** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-Q**

 

**(Mark One)**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

** **

**For thequarterly period ended September 30, 2004**

 

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For thetransition period from                     to                    **

 

**Commissionfile number   0-14289**

 

**GREENECOUNTY BANCSHARES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Tennessee**                                                                | **62-1222567**                       |
|------------------------------------------------------------------------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)              | (I.R.S. Employer Identification No.) |
|                                                                         |                                 |
| **100 North Main Street, Greeneville,  Tennessee**                           | **37743-4992**                       |
| (Address of principal executive offices)                                     | (Zip Code)                           |
|                                                                         |                                 |
| Registrant’s telephone number, including area code: **(423) 639-5111**. |

 

Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 **ý  **NO**o**

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)YES **ý   **NO**o**

 

As ofNovember 5, 2004, the number of shares outstanding of the issuer’s common stockwas: 7,646,330.

 

 

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** **

**PART 1 – FINANCIAL INFORMATION**

 

# **ITEM1.  FINANCIAL STATEMENTS**

 

The unaudited condensedconsolidated financial statements of the Registrant and its wholly ownedsubsidiaries are as follows:

 
| Condensed Consolidated Balance Sheets –  September 30, 2004 and December 31, 2003.                                                   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                      |   |
| Condensed Consolidated Statements of Income  and Comprehensive Income - For the three and nine months ended September 30,  2004 and 2003. |   |
|                                                                                                                                      |   |
| Condensed Consolidated Statement of Changes  in Shareholders’ Equity – For the nine months ended September 30, 2004.            |   |
|                                                                                                                                      |   |
| Condensed Consolidated Statements of Cash  Flows - For the nine months ended September 30, 2004 and 2003.                                 |   |
|                                                                                                                                      |   |
| Notes to Condensed Consolidated Financial  Statements.                                                                                    |   |

 

1

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** **

**GREENE COUNTY BANCSHARES, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**September 30, 2004 and December 31, 2003**

**(Amounts in thousands, except share and per share data)**

 
| ** **                                                                                      | ** ** | **(Unaudited)**         | ** ** | ** **              | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                      | ** ** | **September 30,  2004** | ** ** | **December 31,  2003*** | ** ** |
| **ASSETS**                                                                                      |       |                    |       |                    |       |
| Cash and due from banks                                                                         |       | $                       | 30,450     |                    | $          | 36,087 |   |
| Federal funds sold                                                                              |       | 722                     |       | 5,254                   |       |
| Securities available for sale                                                                   |       | 27,598                  |       | 33,199                  |       |
| Securities held to maturity (with a market  value of $4,641 and $5,846)                         |       | 4,482                   |       | 5,632                   |       |
| FHLB, Bankers Bank and other stock, at cost                                                     |       | 6,154                   |       | 5,992                   |       |
| Loans held for sale                                                                             |       | 1,865                   |       | 3,546                   |       |
| Loans                                                                                           |       | 981,506                 |       | 952,225                 |       |
| Less: Allowance for loan losses                                                                 |       | (14,850                 | )          | (14,564                 | )          |
| Net loans                                                                                       |       | 966,656                 |       | 937,661                 |       |
| Premises and equipment, net                                                                     |       | 34,867                  |       | 33,886                  |       |
| Goodwill and other intangible assets                                                            |       | 20,508                  |       | 20,970                  |       |
| Other assets                                                                                    |       | 26,926                  |       | 26,295                  |       |
| Total assets                                                                                    |       | $                       | 1,120,228  |                    | $          | 1,108,522 |   |
|                                                                                            |       |                    |       |                    |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                   |       |                    |       |                    |       |
| Liabilities                                                                                     |       |                    |       |                    |       |
| Deposits                                                                                        |       | $                       | 878,088    |                    | $          | 907,115 |   |
| Repurchase agreements                                                                           |       | 10,470                  |       | 12,896                  |       |
| FHLB advances and notes payable                                                                 |       | 100,757                 |       | 63,030                  |       |
| Subordinated debentures                                                                         |       | 10,310                  |       | 10,310                  |       |
| Accrued interest payable and other  liabilities                                                 |       | 12,589                  |       | 13,236                  |       |
| Total liabilities                                                                               |       | 1,012,214               |       | 1,006,587               |       |
|                                                                                            |       |                    |       |                    |       |
| Shareholders’ equity                                                                       |       |                    |       |                    |       |
| Common stock: $2 par, 15,000,000 shares  authorized, 7,644,650 and 7,659,929 shares outstanding |       | 15,290                  |       | 15,320                  |       |
| Additional paid in capital                                                                      |       | 24,119                  |       | 24,482                  |       |
| Retained earnings                                                                               |       | 68,533                  |       | 61,947                  |       |
| Accumulated other comprehensive income                                                          |       | 72                      |       | 186                     |       |
| Total shareholders’ equity                                                                 |       | 108,014                 |       | 101,935                 |       |
| Total liabilities and shareholders’ equity                                                 |       | $                       | 1,120,228  |                    | $          | 1,108,522 |   |

 

----

* Derived from audited consolidated financial statements.

 

See accompanying notes.

 

2

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**GREENE COUNTY BANCSHARES, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF INCOMEAND COMPREHENSIVE INCOME**

**Three and Nine Months Ended September 30,2004 and 2003**

**(Amounts in thousands, except share and pershare data)**

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** |   | **2003** |   |
| ** **                                           | ** ** | **(Unaudited)**                       |       | **(Unaudited)**                      |       |
| Interest income                                      |       |                                  |       |                                 |       |   |   |   |   |
| Interest and fees on loans                           |       | $                                     | 15,796     |                                 | $          | 13,603 |   | $ | 46,843 |   | $ | 40,942 |   |
| Investment securities                                |       | 344                                   |       | 117                                  |       | 1,069 |   | 761 |   |
| Federal funds sold and interest-earning  deposits    |       | 2                                     |       | 143                                  |       | 29 |   | 242 |   |
|                                                 |       | 16,142                                |       | 13,863                               |       | 47,941 |   | 41,945 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Interest expense                                     |       |                                  |       |                                 |       |   |   |   |   |
| Deposits                                             |       | 2,665                                 |       | 2,856                                |       | 8,857 |   | 9,610 |   |
| Borrowings                                           |       | 1,065                                 |       | 850                                  |       | 2,809 |   | 2,320 |   |
|                                                 |       | 3,730                                 |       | 3,706                                |       | 11,666 |   | 11,930 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net interest income                                  |       | 12,412                                |       | 10,157                               |       | 36,275 |   | 30,015 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Provision for loan losses                            |       | 1,062                                 |       | 1,655                                |       | 3,747 |   | 4,510 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net interest income after provision for  loan losses |       | 11,350                                |       | 8,502                                |       | 32,528 |   | 25,505 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Noninterest income                                   |       |                                  |       |                                 |       |   |   |   |   |
| Service charges and fees                             |       | 2,436                                 |       | 2,388                                |       | 7,349 |   | 6,919 |   |
| Other                                                |       | 584                                   |       | 572                                  |       | 1,835 |   | 1,662 |   |
|                                                 |       | 3,020                                 |       | 2,960                                |       | 9,184 |   | 8,581 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Noninterest expense                                  |       |                                  |       |                                 |       |   |   |   |   |
| Salaries and employee benefits                       |       | 4,800                                 |       | 3,997                                |       | 13,971 |   | 12,086 |   |
| Occupancy and furniture and equipment  expense       |       | 1,494                                 |       | 1,184                                |       | 4,445 |   | 3,357 |   |
| Other                                                |       | 2,917                                 |       | 2,198                                |       | 8,320 |   | 6,860 |   |
|                                                 |       | 9,211                                 |       | 7,379                                |       | 26,736 |   | 22,303 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Income before income taxes                           |       | 5,159                                 |       | 4,083                                |       | 14,976 |   | 11,783 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Provision for income taxes                           |       | 1,946                                 |       | 1,483                                |       | 5,636 |   | 4,264 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net income                                           |       | $                                     | 3,213      |                                 | $          | 2,600 |   | $ | 9,340 |   | $ | 7,519 |   |
| Comprehensive income                                 |       | $                                     | 3,418      |                                 | $          | 2,550 |   | $ | 9,226 |   | $ | 7,546 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Per share of common stock:                           |       |                                  |       |                                 |       |   |   |   |   |
| Basic earnings                                       |       | $                                     | 0.42       |                                 | $          | 0.38 |   | $ | 1.22 |   | $ | 1.10 |   |
| Diluted earnings                                     |       | 0.42                                  |       | 0.38                                 |       | 1.21 |   | 1.09 |   |
| Dividends                                            |       | 0.12                                  |       | 0.12                                 |       | 0.36 |   | 0.36 |   |
|                                                 |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average shares outstanding:                 |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                                |       | 7,644,544                             |       | 6,823,315                            |       | 7,657,078 |   | 6,822,040 |   |
| Diluted                                              |       | 7,710,335                             |       | 6,894,097                            |       | 7,724,756 |   | 6,893,420 |   |

