UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2008
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission File Number: 0-30535
GRAYSON BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
Virginia 54-1647596
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
113 West Main Street
Independence, Virginia 24348
(Address of principal executive offices) (Zip Code)
(276) 773-2811
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes |X| No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See definition of "large accelerated filer," "accelerated
filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if smaller reporting company) Smaller reporting company |X|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [ ] No |X|
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the
latest practicable date:
1,718,968 shares of Common Stock, par value
$1.25 per share, outstanding as of August 13, 2008.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets--June 30, 2008
and December 31, 2007 3
Unaudited Consolidated Statements of Income--Six Months Ended
June 30, 2008 and June 30, 2007 4
Unaudited Consolidated Statements of Income--Three Months Ended
June 30, 2008 and June 30, 2007 5
Consolidated Statements of Changes in Stockholders' Equity--Six Months
Ended June 30, 2008 (Unaudited) and Year Ended December 31, 2007 (Audited) 6
Unaudited Consolidated Statements of Cash Flows--Six Months Ended
June 30, 2008 and June 30, 2007 7
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
Item 4. Controls and Procedures 17
PART II OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits 18
Signatures 19
2
Part I. Financial Information
Item 1. Financial Statements
Grayson Bankshares, Inc. and Subsidiary
Consolidated Balance Sheets
June 30, 2008 and December 31, 2007
- -------------------------------------------------------------------------------------------------------------------
June 30, December 31,
Assets 2008 2007
--------------- ----------------
(Unaudited) (Audited)
Cash and due from banks $ 10,672,764 $ 10,746,139
Federal funds sold 11,850,899 24,637,131
Investment securities available for sale 48,227,386 38,429,328
Investment securities held to maturity
(fair value approximately $3,069,217 at June 30, 2008,
and $3,064,241 at December 31, 2007) 3,025,616 3,014,048
Restricted equity securities 1,404,750 1,129,850
Loans, net of allowance for loan losses of $2,789,755
at June 30, 2008 and $2,757,745 at December 31, 2007 269,331,490 263,729,116
Cash value of life insurance 7,583,952 5,598,853
Foreclosed assets 100,000 160,000
Property and equipment, net 9,133,192 8,485,058
Accrued income 3,477,017 2,996,261
Other assets 2,818,483 2,560,615
--------------- ----------------
$ 367,625,549 $ 361,486,399
=============== ================
Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest-bearing $ 43,542,588 $ 44,630,854
Interest-bearing 267,606,274 264,542,840
--------------- ----------------
Total deposits 311,148,862 309,173,694
Long-term debt 25,000,000 20,000,000
Accrued interest payable 594,193 536,393
Other liabilities 522,940 1,485,439
--------------- ----------------
337,265,995 331,195,526
--------------- ----------------
Commitments and contingencies - -
Stockholders' equity
Preferred stock, $25 par value; 500,000
shares authorized; none issued - -
Common stock, $1.25 par value; 2,000,000 shares
authorized; 1,718,968 shares issued and
outstanding 2,148,710 2,148,710
Surplus 521,625 521,625
Retained earnings 29,647,374 29,026,036
Accumulated other comprehensive loss (1,958,155) (1,405,498)
--------------- ----------------
30,359,554 30,290,873
--------------- ----------------
$ 367,625,549 $ 361,486,399
=============== ================
See Notes to Consolidated Financial Statements.
3
Grayson Bankshares, Inc. and Subsidiary
Consolidated Statements of Income
For the Six Months ended June 30, 2008 and 2007
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
2008 2007
------------- --------------
Interest income: (Unaudited) (Unaudited)
Loans and fees on loans $ 9,882,500 $ 10,065,117
Federal funds sold 258,758 349,775
Investment securities:
Taxable 833,049 653,675
Exempt from federal income tax 242,904 206,108
------------- --------------
11,217,211 11,274,675
------------- --------------
Interest expense:
Deposits 5,046,566 5,062,314
Interest on borrowings 463,000 256,562
------------- --------------
5,509,566 5,318,876
------------- --------------
Net interest income 5,707,645 5,955,799
Provision for loan losses 200,000 135,000
------------- --------------
Net interest income after
provision for loan losses 5,507,645 5,820,799
------------- --------------
Noninterest income:
Service charges on deposit accounts 459,483 342,762
Increase in cash value of life insurance 156,000 111,000
Net realized gains (losses) on securities 15,717 (9,982)
Other income 451,657 563,715
------------- --------------
1,082,857 1,007,495
------------- --------------
Noninterest expense:
Salaries and employee benefits 2,925,720 2,801,094
Occupancy expense 181,035 177,438
Equipment expense 451,340 420,107
Other expense 1,222,102 1,102,763
------------- --------------
4,780,197 4,501,402
------------- --------------
Income before income taxes 1,810,305 2,326,892
Income tax expense 467,000 696,000
------------- --------------
Net income $ 1,343,305 $ 1,630,892
============= ==============
Basic earnings per share $ 0.78 $ 0.95
============= ==============
Weighted average shares outstanding 1,718,968 1,718,968
============= ==============
Dividends declared per share $ 0.42 $ 0.40
============= ==============
See Notes to Consolidated Financial Statements.
