulatory Restrictions, continued
Capital Requirements, continued
As of December 31, 2004 and 2003, the Bank met the criteria to be considered
well capitalized under the regulatory framework from prompt corrective action.
To be categorized as well capitalized the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
following table.
The Company's and Bank's actual capital amounts (in thousands) and ratios are
also presented in the table.
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Required Action Provisions
----------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ----- ------------- ----- -------------- -----
December 31, 2004:
Total Capital
(to Risk-Weighted Assets)
Consolidated $ 28,739 15.8% $ 14,509 8.0% $ 18,136 10.0%
Grayson National Bank $ 24,268 13.4% $ 14,463 8.0% $ 18,078 10.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $ 26,468 14.6% $ 7,254 4.0% $ 10,881 6.0%
Grayson National Bank $ 22,004 12.2% $ 7,231 4.0% $ 10,847 6.0%
Tier I Capital
(to Average Assets)
Consolidated $ 26,468 9.9% $ 10,673 4.0% $ 13,341 5.0%
Grayson National Bank $ 22,004 8.3% $ 10,633 4.0% $ 13,291 5.0%
December 31, 2003:
Total Capital
(to Risk-Weighted Assets)
Consolidated $ 26,449 15.3% $ 13,844 8.0% $ 17,305 10.0%
Grayson National Bank $ 22,451 13.0% $ 13,800 8.0% $ 17,250 10.0%
Tier I Capital
(to Risk-Weighted Assets)
Consolidated $ 24,283 14.0% $ 6,922 4.0% $ 10,383 6.0%
Grayson National Bank $ 20,292 11.8% $ 6,900 4.0% $ 10,350 6.0%
Tier I Capital
(to Average Assets)
Consolidated $ 24,283 9.3% $ 10,408 4.0% $ 13,010 5.0%
Grayson National Bank $ 20,292 7.8% $ 10,368 4.0% $ 12,960 5.0%
26
Note 17. Transactions with Related Parties
The Bank has entered into transactions with its directors, significant
shareholders and their affiliates (related parties). Such transactions were made
in the ordinary course of business on substantially the same terms and
conditions, including interest rates and collateral, as those prevailing at the
same time for comparable transactions with other customers, and did not, in the
opinion of management, involve more than normal credit risk or present other
unfavorable features.
Aggregate 2004 and 2003 loan transactions with related parties were as follows:
2004 2003
----------- -----------
Balance, beginning $ 1,794,312 $ 2,676,098
New loans 1,674,816 549,261
Repayments (724,708) (1,431,047)
----------- -----------
Balance, ending $ 2,744,420 $ 1,794,312
=========== ===========
Note 18. Parent Company Financial Information
Condensed financial information of Grayson Bankshares, Inc. is presented as
follows:
Balance Sheets
December 31, 2004 and 2003
2004 2003
------------ ------------
Assets
Cash and due from banks $ 2,855,513 $ 2,927,262
Securities available for sale 1,056,900 1,088,875
Investment in affiliate bank at equity 22,239,543 20,609,391
Other assets 25,090 1,883
------------ ------------
Total assets $ 26,177,046 $ 24,627,411
============ ============
Liabilities
Other liabilities $ -- $ 26,615
Stockholders' equity
Common stock 2,148,710 2,148,710
Surplus 521,625 521,625
Retained earnings 23,797,289 21,587,202
Accumulated other comprehensive income (290,578) 343,259
------------ ------------
Total stockholders' equity 26,177,046 24,600,796
------------ ------------
Total liabilities and stockholders' equity $ 26,177,046 $ 24,627,411
============ ============
27
Note 18. Parent Company Financial Information, continued
Statements of Income
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
---------------- --------------- ----------------
Income:
Dividends from affiliate bank $ 1,031,381 $ 859,484 $ 790,725
Interest on taxable securities 57,507 52,281 55,799
Net realized gains on securities 20,454 - -
---------------- --------------- ----------------
1,109,342 911,765 846,524
---------------- --------------- ----------------
Expenses:
Management and professional fees 113,401 89,719 88,464
Other expenses 13,224 11,150 8,964
---------------- --------------- ----------------
126,625 100,869 97,428
---------------- --------------- ----------------
Income before tax benefit and equity
in undistributed income of affiliate 982,717 810,896 749,096