 

See accompanying notes.

 

3

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** **

**GREENE COUNTY BANCSHARES, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CHANGESIN SHAREHOLDERS’ EQUITY**

**For Nine Months Ended September 30, 2004**

**(Amounts in thousands, except share and pershare data)**

** **
| ** **                                                              | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Compre-  hensive  Income (loss)** | ** ** | **Total  Share-  holders’  Equity** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                              |
| ** **                                                              |
| ** **                                                              |
| ** **                                                              |
|                                                                    |       |              |       |                             |       |                   |       |                                                    |       |                                     |       |
| **Balance, January 1, 2004**                                            |       | $                 | 15,320     |                             | $          | 24,482                 |       | $                                                       | 61,947     |                                     | $          | 186 |   | $ | 101,935 |   |
|                                                                    |       |              |       |                             |       |                   |       |                                                    |       |                                     |       |
| Common stock transactions:                                              |       |              |       |                             |       |                   |       |                                                    |       |                                     |       |
| Issuance of 10,421 shares under stock  option plan                      |       | 21                |       | 120                              |       |                   |       |                                                    |       | 141                                      |       |
| Repurchase of common stock, 25,700 shares                               |       | (51               | )          | (487                             | )          |                   |       |                                                    |       | (538                                     | )     |
| Tax benefit from exercise of nonincentive  stock options                |       |              |       | 4                                |       |                   |       |                                                    |       | 4                                        |       |
| Dividends ($.36 per share)                                              |       | —            |       |                             |       | (2,754                 | )          |                                                    |       | (2,754                                   | )     |
| Comprehensive income:                                                   |       |              |       |                             |       |                   |       |                                                    |       |                                     |       |
| Net income                                                              |       | —            |       |                             |       | 9,340                  |       |                                                    |       | 9,340                                    |       |
| Change in unrealized gains (losses), net of  reclassification and taxes |       | —            |       |                             |       |                   |       | (114                                                    | )     | (114                                     | )     |
| Total comprehensive income                                              |       | —            |       | —                           |       | —                 |       | —                                                  |       | 9,226                                    |       |
|                                                                    |       |              |       |                             |       |                   |       |                                                    |       |                                     |       |
| **Balance, September 30, 2004**                                         |       | $                 | 15,290     |                             | $          | 24,119                 |       | $                                                       | 68,533     |                                     | $          | 72 |   | $ | 108,014 |   |

 

See accompanying notes.

 

4

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** **

**GREENE COUNTY BANCSHARES, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**For the Nine Months Ended September 30, 2004and 2003**

**(Amounts in thousands, except share and pershare data)**

 
| ** **                                                                                 | ** ** | **September 30,  2004** |   | **September 30,  2003** |   |
|--------------------------------------------------------------------------------------------|------------|-------------------------|--------|-------------------------|--------|
| ** **                                                                                 |       | **(Unaudited)**         |   |
| **Cash flows from operating activities**                                                   |       |                    |   |                    |   |
| Net income                                                                                 |       | $                       | 9,340  |                    | $      | 7,519 |   |
| Adjustments to reconcile net income to net  cash from operating activities                 |       |                    |   |                    |   |
| Provision for loan losses                                                                  |       | 3,747                   |   | 4,510                   |   |
| Depreciation and amortization                                                              |       | 2,297                   |   | 1,519                   |   |
| Security amortization and accretion, net                                                   |       | 83                      |   | 113                     |   |
| FHLB stock dividends                                                                       |       | (162                    | )      | (139                    | )      |
| Net gain on sale of mortgage loans                                                         |       | (368                    | )      | (927                    | )      |
| Originations of mortgage loans held for  sale                                              |       | (36,085                 | )      | (61,460                 | )      |
| Proceeds from sales of mortgage loans                                                      |       | 38,134                  |   | 65,190                  |   |
| Net losses from sales of fixed assets                                                      |       | 47                      |   | 104                     |   |
| Net loss on OREO and repossessed assets                                                    |       | 216                     |   | 199                     |   |
| Net changes:                                                                               |       |                    |   |                    |   |
| Other assets                                                                               |       | 2,199                   |   | 245                     |   |
| Accrued interest payable and other  liabilities                                            |       | (643                    | )      | (2,808                  | )      |
| Net cash from operating activities                                                         |       | 18,805                  |   | 14,065                  |   |
| **Cash flows from investing activities**                                                   |       |                    |   |                    |   |
| Net change in securities and other  interest-earning investments                           |       | 6,488                   |   | 10,475                  |   |
| Increase in cash surrender value of life  insurance                                        |       | (2,858                  | )      | (561                    | )      |
| Net increase in loans                                                                      |       | (36,005                 | )      | (67,104                 | )      |
| Improvements to other real estate and  proceeds from sales of other real estate owned, net |       | 3,145                   |   | 4,564                   |   |
| Proceeds from fixed assets additions and  sale of fixed assets, net                        |       | (2,866                  | )      | (3,104                  | )      |
| Net cash from investing activities                                                         |       | (32,096                 | )      | (55,730                 | )      |
| **Cash flows from financing activities**                                                   |       |                    |   |                    |   |
| Net decrease in deposits                                                                   |       | (29,027                 | )      | (14,825                 | )      |
| Net (decrease) increase in repurchase  agreements                                          |       | (2,426                  | )      | 10,482                  |   |
| Net increase in FHLB advances and notes  payable                                           |       | 37,726                  |   | 6,707                   |   |
| Proceeds from subordinated debentures                                                      |       | —                  |   | 10,000                  |   |
| Dividends paid                                                                             |       | (2,754                  | )      | (2,456                  | )      |
| Proceeds from issuance of common stock                                                     |       | 141                     |   | 37                      |   |
| Repurchase of common stock                                                                 |       | (538                    | )      | —                  |   |
| Net cash from financing activities                                                         |       | 3,122                   |   | 9,945                   |   |
| **Net decrease in cash and cash equivalents**                                              |       | (10,169                 | )      | (31,720                 | )      |
| Cash and cash equivalents, beginning of  year                                              |       | 41,341                  |   | 62,959                  |   |
| **Cash and cash equivalents, end of period**                                               |       | $                       | 31,172 |                    | $      | 31,239 |   |
| ** **                                                                                 |       |                    |   |                    |   |
| **Supplemental disclosures – cash and noncash**                                       |       |                    |   |                    |   |
| Interest paid                                                                              |       | $                       | 12,585 |                    | $      | 12,578 |   |
| Income taxes paid                                                                          |       | 3,527                   |   | 3,790                   |   |
| Loans transferred to other real estate                                                     |       | 3,817                   |   | 5,195                   |   |
| Unrealized (loss) gain on available for  sale securities, net of tax                       |       | (114                    | )      | 27                      |   |

 

See accompanying notes.