4
Grayson Bankshares, Inc. and Subsidiary
Consolidated Statements of Income
For the Three Months ended June 30, 2008 and 2007
- -------------------------------------------------------------------------------------------------------------------
Three Months Ended
June 30,
2008 2007
------------- --------------
Interest income: (Unaudited) (Unaudited)
Loans and fees on loans $ 4,793,415 $ 5,176,307
Federal funds sold 85,305 171,573
Investment securities:
Taxable 478,711 317,455
Exempt from federal income tax 120,264 111,819
------------- --------------
5,477,695 5,777,154
------------- --------------
Interest expense:
Deposits 2,412,132 2,581,963
Interest on borrowings 250,000 115,788
------------- --------------
2,662,132 2,697,751
------------- --------------
Net interest income 2,815,563 3,079,403
Provision for loan losses 125,000 75,000
------------- --------------
Net interest income after
provision for loan losses 2,690,563 3,004,403
------------- --------------
Noninterest income:
Service charges on deposit accounts 241,959 224,582
Increase in cash value of life insurance 75,000 55,500
Net realized gains (losses) on securities (130) (9,759)
Other income 283,600 163,483
------------- --------------
600,429 433,806
------------- --------------
Noninterest expense:
Salaries and employee benefits 1,493,643 1,422,051
Occupancy expense 92,328 90,110
Equipment expense 240,378 219,663
Other expense 616,638 585,955
------------- --------------
2,442,987 2,317,779
------------- --------------
Income before income taxes 848,005 1,120,430
Income tax expense 196,000 333,500
------------- --------------
Net income $ 652,005 $ 786,930
============= ==============
Basic earnings per share $ 0.38 $ 0.46
============= ==============
Weighted average shares outstanding 1,718,968 1,718,968
============= ==============
Dividends declared per share $ 0.21 $ 0.20
============= ==============
See Notes to Consolidated Financial Statements.
5
Grayson Bankshares, Inc. and Subsidiary
Consolidated Statements of Stockholders' Equity
For the Six Months ended June 30, 2008 (unaudited) and the Year ended December 31, 2007 (audited)
- -------------------------------------------------------------------------------------------------------------------
Accumulated
Other
Common Stock Retained Comprehensive
Shares Amount Surplus Earnings Income (Loss) Total
---------- ----------- ----------- ------------- ---------------- -------------
Balance, December 31, 2006 1,718,968 $ 2,148,710 $ 521,625 $ 27,336,848 $ (1,703,014) $ 28,304,169
Comprehensive income
Net income - - - 3,167,501 - 3,167,501
Net change in pension reserve
net of income taxes of $156,273 - - - - 303,354 303,354
Net change in unrealized
gain (loss) on investment
securities available for
sale, net of taxes of ($6,191) - - - - (12,018) (12,018)
Reclassification adjustment,
net of income taxes of $3,184 - - - - 6,180 6,180
-------------
Total comprehensive income 3,465,017
Dividends paid
($.86 per share) - - - (1,478,313) - (1,478,313)
--------- ----------- ----------- ------------- ---------------- -------------
Balance, December 31, 2007 1,718,968 $ 2,148,710 $ 521,625 $ 29,026,036 $ (1,405,498) $ 30,290,873
Comprehensive income
Net income - - - 1,343,305 - 1,343,305
Net change in unrealized
gain (loss) on investment
securities available for
sale, net of taxes of ($290,046) - - - - (563,030) (563,030)
Reclassification adjustment,
net of income taxes of $5,344 - - - - 10,373 10,373
-------------
Total comprehensive income 790,648
Dividends paid
($.42 per share) - - - (721,967) - (721,967)
--------- ----------- ----------- ------------- ---------------- -------------
Balance, June 30, 2008 1,718,968 $ 2,148,710 $ 521,625 $ 29,647,374 $ (1,958,155) $ 30,359,554
========= =========== =========== ============= ================ =============
See Notes to Consolidated Financial Statements.