Federal income tax benefit 15,866 16,180 13,814
---------------- --------------- ----------------
Income before equity in undistributed
income of affiliate 998,583 827,076 762,910
Equity in undistributed income of affiliate 2,242,885 2,511,483 1,773,549
---------------- --------------- ----------------
Net income $ 3,241,468 $ 3,338,559 $ 2,536,459
================ =============== ================
Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
2004 2003 2002
---------------- --------------- ----------------
Cash flows from operating activities
Net income $ 3,241,468 $ 3,338,559 $ 2,536,459
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed income of affiliate (2,242,885) (2,511,483) (1,773,549)
Net realized gains on securities (20,454) - -
Net (increase) decrease in other assets (12,336) (89) (3,157)
Net increase (decrease) in other liabilities (26,615) (131) (18,096)
---------------- --------------- ----------------
Net cash provided by operating activities 939,178 826,856 741,657
---------------- --------------- ----------------
Cash flows from investing activities
Purchases of investment securities (300,000) (500,000) (300,000)
Sales of investment securities 320,454 - -
Maturities of investment securities - 400,000 300,000
---------------- --------------- ----------------
Net cash provided (used) by investing activities 20,454 (100,000) -
---------------- --------------- ----------------
Cash flows from financing activities
Dividends paid (1,031,381) (1,718,968) (790,725)
---------------- --------------- ----------------
Net cash used by financing activities (1,031,381) (1,718,968) (790,725)
---------------- --------------- ----------------
Net increase (decrease) in cash and due from banks (71,749) (992,112) (49,068)
Cash and cash equivalents, beginning 2,927,262 3,919,374 3,968,442
---------------- --------------- ----------------
Cash and cash equivalents, ending $ 2,855,513 $ 2,927,262 $ 3,919,374
================ =============== ================
Staff
- --------------------------------------------------------------------------------
Loan Department and Mortgage Origination
- ----------------------------------------
Pam Neill Judy Carpenter Pat Sage Robin Fincher
Jena Reeves Sandra Blevins Valerie Cowden
Tellers
- -------
Brenda Brown Mary Jane Leonard Donna Anders LeAngela Haynes
Donna Coleman Erin Cox Jeanne' Funk Kristi Nichols
Deranda Roop Rose Gonzalez Anita McGrady Mary Blevins
Ann Shuler Teresa Edwards Phyllis Fender Peggy Spencer
Nancy Burkett Christine Saltz Sheila Taylor Candee Harris
Dorothy Galyean Angela Lawrence Lisa Buchanan Tammy Herrington
Barbara McBride Sherita Sizemore Pat Richardson Cindy Seldon
Terry Davis Lynn Cox Sherry Key Joyce Reavis
Hilda Anderson Mary Jane Patton Susan Roberts Stacey Horton
Sue Bledsoe Debra Pickett Melissa Spencer Becky Hall
Tracy Bowman Christine Bolen Peggy Gravely Kim Banks
Bookkeeping & Proof
- -------------------
Becky Callahan Rhonda Lineberry Dorothy Hash Nancy Hale
Rhonda James Janna Billings Elaine Roberts Sparkle Holder
Loretta Painter Lorie Casino
Secretaries and Customer Service Personnel
- ------------------------------------------
Judy Cummings Carol Moxley Elisa Blevins Cindy Teaster
Glenda Ward Sue Faddis Karen Overstreet Beverly Burcham
Rebecca Reedy Julie Horton
Receptionists and Office Services
- ---------------------------------
Brenda Thompson Greg Reedy Faye Dotson
46
Board of Directors and Officers
- --------------------------------------------------------------------------------
Board of Directors
------------------
Julian L. Givens..........................................................................................Physician
Jacky K. Anderson................................................Grayson Bankshares, Inc. and Grayson National Bank
Jack E. Guynn, Jr...........................................................................Guynn Enterprises, Inc.
Fred B. Jones................................................................................................Farmer
Jean W. Lindsey.................................................................................Walter's Drug, Inc.