 

5

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** **

**GREENE COUNTY BANCSHARES, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**September 30, 2004**

**Unaudited**

**(Amounts inthousands, except share and per share data)**

** **

**NOTE 1 – PRINCIPLES OF CONSOLIDATION**

 

The accompanyingunaudited condensed consolidated financial statements of Greene CountyBancshares, Inc. (the “Company”) and its wholly owned subsidiary, Greene CountyBank (the “Bank”), have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim information andin accordance with the instructions to Form 10-Q and Article 10 of RegulationS-X as promulgated by the Securities and Exchange Commission (“SEC”).Accordingly, they do not include all the information and footnotes required byaccounting principles generally accepted in the United States of America forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the three and ninemonths ended September 30, 2004 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2004. For furtherinformation, refer to the consolidated financial statements and footnotesthereto included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003. Certain amounts from prior period financial statements havebeen reclassified to conform to the current year’s presentation.

 

# **NOTE2 – STOCK COMPENSATION**

 

Employee compensationexpense under stock option plans is reported if options are granted belowmarket price at grant date, whereas expense for options granted at market priceare reported on a pro forma basis. Pro forma disclosures of net income andearnings per share are shown below using the fair value method of SFASNo. 123 to measure expense for options using the Black-Scholes option pricingmodel to estimate fair value.

 

Theshareholders of the Company approved, at their annual meeting on April 22,2004, the Greene County Bancshares, Inc. 2004 Long-Term Incentive Plan (the “Plan”), for the purpose ofattracting, retaining and motivating employees, officers and directors of theCompany and to provide incentives and awards for superior performance. The Planreserved 500,000 shares of common stock for issuance. No options have yet beengranted under the Plan but options have been granted under the Company’sprevious stock option plans.

 

The followingdisclosures show the effect on income and earnings per share had theoutstanding options’ fair value been recorded using the Black-Scholes model.

 
| ** **                                                                                                          | ** ** | **Three Months Ended****September  30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2004**                                | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                |       |                                    |       |                                |       |   |   |   |   |
| Net income:                                                                                                         |       |                                    |       |                                |       |   |   |   |   |
| As reported                                                                                                         |       | $                                       | 3,213      |                                | $          | 2,600 |   | $ | 9,340 |   | $ | 7,519 |   |
| Deduct: Total stock-based compensation  expense determined under fair value-based method for all awards, net of tax |       | (38                                     | )          | (29                                 | )          | (113 | ) | (86 | ) |
| Pro forma                                                                                                           |       | $                                       | 3,175      |                                | $          | 2,571 |   | $ | 9,227 |   | $ | 7,433 |   |
|                                                                                                                |       |                                    |       |                                |       |   |   |   |   |
| Earnings per common share:                                                                                          |       |                                    |       |                                |       |   |   |   |   |
| As reported                                                                                                         |       | $                                       | 0.42       |                                | $          | 0.38 |   | $ | 1.22 |   | $ | 1.10 |   |
| Pro forma                                                                                                           |       | $                                       | 0.42       |                                | $          | 0.37 |   | $ | 1.20 |   | $ | 1.08 |   |
|                                                                                                                |       |                                    |       |                                |       |   |   |   |   |
| Diluted earnings per common share:                                                                                  |       |                                    |       |                                |       |   |   |   |   |
| As reported                                                                                                         |       | $                                       | 0.42       |                                | $          | 0.38 |   | $ | 1.21 |   | $ | 1.09 |   |
| Pro forma                                                                                                           |       | $                                       | 0.41       |                                | $          | 0.37 |   | $ | 1.19 |   | $ | 1.07 |   |

 

6

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# ** **

# **NOTE3 – ALLOWANCE FOR LOAN LOSSES**

 

Transactionsin the allowance for loan losses for the nine months ended September 30, 2004and twelve months ended December 31, 2003 were as follows:

 
| ** **                      | ** ** | **September 30,  2004** |   | **December 31,  2003** |   |
|---------------------------------|------------|-------------------------|--------|------------------------|--------|
|                            |       |                    |   |                   |   |
| Balance at beginning of year    |       | $                       | 14,564 |                   | $      | 12,586 |   |
| Add (deduct):                   |       |                    |   |                   |   |
| Reserve acquired in acquisition |       | —                  |   | 1,340                  |   |
| Provision                       |       | 3,747                   |   | 5,775                  |   |
| Loans charged off               |       | (4,914                  | )      | (6,797                 | )      |
| Recoveries of loans charged off |       | 1,453                   |   | 1,660                  |   |
| Ending balance                  |       | $                       | 14,850 |                   | $      | 14,564 |   |

 
| ** **                              | ** ** | **September 30,  2004** |   | **December 31,  2003** |   |
|-----------------------------------------|------------|-------------------------|--------|------------------------|--------|
|                                    |       |                    |   |                   |   |
| Loans past due 90 days still on accrual |       | $                       | 979    |                   | $      | 224 |   |
| Nonaccrual loans                        |       | 7,214                   |   | 4,305                  |   |
| Total                                   |       | $                       | 8,193  |                   | $      | 4,529 |   |

 

7

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# ** **

# **NOTE4 – EARNINGS PER SHARE OF COMMON STOCK**

 

Basic earnings per share(EPS) of common stock is computed by dividing net income by the weightedaverage number of common shares outstanding during the period. Diluted earningsper share of common stock is computed by dividing net income by the weightedaverage number of common shares and potential common shares outstanding duringthe period. Stock options are regarded as potential common shares. Potentialcommon shares are computed using the treasury stock method. For the three andnine months ended September 30, 2004, 72,155 options are excluded from theeffect of dilutive securities because they are anti-dilutive; 70,105 optionsare similarly excluded from the effect of dilutive securities for the three andnine months ended September 30, 2003.