6
Grayson Bankshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the Six Months ended June 30, 2008 and 2007
- -------------------------------------------------------------------------------------------------------------------
Six Months Ended
June 30,
2008 2007
------------- --------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net income $ 1,343,305 $ 1,630,892
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization 387,000 375,000
Provision for loan losses 200,000 135,000
Deferred income taxes 269,000 258,000
Net realized (gains) losses on securities (15,716) 9,982
Accretion of discount on securities, net of
amortization of premiums (7,400) (24,563)
Deferred compensation (25,336) (5,086)
Net realized gain on foreclosed assets (21,926) (48,722)
Life insurance income (119,902) -
Changes in assets and liabilities:
Cash value of life insurance (156,000) (111,000)
Accrued income (480,756) (281,119)
Other assets (242,166) (254,528)
Accrued interest payable 57,800 (115,951)
Other liabilities (937,163) (758,766)
------------- --------------
Net cash provided by operating activities 250,740 809,139
------------- --------------
Cash flows from investing activities:
Net decrease in federal funds sold 12,786,232 7,923,582
Purchases of investment securities (28,236,274) (8,090,240)
Sales of investment securities - 1,982,500
Maturities of investment securities 17,612,405 9,277,353
(Purchases) sales of restricted equity securities (274,900) 457,600
Net increase in loans (5,977,374) (12,051,769)
Purchases of bank-owned life insurance (2,000,000) -
Proceeds from life insurance contracts 290,803 -
Proceeds from the sale of foreclosed assets 256,926 108,722
Purchases of property and equipment, net of sales (1,035,134) (580,725)
------------- --------------
Net cash used in investing activities (6,577,316) (972,977)
------------- --------------
Cash flows from financing activities:
Net increase in deposits 1,975,168 11,934,024
Dividends paid (721,967) (687,587)
Net increase (decrease) in long-term debt 5,000,000 (10,000,000)
------------- --------------
Net cash provided by financing activities 6,253,201 1,246,437
------------- --------------
Net increase (decrease) in cash and cash equivalents (73,375) 1,082,599
Cash and cash equivalents, beginning 10,746,139 10,120,984
------------- --------------
Cash and cash equivalents, ending $ 10,672,764 $ 11,203,583
============= ==============
Supplemental disclosure of cash flow information:
Interest paid $ 5,451,766 $ 5,434,827
============= ==============
Taxes paid $ 130,000 $ 364,468
============= ==============
Transfers of loans to foreclosed properties $ 175,000 $ -
============= ==============
See Notes to Consolidated Financial Statements.
7
Grayson Bankshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------------------
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") in a bank holding company reorganization. The Bank
was acquired by the Company on July 1, 1992.
The Bank was organized under the laws of the United States in 1900 and currently serves Grayson County, Virginia
and surrounding areas through nine 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 Board of Governors of
the Federal Reserve System.
The consolidated financial statements as of June 30, 2008 and for the periods ended June 30, 2008 and 2007
included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. In the opinion of management, the information furnished in the interim
consolidated financial statements reflects all adjustments necessary to present fairly the Company's consolidated
financial position, results of operations, changes in stockholders' equity and cash flows for such interim
periods. Management believes that all interim period adjustments are of a normal recurring nature. These
consolidated financial statements should be read in conjunction with the Company's audited financial statements
and the notes thereto as of December 31, 2007, included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2007. The results of operations for the three-month and six-month periods ended
June 30, 2008 are not necessarily indicative of the results to be expected for the full year.
The accounting and reporting policies of the Company and the Bank follow generally accepted accounting principles
and general practices within the financial services industry.
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.
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 $2,825,000 and $2,775,000 for the periods including June
30, 2008 and December 31, 2007, respectively.
Note 3. Allowance for Loan Losses
The following is an analysis of the allowance for loan losses for the six months ended June 30, 2008 and 2007.