Charles T. Sturgill...................................................................Grayson County Clerk of Court
Dennis B. Gambill................................................Grayson Bankshares, Inc. and Grayson National Bank
Carl J. Richardson...................................................................Retired, Grayson National Bank
J. David Vaughan..................................................................................Vaughan Furniture
Thomas E. Jackson, Jr...............................................................................Attorney-at-Law
Grayson Bankshares Officers
---------------------------
Julian L. Givens..............................................................................Chairman of the Board
Jacky K. Anderson.................................................................................President and CEO
Dennis B. Gambill....................................................................................Vice President
Brenda C. Smith...........................................................................................Secretary
Blake M. Edwards............................................................................Chief Financial Officer
Grayson National Bank Officers
------------------------------
Julian L. Givens..............................................................................Chairman of the Board
Charles T. Sturgill...................................................................................Vice Chairman
Jacky K. Anderson.................................................................................President and CEO
Dennis B. Gambill..........................................................................Executive Vice President
Curtis A. Jennings............................................................................Senior Vice President
Brenda C. Smith...............................................................................Senior Vice President
Blake M. Edwards............................................................................Chief Financial Officer
Peggy H. Haga...................................................................Vice President-Customer Service Rep
Ann W. Graham....................................................................................Operations Manager
Darlene B. Hensdell...............................................................Assistant VP-Customer Service Rep
Sarah S. Cox......................................................................Assistant VP-Customer Service Rep
Jerry D. Wright......................................................................................Vice President
Delma C. Smith......................................................................Assistant VP-Branch Coordinator
Kathy T. Watson.........................................................................Information Systems Manager
Linda B. Eller.........................................................Executive Secretary/Administrative Assistant
Rodney R. Halsey......................................................................Assistant VP-Loan Officer-EDP
Tom D. Gentry...............................................................................Commercial Loan Officer
Carolyn A. Cornett........................................................Vice President-Auditor/Compliance Officer
Lori C. Vaught.................................................................................Credit Administrator
Robert T. Fender................................................................................Loan Review Officer
Deborah J. McCormick ...........................................................................Collections Officer
Marcia T. Sutherland...................................................................................Loan Officer
Charles W. Smith......................................................................Loan Officer/Security Officer
Larry D. Osborne............................................Assistant VP-Branch Manager of East Independence Office
Brenda C. Parks..................................................................Branch Manager of Troutdale Office
Carol Lee Sutherland.............................................................Branch Manager of Elk Creek Office
Ronald P. Porter......................................................Vice President-Branch Manager of Galax Office
Sharon D. Caudill.............................................Assistant Branch Manager of Galax Office-Loan Officer
Greg L. Bare........................................................................Branch Manager of Sparta Office
Sheila G. Douglas............................................Assistant Branch Manager of Sparta Office-Loan Officer
Ruby A. Stuart....................................................Regional Manager/Branch Manager of Carroll Office
G. Kevin Weatherman.........................................Assistant Branch Manager of Carroll Office-Loan Officer
Kay B. Carter...................................................................Branch Manager of Hillsville Office
Doug E. Morgan...........................................Assistant Branch Manager of Hillsville Office-Loan Officer
47
Stockholder Information
- -------------------------------------------------------------------------------
Annual Meeting
- --------------
The annual meeting of stockholders will be held at 1:00 p.m. on April 12, 2005,
at the Grayson National Bank Conference Center, 558 East Main Street,
Independence, Virginia, located in the Guynn Shopping Center.
Requests for Information
- ------------------------
Requests for information should be directed to Mrs. Brenda C. Smith, Corporate
Secretary, at The Grayson National Bank, Post Office Box 186, Independence,
Virginia, 24348; telephone (276) 773-2811.
Independent Auditors Stock Transfer Agent
-------------------- --------------------
Larrowe & Company, PLC The Grayson National Bank
Certified Public Accountants Post Office Box 186
Post Office Box 760 Independence, VA 24348
Galax, Virginia 24333
Federal Deposit Insurance Corporation
- -------------------------------------
The Bank is a member of the FDIC. This statement has not been reviewed, or
confirmed for accuracy or relevance by the Federal Deposit Insurance
Corporation.
Banking Offices
---------------
Main Office Elk Creek Office
113 West Main Street 60 Comers Rock Road
Independence, Virginia 24348 Elk Creek, Virginia 24326
(276) 773-2811 (276) 655-4011
East Independence Office Troutdale Office
802 East Main Street 101 Ripshin Road
Independence, Virginia 24348 Troutdale, Virginia 24378
(276) 773-2811 (276) 677-3722
Galax Office Sparta Office
209 West Grayson Street 98 South Grayson Street
Galax, Virginia Sparta, North Carolina 28675
(276) 238-2411 (336) 372-2811
Carroll Office Hillsville Office
8351 Carrollton Pike 419 South Main Street
Galax, Virginia 24333 Hillsville, Virginia 24343
(276) 238-8112 (276) 728-2810
- -------------------------------------------------------------------------------
Management's Discussion and Analysis
- --------------------------------------------------------------------------------