 

The following is a reconciliation of the numerators and denominatorsused in the basic and diluted earnings per share computations for the three andnine months ended September 30, 2004 and 2003:

 
| ** **                                                        | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                                        | ** ** | **Income**                           | ** ** | **Shares** | ** ** | **Income** |   | **Shares** |   |
| ** **                                                        | ** ** | **(Numerator)**                      | ** ** | **(Denominator)** | ** ** | **(Numerator)** |   | **(Denominator)** |   |
|                                                              |       |                                 |       |   |   |   |   |   |   |
| **Basic EPS**                                                     |       |                                 |       |   |   |   |   |   |   |
| Income available to common shareholders                           |       | $                                    | 3,213      |   | 7,644,544 |   | $ | 2,600 |   | 6,823,315 |   |
|                                                              |       |                                 |       |   |   |   |   |   |   |
| **Effect of dilutive securities**                                 |       |                                 |       |   |   |   |   |   |   |
| Stock options outstanding                                         |       | —                               |       | 65,791 |   | — |   | 70,782 |   |
|                                                              |       |                                 |       |   |   |   |   |   |   |
| **Diluted EPS**                                                   |       |                                 |       |   |   |   |   |   |   |
| Income available to common shareholders  plus assumed conversions |       | $                                    | 3,213      |   | 7,710,335 |   | $ | 2,600 |   | 6,894,097 |   |

 
|                                                              |       | **Nine Months Ended September 30,** |       |
|-------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                        |       | **2004**                            |       | **2003** |   |
| ** **                                                        | ** ** | **Income**                          | ** ** | **Shares** | ** ** | **Income** |   | **Shares** |   |
| ** **                                                        | ** ** | **(Numerator)**                     | ** ** | **(Denominator)** | ** ** | **(Numerator)** |   | **(Denominator)** |   |
|                                                              |       |                                |       |   |   |   |   |   |   |
| **Basic EPS**                                                     |       |                                |       |   |   |   |   |   |   |
| Income available to common shareholders                           |       | $                                   | 9,340      |   | 7,657,078 |   | $ | 7,519 |   | 6,822,040 |   |
|                                                              |       |                                |       |   |   |   |   |   |   |
| **Effect of dilutive securities**                                 |       |                                |       |   |   |   |   |   |   |
| Stock options outstanding                                         |       | —                              |       | 67,678 |   | — |   | 71,380 |   |
|                                                              |       |                                |       |   |   |   |   |   |   |
| **Diluted EPS**                                                   |       |                                |       |   |   |   |   |   |   |
| Income available to common shareholders  plus assumed conversions |       | $                                   | 9,340      |   | 7,724,756 |   | $ | 7,519 |   | 6,893,420 |   |

 

8

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# ** **

# **NOTE5 – SEGMENT INFORMATION**

 

**TheCompany’s operating segments include banking, mortgage banking, consumerfinance, subprime automobile lending and title insurance. The reportablesegments are determined by the products and services offered, and internalreporting. Loans, investments, and deposits provide the revenues in the bankingoperation, loans and fees provide the revenues in consumer finance, mortgagebanking, and subprime lending and insurance commissions provide revenues forthe title insurance company. Consumer finance, subprime automobile lending andtitle insurance do not meet the quantitative threshold on an individual basis,and are therefore shown below in “other”. Mortgage banking operations areincluded in “Bank”.  All operations aredomestic.**

 

Segment performance isevaluated using net interest income and noninterest income. Income taxes areallocated based on income before income taxes, and indirect expenses (includingmanagement fees) are allocated based on time spent for each segment. Transactionsamong segments are made at fair value. Information reported internally forperformance assessment follows.

 
| **Three months ended September 30, 2004** | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
| Net interest income                       |       | $        | 11,049     |      | $          | 1,363     |       | $ | 12,412 |   |
| Provision for loan losses                 |       | 838      |       | 224       |       | 1,062     |       |
| Noninterest income                        |       | 2,828    |       | 192       |       | 3,020     |       |
| Noninterest expense                       |       | 8,127    |       | 1,084     |       | 9,211     |       |
| Income tax expense                        |       | 1,870    |       | 76        |       | 1,946     |       |
| **Segment profit**                        |       | $        | 3,042      |      | $          | 171       |       | $ | 3,213 |   |
| **Segment assets at September 30, 2004**  |       | $        | 1,087,230  |      | $          | 32,998    |       | $ | 1,120,228 |   |

 
| **Three months ended September 30, 2003** | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
| Net interest income                       |       | $        | 8,518      |      | $          | 1,639     |       | $ | 10,157 |   |
| Provision for loan losses                 |       | 1,099    |       | 556       |       | 1,655     |       |
| Noninterest income                        |       | 2,590    |       | 370       |       | 2,960     |       |
| Noninterest expense                       |       | 6,133    |       | 1,246     |       | 7,379     |       |
| Income tax expense                        |       | 1,387    |       | 96        |       | 1,483     |       |
| **Segment profit**                        |       | $        | 2,489      |      | $          | 111       |       | $ | 2,600 |   |
| **Segment assets at September 30, 2003**  |       | $        | 869,200    |      | $          | 35,255    |       | $ | 904,455 |   |

 
| **Nine months ended September 30, 2004** | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
| Net interest income                      |       | $        | 31,947     |      | $          | 4,328     |       | $ | 36,275 |   |
| Provision for loan losses                |       | 2,674    |       | 1,073     |       | 3,747     |       |
| Noninterest income                       |       | 8,402    |       | 782       |       | 9,184     |       |
| Noninterest expense                      |       | 23,330   |       | 3,406     |       | 26,736    |       |
| Income tax expense                       |       | 5,447    |       | 189       |       | 5,636     |       |
| **Segment profit**                       |       | $        | 8,898      |      | $          | 442       |       | $ | 9,340 |   |

 
| **Nine  months ended September 30, 2003** | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
| Net interest income                       |       | $        | 25,141     |      | $          | 4,874     |       | $ | 30,015 |   |
| Provision for loan losses                 |       | 2,865    |       | 1,645     |       | 4,510     |       |
| Noninterest income                        |       | 7,473    |       | 1,108     |       | 8,581     |       |
| Noninterest expense                       |       | 18,633   |       | 3,670     |       | 22,303    |       |
| Income tax expense                        |       | 4,009    |       | 255       |       | 4,264     |       |
| **Segment profit**                        |       | $        | 7,107      |      | $          | 412       |       | $ | 7,519 |   |

 

9

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**AssetQuality Ratios**

 
| **As of and for the period ended September 30, 2004**                        | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
|                                                                         |       |     |       |      |       |      |       |
| Nonperforming loans as a percentage of  total loans                          |       | 0.77     | %          | 1.67      | %          | 0.83      | %          |
| Nonperforming assets as a percentage of  total assets                        |       | 1.01     | %          | 3.18      | %          | 1.10      | %          |
| Allowance for loan losses as a percentage  of total loans                    |       | 1.25     | %          | 6.19      | %          | 1.50      | %          |
| Allowance for loan losses as a percentage  of nonperforming assets           |       | 108.50   | %          | 249.81    | %          | 120.52    | %          |
| Annualized net charge-offs to average total  loans, net of unearned interest |       | 0.30     | %          | 3.98      | %          | 0.47      | %          |

 
| **As of and for the period ended September 30, 2003**                        | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
|                                                                         |       |     |       |      |       |      |       |
| Nonperforming loans as a percentage of  total loans                          |       | 0.49     | %          | 1.58      | %          | 0.57      | %          |
| Nonperforming assets as a percentage of  total assets                        |       | 0.95     | %          | 2.88      | %          | 1.09      | %          |
| Allowance for loan losses as a percentage  of total loans                    |       | 1.19     | %          | 7.22      | %          | 1.56      | %          |
| Allowance for loan losses as a percentage  of nonperforming assets           |       | 110.96   | %          | 249.61    | %          | 129.03    | %          |
| Annualized net charge-offs to average total  loans, net of unearned interest |       | 0.41     | %          | 5.67      | %          | 0.74      | %          |

 
| **As of and for the period ended December 31, 2003**               | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
|                                                               |       |     |       |      |       |      |       |
| Nonperforming loans as a percentage of  total loans                |       | 0.40     | %          | 1.64      | %          | 0.47      | %          |
| Nonperforming assets as a percentage of  total assets              |       | 0.68     | %          | 3.38      | %          | 0.79      | %          |
| Allowance for loan losses as a percentage  of total loans          |       | 1.24     | %          | 6.45      | %          | 1.51      | %          |
| Allowance for loan losses as a percentage  of nonperforming assets |       | 154.91   | %          | 239.41    | %          | 166.35    | %          |
| Net charge-offs to average total loans, net  of unearned interest  |       | 0.33     | %          | 5.53      | %          | 0.64      | %          |

 

10

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# ** **

# **NOTE6 – GOODWILL AND OTHER INTANGIBLE ASSETS**

 

**Goodwill**

 

Goodwill was no longeramortized starting in 2002; however, it is periodically evaluated forimpairment and no impairment was recognized during the first nine months of2004.