2008 2007
------------- --------------
Balance, beginning $ 2,757,745 $ 2,901,997
Provision charged to expense 200,000 135,000
Recoveries of amounts charged off 162,911 46,358
Amounts charged off (330,901) (139,585)
------------- --------------
Balance, ending $ 2,789,755 $ 2,943,770
============= ==============
8
Grayson Bankshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------------------
Note 4. Income Taxes
A reconciliation of income tax expense computed at the statutory federal income tax rate to income tax expense
included in the statements of income for the six months ended June 30, 2008 and 2007 follows:
2008 2007
------------- --------------
Tax at statutory federal rate $ 615,504 $ 791,143
Tax exempt interest income (99,947) (84,899)
Other tax exempt income (93,807) (43,192)
Other 45,250 32,948
------------- --------------
$ 467,000 $ 696,000
============= ==============
Note 5. Employee Benefit Plan
The Bank has a qualified noncontributory defined benefit pension plan that covers substantially all of its
employees. The benefits are primarily based on years of service and earnings. The following is a summary of net
periodic pension costs for the six-month periods ended June 30, 2008 and 2007.
2008 2007
------------- --------------
Service cost $ 195,790 $ 193,828
Interest cost 183,948 178,916
Expected return on plan assets (221,218) (183,544)
Amortization of net obligation at transition (18) (18)
Amortization of prior service cost 5,032 5,032
Amortization of net (gain) or loss 25,864 38,886
------------- --------------
Net periodic benefit cost $ 189,398 $ 233,100
============= ==============
Note 6. Commitments and Contingencies
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 June 30, 2008 and 2007 is as follows:
2008 2007
------------- --------------
Commitments to extend credit $ 18,938,289 $ 20,959,836
Standby letters of credit - -
------------- --------------
$ 18,938,289 $ 20,959,836
============= ==============
Commitments to extend credit are agreements to lend to a customer, at a fixed or variable interest rate, 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.
9
Grayson Bankshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------------------
Note 6. Commitments and Contingencies, continued
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
that the Bank deems necessary.
Note 7. Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and
to determine fair value disclosures. Securities available for sale, and derivatives are recorded at fair value
on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other
assets on a nonrecurring basis, such as foreclosed assets. These nonrecurring fair value adjustments typically
involve application of lower of cost or market accounting or write-downs of individual assets.
Fair Value Hierarchy
Under SFAS 157, the Company groups assets and liabilities at fair value in three levels, based on the markets in
which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
These levels are:
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices
for identical or similar instruments in markets that are not active, and model-based valuation
techniques for which all significant assumptions are observable in the market.
Level 3 - Valuation is generated from model-based techniques that use at least one significant
assumption not observable in the market. These unobservable assumptions reflect estimates of
assumptions that market participants would use in pricing the asset or liability. Valuation techniques
may include the use of option pricing models, discounted cash flow models and similar techniques.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement
is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using
independent pricing models or other model-based valuation techniques such as the present value of future cash
flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss
assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange,
U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money
market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities,
municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities
in less liquid markets.
10
Grayson Bankshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------------------
Note 7. Fair Value, continued
Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is
considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment
of interest and principal will not be made in accordance with the contractual terms of the loan agreement are
considered impaired. Once a loan is identified as individually impaired, management measures impairment in
accordance with SFAS 114, "Accounting by Creditors for Impairment of a Loan, " (SFAS 114). The fair value of
impaired loans is estimated using one of several methods, including collateral value, market value of similar
debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an
allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded
investments in such loans. At June 30, 2008, substantially all of the total impaired loans were evaluated based
on the fair value of the collateral. In accordance with SFAS 157, impaired loans where an allowance is
established based on the fair value of collateral require classification in the fair value hierarchy. When the
fair value of the collateral is based on an observable market price or a current appraised value, the Company
records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management
determines the fair value of the collateral is further impaired below the appraised value and there is no
observable market price, the Company records the impaired loan as nonrecurring Level 3.
Derivative Assets and Liabilities
Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter
markets where quoted market prices are not readily available. Management engages third-party intermediaries to
determine the fair market value of these derivative instruments and classifies these instruments as Level 2.
Examples of Level 2 derivatives are interest rate swaps, caps and floors. No derivative instruments were held as
of June 30, 2008, or December 31, 2007.
Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently,
foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent
market prices, appraised values of the collateral or management's estimation of the value of the collateral.
When the fair value of the collateral is based on an observable market price or a current appraised value, the
Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below the appraised value and there is
no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
June 30, 2008 Total Level 1 Level 2 Level 3
--------------- --------------- --------------- ----------------
Investment securities available for sale $ 48,227,386 $ - $ 48,227,386 $ -
Derivative assets - - - -
-------------- ---------------- --------------- ----------------
Total assets at fair value $ 48,227,386 $ - $ 48,227,386 $ -
=============== ================ =============== ================
Derivative liabilities - - - -
--------------- ---------------- --------------- ----------------
Total liabilities at fair value $ - $ - $ - $ -
=============== ================ =============== ================
11
Grayson Bankshares, Inc. and Subsidiary
Notes to Consolidated Financial Statements
- -------------------------------------------------------------------------------------------------------------------
Note 7. Fair Value, continued
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a
nonrecurring basis in accordance with U.S. generally accepted accounting principals. These include assets and
liabilities that are measured at the lower of cost or market that were recognized at fair value below cost at the
end of the period. Assets and liabilities measured at fair value on a nonrecurring basis are included in the
table below.
June 30, 2008 Total Level 1 Level 2 Level 3
-------------- --------------- --------------- ----------------
Loans $ 572,283 $ - $ 572,283 $ -
Foreclosed assets 100,000 - 100,000 -
--------------- --------------- --------------- ----------------
Total assets at fair value $ 672,283 $ - $ 672,283 $ -
=============== =============== =============== ================
Total liabilities at fair value $ - $ - $ - $ -
=============== =============== =============== ================
Note 8. Emerging Issues Task Force (EITF) 06-10
In March 2007, the FASB ratified the consensuses reached by the Financial Accounting Standards Board's (FASB's)
Emerging Issues Task Force relating to EITF 06-10, "Accounting for Collateral Assignment Split-Dollar Life
Insurance Arrangements" (EITF 06-10). EITF 06-10 states that entities with collateral split-dollar life
insurance arrangements that provide a benefit to an employee that extends to postretirement periods should
recognize a liability for future benefits in accordance with SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions", (if in substance a postretirement benefit plan exists). The
Company evaluated the impact of applying this issue as a change in accounting principle through a
cumulative-effect adjustment to retained earnings. Because the Bank has a limited number of split-dollar life
insurance arrangements in effect, all of which are term-based arrangements expiring between the years 2009 and
2013, the Company determined that the liability for future benefits was not significant.
Note 9. Subsequent Event
On August 11, 2008, S&P downgraded the credit rating of the Federal Home Loan Mortgage Corporation (FHLMC) to a
rating of A and they remained on a negative credit watch. Due to this downgrade, the valuation of our preferred
stock in FHLMC has been reduced significantly. Management is assessing this change in circumstances for other
than temporary impairment.
12
Part I. Financial Information
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations
- -------------------------------------------------------------------------------------------------------------------
General
The following discussion provides information about the major components of the results of operations and
financial condition of the Company. This discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report.
Critical Accounting Policies
For a discussion of the Company's critical accounting policies, including its allowance for loan losses, see the
Company's Annual Report on Form 10-K for the year ended December 31, 2007.
Results of Operations
Total interest income decreased by $299,459 for the quarter ended June 30, 2008 compared to the quarter ended
June 30, 2007, while interest expense on deposits and other borrowings decreased by $35,619 over the same
period. The decrease in interest income was attributable primarily to decreases in interest rates. Since
September 2007, the Federal Reserve has lowered its target overnight borrowing rate by 3.25%, resulting in
immediate reductions in federal funds interest as well as interest on loans indexed to the prime lending rate.
The decrease in interest rates did not have as great an impact on interest expense as deposits have not repriced
as quickly as loans and federal funds sold, thus leading to a decrease in the bank's net interest margin. An
increase in borrowings from the Federal Home Loan Bank also increased interest expense. The result was a
decrease in net interest income of $263,840, or 8.57% for the quarter ended June 30, 2008, compared to the
quarter ended June 30, 2007.
The provision for loan losses was $125,000 for the quarter ended June 30, 2008 and $75,000 for the same period in
2007. The increase was due to a specific charge-off on a commercial loan. The reserve for loan losses at June
30, 2008 was approximately 1.03% of total loans. Management believes the provision and the resulting allowance
for loan losses are adequate.