 

The change in thecarrying amount of goodwill for the nine months ended September 30, 2004 is asfollows:

 
| Beginning of year                         |   | $      | 15,885 |   |
|-------------------------------------------|--------|--------|--------|--------|
| Goodwill from acquisition during the year |   | — |   |
| End of quarter                            |   | $      | 15,885 |   |

 

**Core deposit and otherintangibles**

 

Other intangible assetsconsist of core deposit intangibles arising from whole bank and branchacquisitions. They are initially measured at fair value and then are amortizedon a straight-line method over their estimated useful lives, which is 10 years.

 

Core deposit intangibleshad a gross carrying amount of $6,367 for the period ended September 30, 2004and the year ended December 31, 2003 and accumulated amortization of $1,744 and$1,282 for the same periods, respectively. Aggregate amortization expense forthe three and nine months ended September 30, 2004 was $154 and $462,respectively. Annual estimated amortization expense for the next five years is:

 
| 2004  |   | $   | 616    |   |
|-------|--------|-----|--------|--------|
| 2005  |   | 616 |   |
| 2006  |   | 506 |   |
| 2007  |   | 506 |   |
| 2008  |   | 506 |   |
| Total |   | $   | 2,750  |   |

 

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| **ITEM 2.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS** |
|-------------|-------------------------------------------------------------------------------------------------|

 

**Forward-LookingStatements**

 

**This Quarterly Report on Form 10-Q, includingall documents incorporated herein by reference, contains forward-lookingstatements. Additional written or oral forward-looking statements may be madeby the Company from time to time in filings with the Securities and ExchangeCommission (“SEC”) or otherwise. The words “believe”, “expect”, “seek”, and “intend”and similar expressions identify forward-looking statements, which speak onlyas of the date the statement is made. The use of “annualized” information, which extrapolates nine monthsactual financial results to the full year 2004, is also forward-looking.  Such forward-looking statements are withinthe meaning of that term in Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended.Such statements may include, but are not limited to, projections of income orloss, expenditures, acquisitions, plans for future operations, financing needsor plans relating to services of the Company, as well as assumptions relatingto the foregoing. The Company’s actual results may differ materially from theresults anticipated in forward-looking statements due to a variety of factors,including, but not limited to (1) unanticipated deterioration in the financialcondition of borrowers resulting in significant increases in loan losses andprovisions for those losses; (2) lack of sustained growth in the economy in themarkets that the Bank serves; (3) increased competition with other financialinstitutions in the markets that the Bank serves; (4) changes in thelegislative and regulatory environment; and (5) the loss of key personnel.**

 

**Presentationof Amounts**

 

**All dollar amounts set forth below, other than per-share amounts, arein thousands unless otherwise noted.**

 

**General**

 

Greene CountyBancshares, Inc. (the “Company”) is the bank holding company for Greene CountyBank (the “Bank”), a Tennessee-chartered commercial bank that conducts theprincipal business of the Company. In addition to its commercial bankingoperations, the Bank conducts separate businesses through its threewholly-owned subsidiaries: Superior Financial Services, Inc. (“SuperiorFinancial”), a consumer finance company; GCB Acceptance Corporation (“GCBAcceptance”), a subprime automobile lending company; and Fairway Title Co., atitle company formed in 1998. The Bank also operates a mortgage bankingoperation which has its main office in Knox County, Tennessee and thisoperation also has representatives located throughout the Company’s branchsystem.

 

On November21, 2003, the Company entered the Middle Tennessee market by completing itsacquisition of Gallatin, Tennessee-based Independent Bankshares Corporation (“IBC”).  IBC was the bank holding company for FirstIndependent Bank, which had four offices in Gallatin and Hendersonville,Tennessee, and Rutherford Bank and Trust, with three offices in Murfreesboroand Smyrna, Tennessee.  First IndependentBank and Rutherford Bank and Trust were subsequently merged with the Bank, withthe Bank as the surviving entity.  TheCompany completed the IBC system conversion process during the latter part ofthe quarter ended March 31, 2004.

 

On September20, 2004, the Company announced that it has agreed to purchase three branchoffices in Lawrence County, Tennessee, from National Bank of Commerce.  These branches, two located in Lawrenceburgand the third in St. Joseph, have a combined total of approximately $68 millionin deposits and $31 million in loans outstanding.  The transaction is expected to be completedby year’s end and is subject to regulatory approvals and other customaryconditions.

 

On September27, 2004, the Company announced that it plans to establish new bankingoperations in Nashville, Tennessee to serve the surrounding metropolitanarea.  This new initiative, named MiddleTennessee Bank & Trust, is expected to complement the Company’s existingpresence in the mid-state and help fill in the market between Sumner andRutherford Counties of Tennessee.  Eachbanking location will operate as a branch office of the Bank.  The first branch office for Middle TennesseeBank & Trust is set to open in Donelson, Tennessee in mid-November 2004.

 

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**Growth and Business Strategy**

 

The Company expects that, over the intermediate term, its growth frommergers and acquisitions, including acquisitions of both entire financialinstitutions and selected branches of financial institutions, willcontinue.  With respect to theacquisition of entire financial institutions, the Company is focusing oninstitutions with assets between $100 million and $400 million.  De novo branching is also expected to be amethod of growth, particularly in high-growth and otherdemographically-desirable markets.

 

The Company’s strategic plan outlines a geographic expansion policywithin a 300-mile radius of Greene County, Tennessee. This policy could resultin the Company expanding westward and eastward up to and including Nashville,Tennessee and Roanoke, Virginia, respectively, east/southeast up to andincluding the Piedmont area of North Carolina and western North Carolina,southward to northern Georgia and northward into eastern and central Kentucky.In particular, the Company believes the markets in and around Knoxville andNashville, Tennessee are highly desirable areas with respect to expansion andgrowth plans.

 

The Company iscontinuously investigating and analyzing other lines and areas ofbusiness.  These include, but are notlimited to, various types of insurance, real estate activities, etc.Conversely, the Company frequently evaluates and analyzes the profitability, riskfactors and viability of its various business lines and segments and, dependingupon the results of these evaluations and analyses, may conclude to exitcertain segments and/or business lines. Further, in conjunction with theseongoing evaluations and analyses, the Company may decide to sell, merge orclose certain branch facilities.

 

**Overview**

 

The Company’s results of operations forthe third quarter and year-to-date period ended September 30, 2004, compared tothe same periods in 2003, reflected a significant increase in net interestincome due, in part, to the November 2003 acquisition of IBC in MiddleTennessee, which added seven branch offices, as well as growth in other keymarkets, most notably in Blount County and Knoxville, Tennessee.  Becauseof this growth and the associated increase in loans, along with the short-terminterest rate increases by the Federal Reserve Board (“FRB”) beginning in thequarter ended September 30, 2004, the Company experienced an increase in netincome and earnings per share for the quarter versus the same period last year.

 

**Critical Accounting Policies and Estimates**

 

The Company’sconsolidated financial statements and accompanying notes have been prepared inaccordance with accounting principles generally accepted in the United Statesof America.  The preparation of thesefinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities, the disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reported periods.

 

Managementcontinually evaluates the Company’s accounting policies and estimates it usesto prepare the consolidated financial statements.  In general, management’s estimates are basedon historical experience, information from regulators and third partyprofessionals and various assumptions that are believed to be reasonable underthe facts and circumstances.  Actualresults could differ from those estimates made by management.

 

The Company believes its critical accounting policies and estimatesinclude the valuation of the allowance for loan losses and the fair value offinancial instruments and other accounts. Based on management’s calculation, anallowance of $14,850, or 1.50%, of total loans was an adequate estimate oflosses within the loan portfolio as of September 30, 2004.  This estimate resulted in a provision forloan losses on the income statement of $1,062 and $3,747, respectively, for thethree and nine months ended September 30, 2004. If the mix and amount of future charge-off percentages differsignificantly from those assumptions used by management in making itsdetermination, the allowance for loan losses and provision for loan losses onthe income statement could be materially affected.

 

13

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Theconsolidated financial statements include certain accounting and disclosuresthat require management to make estimates about fair values. Estimates of fairvalue are used in the accounting for securities available for sale, loans heldfor sale, goodwill, other intangible assets, and acquisition purchaseaccounting adjustments.  Estimates offair values are used in disclosures regarding securities held to maturity,stock compensation, commitments, and the fair values of financial instruments.Fair values are estimated using relevant market information and otherassumptions such as interest rates, credit risk, prepayments and otherfactors.  The fair values of financialinstruments are subject to change as influenced by market conditions.

 

**Liquidityand Capital Resources**

 

**Liquidity.** Liquidity refers to the ability or the financial flexibility to managefuture cash flows to meet the needs of depositors and borrowers and fundoperations. Maintaining appropriate levels of liquidity allows the Company tohave sufficient funds available for reserve requirements, customer demand forloans, withdrawal of deposit balances and maturities of deposits and otherliabilities. The Company’s liquid assets include cash and due from banks,federal funds sold, investment securities and loans held for sale. Includingsecurities pledged to collateralize municipal deposits, these assetsrepresented 7.13% of the total liquidity base at September 30, 2004, as comparedto 9.03% at December 31, 2003. The liquidity base is generally defined toinclude deposits, repurchase agreements, notes payable and subordinateddebentures.  In addition, the Companymaintains borrowing availability with the Federal Home Loan Bank of Cincinnati(“FHLB”) approximating $21,706 at September 30, 2004. The Company alsomaintains federal funds lines of credit totaling $106,000 at eightcorrespondent banks of which $106,000 was available at September 30, 2004. TheCompany believes it has sufficient liquidity to satisfy its current operatingneeds.

 

For the ninemonths ended September 30, 2004, operating activities of the Company provided$18,805 of cash flows. Net income of $9,340 comprised a substantial portion ofthe cash generated from operations.  Cashflows from operating activities were also positively affected by variousnon-cash items, including (i) $3,747 in provision for loan losses, (ii) $2,297of depreciation and amortization and (iii) $2,199 net change in otherassets.  In addition, the cash flowsprovided by the proceeds from sales of mortgage loans exceeded the cash flowsused by the originations of mortgage loans held for sale by $2,049.

 

The Company’snet increase in loans originated, net of principal collected, used $36,005 incash flows and was the primary component of the $32,096 in net cash used ininvesting activities.  The increase incash surrender value of life insurance, reflecting both normal increases viaearnings and also purchases of additional insurance related to certain benefitplans, used $2,858 in cash flows, and fixed asset additions, net of proceedsfrom sale of fixed assets, used $2,866 in cash flows.  Offsetting, in part, this use of cash flowswere the net changes in securities and other interest-earning investments andin improvements to other real estate and proceeds from sales of other realestate owned, net, in the amounts of $6,488 and $3,145, respectively.

 

The netincrease in notes payable provided $37,726 in cash flows and was the primarycomponent in net cash generated from financing activities in the amount of$3,122, as the Company elected to increase its short-term borrowings from theFHLB to offset the $29,027 decrease in deposits resulting from the Company’sdecision to reduce higher cost deposits. In addition, dividends paid in theamount of $2,754 further reduced the total net cash provided from financingactivities.

 

**Capital Resources.**  The Company’s capital position is reflectedin its shareholders’ equity, subject to certain adjustments for regulatorypurposes. Shareholders’ equity, or capital, is a measure of the Company’s networth, soundness and viability. The Company continues to exhibit a strongcapital position while consistently paying dividends to its shareholders.Further, the capital base of the Company allows it to take advantage ofbusiness opportunities while maintaining the level of resources deemedappropriate by management of the Company to address business risks inherent inthe Company’s daily operations.

 

Shareholders’equity on September 30, 2004 was $108,014, an increase of $6,079, or 5.96%,from $101,935 on December 31, 2003. The increase in shareholders’ equityprimarily reflected net income for the nine months ended September 30, 2004 of$9,340 ($1.21 per share, assuming dilution). This increase was offset byquarterly dividend payments during the nine months ended September 30, 2004totaling $2,754 ($0.36 per share).

 

On September 18,2002 the Company announced that its Board of Directors had authorized therepurchase of up to $2,000 of the Company’s outstanding shares of common stockbeginning in October 2002, and the

 

14

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repurchaseplan was renewed by the Board of Directors in September 2003. On June 4, 2004the Company announced that its Board of Directors had approved an increase inthe amount authorized to be repurchased from $2,000 to $5,000. The repurchaseplan is dependent upon market conditions and there is no guarantee as to theexact number of shares to be repurchased by the Company.  To date, the Company has purchased 25,700shares at an aggregate cost of approximately $538 under this program whichexpired on October 1, 2004.  The Companyexpects that the Board of Directors will renew this repurchase plan in November2004.

 

The Company’s primary source of liquidityis dividends paid by the Bank. Applicable Tennessee statutes and regulations impose restrictions on theamount of dividends that may be declared by the Bank. Further, any dividendpayments are subject to the continuing ability of the Bank to maintain itscompliance with minimum federal regulatory capital requirements and to retainits characterization under federal regulations as a “well-capitalized”institution.

 

Risk-based capital regulations adopted bythe Board of Governors of the FRB and the Federal Deposit Insurance Corporation(the “FDIC”) require bank holding companies and banks, respectively, to achieveand maintain specified ratios of capital to risk-weighted assets. Therisk-based capital rules are designed to measure Tier 1 Capital and TotalCapital in relation to the credit risk of both on- and off-balance sheetitems.  Under the guidelines, one of fourrisk weights is applied to the different on-balance sheet items.  Off-balance sheet items, such as loancommitments, are also subject to risk-weighting after conversion to balancesheet equivalent amounts. All bank holding companies and banks must maintain aminimum total capital to total risk-weighted assets ratio of 8.00%, at leasthalf of which must be in the form of core, or Tier 1, capital (consisting ofshareholders’ equity, less goodwill and other intangible assets and accumulatedother comprehensive income). At September 30, 2004, the Company and the Bankeach satisfied their respective minimum regulatory capital requirements, andthe Bank was “well-capitalized” within the meaning of federal regulatoryrequirements.  The capital ratios of theBank contained within the table below do not differ materially from those ofthe Company.