Noninterest income was $600,429 in the second quarter of 2008 compared to $433,806 in the second quarter of
2007. The majority of the increase came as a result of life insurance proceeds of approximately $120,000.
Noninterest expenses increased by $125,208, or 5.40%, for the quarter ended June 30, 2008 compared to the quarter
ended June 30, 2007. Normal increases in salary and benefit costs accounted for $71,592 of this increase.
The decrease in net interest income combined with the increase in noninterest expense was the principal cause of
the decrease in net income before taxes of $272,425 for the second quarter of 2008, compared to the same quarter
in 2007. Income tax expense decreased accordingly to $196,000 in the quarter, from $333,500 in the second
quarter of 2007. As a result, net income decreased by $134,925, or 17.15%, to $652,005 compared to $786,930 last
year.
For the six months ended June 30, 2008, total interest income decreased by $57,464 compared to the six-month
period ended June 30, 2007, while interest expense increased by $190,690 over the same period. This resulted in
a decrease in net interest income of $248,154, or 4.17%. As stated above, the decrease in interest income was
primarily the result of decreases in interest rates. The increase in interest expense came primarily as a
result of increased borrowings from the Federal Home Loan Bank.
Noninterest income increased by $75,362 for the six-month period ended June 30, 2008 compared to the same period
in 2007. Service charges on deposit accounts increased due to the implementation of an overdraft privilege
program in the second quarter of 2007. Other income decreased due to earnings recognized in the first quarter of
2007 from the Bank's investment in a Small Business Investment Company, that did not recur in 2008.
13
Part I. Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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As indicated above, increases in normal operating costs resulted in an increase in noninterest expense of
$278,795, or 6.19%, for the first six months of 2008 compared to the first six months of 2007. Overall, the
decrease in net interest income and the increase in noninterest expense led to a decrease in net income of
$287,587, or 17.63%, for the six-month period ended June 30, 2008 compared to the six-month period ended June 30,
2007.
Financial Condition
Total assets increased by $6,139,150, or 1.70%, from December 31, 2007 to June 30, 2008. Net loans increased by
$5,602,374, federal funds sold decreased by $12,786,232 and investment securities increased by $9,809,626. The
decrease in federal funds sold came as balances were used to fund the increases in loans and investment
securities. The cash value of life insurance increased as the Bank made an additional investment of $2,000,000
in bank-owned life insurance during the first quarter of 2008.
Total deposits increased by $1,975,168, or 0.64%, from December 31, 2007 to June 30, 2008. The slower deposit
growth came as management moved to lower deposit rates in conjunction with the decreases in rates on loans and
federal funds sold. Long-term debt increased from $20,000,000 at December 31, 2007, to $25,000,000 at June 30,
2008 as the Bank sought to lock in lower-rate funding from the Federal Home Loan Bank. Other liabilities
decreased from $1,485,439 at December 31, 2007 to $522,940 at June 30, 2008 due to a contribution of $949,743 to
the employee defined benefit pension plan.
Shareholders' equity totaled $30,359,554 at June 30, 2008 compared to $30,290,873 at December 31, 2007. The
$68,681 increase was the result of earnings for the six months combined with a decrease in the market value of
securities classified as available for sale, and the payment of dividends of $721,967.
Regulatory guidelines relating to capital adequacy provide minimum risk-based ratios at the Bank level which
assess capital adequacy while encompassing all credit risks, including those related to off-balance sheet
activities. The Bank exceeds all regulatory capital guidelines and is considered to be well capitalized.
Liquidity and Capital Resources
Liquidity is the ability to convert assets to cash to fund depositors' withdrawals or borrowers' loans without
significant loss. Federal fund lines available from correspondent banks totaled $18,400,000 at June 30, 2008.
No balances were outstanding on these lines at June 30, 2008 or December 31, 2007. Long-term debt consists of
borrowings from the Federal Home Loan Bank and Deutsche Bank. Borrowings from the Federal Home Loan Bank, which
are secured by a blanket collateral agreement on the Bank's 1 to 4 family residential real estate loans, totaled
$15,000,000 at June 30, 2008 and $10,000,000 at December 31, 2007. Borrowings from Deutsche Bank, which are
secured by the pledging of specific investment securities, totaled $10,000,000 at each of June 30, 2008, and
December 31, 2007. The unused credit line from the Federal Home Loan Bank as of June 30, 2008 is approximately
$40,000,000.