 

**CAPITAL RATIOS AT SEPTEMBER 30, 2004**

 

| ** **                 | ** ** | **Required  Minimum  Ratio** | ** ** | **Bank** | ** ** |
|----------------------------|------------|------------------------------|------------|----------|------------|
| Tier 1  risk-based capital |       |                         | 4.00       | %        | 10.13      | % |
| Total  risk-based capital  |       |                         | 8.00       | %        | 11.39      | % |
| Leverage  Ratio            |       |                         | 4.00       | %        | 8.98       | % |

 

On September 25, 2003, the Company issued $10,310 of subordinated debentures, as part of a privately placed pool of trust preferred securities.  The securities, due in 2033, bear interest at a floating rate of 2.85% above the three-month LIBOR rate, reset quarterly, and are callable in five years without penalty.  The Company used the proceeds of the offering to support its acquisition of IBC, and the capital raised from the offering qualifies as Tier I capital for regulatory purposes.

 

On May 6,2004, the FRB issued proposed rules which would continue to include trustpreferred securities in the Tier 1 capital of bank holding companies, subjectto stricter quantitative limits and qualitative standards.  The proposed rules also considered the impactof Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (“FIN 46”)and its revision (“FIN 46R”), and the related accounting treatment for trustpreferred securities, on the inclusion of trust preferred securities as Tier 1capital.

 

The Companyhas reviewed these proposed rules and believes that they will have no negativeeffect on the capital treatment of the Company’s existing trust preferredsecurities. In addition, management believes that these proposed rules will notconstrain the Company with respect to the potential issuance of additionaltrust preferred securities in accordance with the Company’s growth plans andattendant regulatory capital needs.

 

The FDIC,however, has indicated to the FRB that it opposes the continuation of trustpreferred securities as Tier 1 regulatory capital. Should the FRB modify itsproposed rules to agree with the FDIC’s opposition to the continuation of trustpreferred securities as Tier 1 regulatory capital, there would be a reductionin the Company’s consolidated capital ratios and the Company may not remain “wellcapitalized”, with respect to total risk-based capital, under FRBguidelines.  However, the Bank would remain “well capitalized”, withrespect to all capital ratios, as a result of the push down accountingtransaction associated with the IBC acquisition. In addition, under such ascenario, the Company’s potential issuance of additional trust preferredsecurities may well be curtailed or

 

15

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eliminated.  As a result, it may be necessary for theCompany to issue additional common stock in association with any futureacquisitions, which, among other things, may be more dilutive to earnings pershare than if the capital requirements of such acquisitions were funded throughthe issuance of additional trust preferred securities.

 

**Off-BalanceSheet Arrangements**

 

At September 30, 2004, the Company had outstanding unused lines of credit and standby letters of credit totaling $204,009 and unfunded loan commitments outstanding of $57,631.  Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.  If needed to fund these outstanding commitments, the Company has the ability to liquidate Federal funds sold or securities available-for-sale or, on a short-term basis, to borrow from the FHLB and/or purchase Federal funds from other financial institutions.  At September 30, 2004, the Company had accommodations with upstream correspondent banks for unsecured Federal funds lines.  These accommodations have various covenants related to their term and availability, and in most cases must be repaid within less than a month.  The following table presents additional information about the Company’s off-balance sheet commitments as of September 30, 2004, which by their terms have contractual maturity dates subsequent to September 30, 2004:

 
| ** **                                | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5  Years** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|------------------------|------------|-----------|------------|
| Commitments to make loans - fixed         |       | $                     | 37,795     |          | $          | —        |       | $                      | —     |      | $          | — |   | $ | 37,795 |   |
| Commitments to make loans – variable |       | 19,836                |       | —        |       | —        |       | —                 |       | 19,836    |       |
| Unused lines of credit                    |       | 115,581               |       | 23,968        |       | 1,990         |       | 35,540                 |       | 177,079   |       |
| Letters of credit                         |       | 5,692                 |       | 18,438        |       | —        |       | 2,800                  |       | 26,930    |       |
| Total                                     |       | $                     | 178,904    |          | $          | 42,406        |       | $                      | 1,990      |      | $          | 38,340 |   | $ | 261,640 |   |

 

**Disclosureof Contractual Obligations**

 

In the ordinary course of operations, theCompany enters into certain contractual obligations.  Such obligations include the funding ofoperations through debt issuances as well as leases for premises and equipment.  The following table summarizes the Company’ssignificant fixed and determinable contractual obligations as of September 30,2004:

 
| ** **                         | ** ** | **Less than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than 5  Years** | ** ** | **Total** | ** ** |
|------------------------------------|------------|-----------------------|------------|---------------|------------|---------------|------------|------------------------|------------|-----------|------------|
| Deposits without a stated maturity |       | $                     | 430,498    |          | $          | —        |       | $                      | —     |      | $          | — |   | $ | 430,498 |   |
| Certificate of deposits            |       | 317,582               |       | 122,368       |       | 7,315         |       | 325                    |       | 447,590   |       |
| Repurchase agreements              |       | 10,470                |       | —        |       | —        |       | —                 |       | 10,470    |       |
| FHLB advances and notes payable    |       | 45,640                |       | 2,096         |       | 5,289         |       | 47,732                 |       | 100,757   |       |
| Subordinated debentures            |       | —                |       | —        |       | —        |       | 10,310                 |       | 10,310    |       |
| Operating lease obligations        |       | 389                   |       | 549           |       | 169           |       | 231                    |       | 1,338     |       |
| Deferred compensation              |       | —                |       | —        |       | —        |       | 2,050                  |       | 2,050     |       |
| Purchase obligations               |       | 142                   |       | —        |       | —        |       | —                 |       | 142       |       |
| Total                              |       | $                     | 804,721    |          | $          | 125,013       |       | $                      | 12,773     |      | $          | 60,648 |   | $ | 1,003,155 |   |

 

Additionally,the Company routinely enters into contracts for services.  These contracts may require payment forservices to be provided in the future and may also contain penalty clauses forearly termination of the contract. Management is not aware of any additional commitments or contingentliabilities which may have a material adverse impact on the liquidity orcapital resources of the Company.

 

**Changes inResults of Operations**

 

**Net income.** Net income for the three months ended September 30, 2004 was $3,213, ascompared to $2,600 for the same period in 2003. This increase of $613, or23.58%, resulted primarily from a $2,255 or 22.20%, increase in net interestincome resulting principally from increased volume of interest-earning assetsas a result primarily of the Company’s acquisition of IBC and growth in theBlount County and Knoxville, Tennessee markets. In addition, the Company’s provision for loan losses decreased $593, or35.83%, from $1,655 for the three months ended September 30, 2003 to $1,062 forthe same period in 2004. Offsetting these increases, in part, was a $1,832,

 

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or 24.83%, increase in totalnon-interest expense from $7,379 for the three months ended September 30, 2003to $9,211 for the same period of 2004, reflecting increases in all categoriesprimarily as a result of the IBC acquisition.

 

Net income for the nine months endedSeptember 30, 2004 was $9,340, as compared to $7,519 for the same period in2003.  The increase of $1,821, or 24.22%,reflects substantially the same trends that existed during the quarter endedSeptember 30, 2004.