The Bank uses cash and federal funds sold to meet its daily funding needs. If funding needs are met through
holdings of excess cash and federal funds, then profits might be sacrificed as higher-yielding investments are
foregone in the interest of liquidity. Therefore management determines, based on such items as loan demand and
deposit activity, an appropriate level of cash and federal funds and seeks to maintain that level.
The Bank's investment security portfolio also serves as a source of liquidity. The primary goals of the
investment portfolio are liquidity management and maturity gap management. As investment securities mature, the
proceeds are reinvested in federal funds sold if the federal funds level needs to be increased; otherwise the
proceeds are reinvested in similar investment securities. The majority of investment securities transactions
consist of replacing securities that have been called or matured. The Bank keeps a portion of its investment
portfolio in unpledged assets that are less than 24 months to maturity. These investments are a preferred source
of funds in that they can be disposed of in any interest rate environment without causing significant damage to
that quarter's profits.
14
Part I. Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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As a result of the steps described above, management believes that the Company maintains overall liquidity
sufficient to satisfy its depositors' requirements and meet its customers' credit needs.
Forward-Looking Statements
Certain information contained in this discussion may include "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These forward-looking statements are generally identified by phrases such as "the Company expects,"
"the Company believes" or words of similar import. Such forward-looking statements involve known and unknown
risks including, but not limited to, changes in general economic and business conditions, interest rate
fluctuations, competition within and from outside the banking industry, new products and services in the banking
industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with
technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations
applicable to the Company. Although the Company believes that its expectations with respect to the
forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business
and operations, there can be no assurance that actual results, performance or achievements of the Company will
not differ materially from any future results, performance or achievements expressed or implied by such
forward-looking statements. For additional information on known and unknown risks, see the "Caution About
Forward Looking Statements" section in the Company's Annual Report on Form 10-K for the year ended December 31,
2007.
15
Part I. Financial Information
Item 3. Quantitative and Qualitative Disclosures about Market Risk
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Not applicable to smaller reporting companies.
16
Part I. Financial Information
Item 4. Controls and Procedures
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As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's President and Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934. Based upon that evaluation, the
Company's President and Chief Executive Officer and Chief Financial Officer concluded that its disclosure
controls and procedures are effective in timely alerting them to material information relating to the Company
(including its consolidated subsidiary) required to be included in its periodic filings with the Securities and
Exchange Commission.
The Company's management is also responsible for establishing and maintaining adequate internal control over
financial reporting. There were no changes in the Company's internal control over financial reporting identified
in connection with the evaluation of it that occurred during the Company's last fiscal quarter that materially
affected, or are reasonably likely to materially affect, internal control over financial reporting.
17
Part II. Other Information
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Item 1. Legal Proceedings
There are no pending legal proceedings to which the Company or the Bank is a party or of which any of
their property is subject.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company's Annual Meeting of Shareholders was held on May 13, 2008.
(b) Not applicable
(c) At the Annual Meeting of Shareholders, the shareholders of the Company were asked to vote on
the election of three of the Company's directors to serve until the third annual meeting following
their election or until their successors have been elected and qualified.
The votes cast for or withheld for the election of directors were as follows:
Name Votes For Votes Withheld
--------------- --------- --------------
Jacky K. Anderson 1,011,092 1,158
Thomas M. Jackson, Jr. 1,006,156 6,094
J. David Vaughan 1,005,152 7,098
(d) Not applicable
Item 5. Other Information
None
Item 6. Exhibits
31.1 Rule 13(a)-14(a) Certification of Chief Executive Officer.
31.2 Rule 13(a)-14(a) Certification of Chief Financial Officer.
32.1 Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350.
18
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.
GRAYSON BANKSHARES, INC.
Date: August 14, 2008 By: /s/ Jacky K. Anderson
---------------------
Jacky K. Anderson
President and CEO
By: /s/ Blake M. Edwards
--------------------
Blake M. Edwards
Chief Financial Officer
19
Exhibit Index
Exhibit No. Description
31.1 Rule 13(a)-14(a) Certification of Chief Executive Officer.
31.2 Rule 13(a)-14(a) Certification of Chief Financial Officer.
32.1 Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350.