 

**Net Interest Income.**  The largest source of earnings for theCompany is net interest income, which is the difference between interest incomeon interest-earning assets and interest paid on deposits and otherinterest-bearing liabilities. The primary factors which affect net interestincome are changes in volume and yields of interest-earning assets andinterest-bearing liabilities, which are affected in part by management’sresponses to changes in interest rates through asset/liability management.During the three months ended September 30, 2004, net interest income was$12,412, as compared to $10,157 for the same period in 2003, representing anincrease of 22.20%. While the Company’s average balances of interest-earningassets increased more than the average balances of interest-bearing liabilitiesin the three months ended September 30, 2004, as compared to the same quarterin 2003, thus enhancing net interest income, such increase was offset, in part,by the reduction in yield on these interest-earning assets which exceeded thedecrease in cost on interest-bearing liabilities.  Nevertheless, the Company experienced asubstantial increase in net interest income, as noted above, in the threemonths ended September 30, 2004 as compared to the same quarter in 2003. Whilethe Company’s net interest margin decreased in the three months ended September30, 2004 as compared to the same period in 2003 (from 4.90% to 4.82%), the Company’snet interest margin for the three months ended September 30, 2004 improved to4.82% from 4.69% for the quarter ended June 30, 2004 principally because of theshort-term interest rate increases by the FRB beginning in the quarter endedSeptember 30, 2004.  The Company believesits net interest margin will resume compression if interest rates decline;however, if interest rates continue to rise, based on the Company’sasset-sensitive interest rate risk position and its current mix ofinterest-earning assets and interest-bearing liabilities, the Company believesits net interest margin will continue to increase.

 

For the ninemonths ended September 30, 2004, net interest income increased by $6,260, or20.86%, to $36,275 from $30,015 for the same period in 2003, and the sametrends outlined above with respect to the three months ended September 30, 2004were observed. The Company’s net interest margin declined to 4.73% for the ninemonths ended September 30, 2004 from 4.89% for the same period in 2003.

 

**Provision for Loan Losses.**  During the three and nine months endedSeptember 30, 2004, loan charge-offs were $1,676 and $4,914, respectively, andrecoveries of charged-off loans were $559 and $1,453, respectively. The Company’sprovision for loan losses decreased by $593, or 35.83%, and $763, or 16.92%, to$1,062 and $3,747 for the three and nine months ended September 30, 2004,respectively, as compared to $1,655 and $4,510 for the same periods in 2003.The Company’s allowance for loan losses increased by $286 to $14,850 atSeptember 30, 2004 from $14,564 at December 31, 2003, with the ratio of theallowance for loan losses to total loans remaining essentially constant fromperiod to period.  As of September 30,2004, most indicators of credit quality, as discussed below, have slightlyworsened compared to December 31, 2003 and September 30, 2003. The ratio ofallowance for loan losses to nonperforming assets was 120.52%, 166.35% and129.03% at September 30, 2004, December 31, 2003 and September 30, 2003, respectively,and the ratio of nonperforming assets to total assets was 1.10%, 0.79% and1.09% at September 30, 2004, December 31, 2003 and September 30, 2003,respectively. The ratio of nonperforming loans to total loans, excluding loansheld for sale, was 0.83%, 0.47% and 0.57% at September 30, 2004, December 31,2003 and September 30, 2003, respectively. Within the Bank, the Company’s largest subsidiary, the ratio ofnonperforming assets to total assets was 1.01%, 0.68% and 0.95% at September30, 2004, December 31, 2003 and September 30, 2003, respectively.  The deterioration of the credit qualityratios is primarily attributably to four commercial real estate loanrelationships and one consumer real estate loan relationship totalingapproximately $3,900 that were placed on non accrual status during the thirdquarter of 2004.  Management believesthat these loans are adequately secured and does not anticipate any materiallosses.

 

The Company’sannualized net charge-offs for the nine months ended September 30, 2004 were$4,615 compared to actual net charge-offs of $5,137 for the year ended December31, 2003.  Annualized net charge-offs as a percentage of averageloans improved from 0.74% for the nine months ended September 30, 2003 to 0.47%for the nine months ended September 30, 2004. Net charge-offs as a percentage of average loans were 0.64% for the yearended December 31, 2003.  Withinthe Bank, annualized net charge-offs as a percentage of average loans fell from0.41% for the nine months ended September 30, 2003 to 0.30% for the same periodin 2004. Net charge-offs within the Bank, as a percentage of average loans,were 0.33% for the year ended December 31, 2003.  Annualized net charge-offsin Superior Financial for the nine months ended September 30, 2004 were $553compared to actual net

 

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charge-offs of $1,070 for theyear ended December 31, 2003. Annualized net charge-offs in the Bank for thenine months ended September 30, 2004 were $2,892 compared to actual netcharge-offs of $2,652 for the year ended December 31, 2003. Annualized netcharge-offs in GCB Acceptance for the nine months ended September 30, 2004 were$1,168 compared to actual net charge-offs of $1,415 for the year ended December31, 2003. At this point, management believes that total net charge-offs for2004 in Superior Financial and GBC Acceptance will decline slightly compared to2003 based on an improving economy and asset quality trends.

 

Based on the Company’s allowance for loanloss calculation and review of the loanportfolio, management believes the allowance for loan losses is adequate atSeptember 30, 2004.

 

**Non-Interest Income.**  Income that is not related tointerest-earning assets, consisting primarily of service charges, commissionsand fees, has become an important supplement to the Company’s traditionalmethod of earning income through interest rate spreads.

 

Totalnon-interest income for the three and nine months ended September 30, 2004 was$3,020 and $9,184, respectively, as compared to $2,960 and $8,581,respectively, for the same periods in 2003. Service charges, commissions andfees remain the largest component of total non-interest income and increasedfrom $2,388 and $6,919 for the three and nine months, respectively, endedSeptember 30, 2003 to $2,436 and $7,349, respectively, for the same periods in2004. This increase primarily reflects additional fees from deposit-relatedproducts offset, in part, by a decline in gains on sales of loans, as well ascommissions and fees, in the Company’s mortgage division, as a result of slowedrefinancing activity.

 

**Non-Interest Expense.**  Control of non-interest expense also is animportant aspect in enhancing income. Non-interest expense includes personnel,occupancy, and other expenses such as data processing, printing and supplies,legal and professional fees, postage, Federal Deposit Insurance Corporationassessment, etc. Total non-interest expense was $9,211 and $26,736 for thethree and nine months ended September 30, 2004 compared to $7,379 and $22,303for the same periods in 2003. The $1,832, or 24.83%, increase in totalnon-interest expense for the three months ended September 30, 2004 compared tothe same period of 2003 principally reflects increases in all categoriesprimarily as a result of the IBC acquisition.

 

Similarly, the$4,433, or 19.88%, increase in total non-interest expense for the nine monthsended September 30, 2004 compared to the same period in 2003 reflectssubstantially the same trends that existed during the quarter ended September30, 2004.

 

Personnel costs are the primary elementof the Company’s non-interest expenses. For the three and nine months endedSeptember 30, 2004, salaries and benefits represented $4,800, or 52.11%, and$13,971, or 52.26%, respectively, of total non-interest expense. This was anincrease of $803, or 20.09%, and $1,885, or 15.60%, respectively, from the$3,997 and $12,086 for the three and nine months ended September 30, 2003.  The Company had 49 branches at September 30,2004 and 50 at December 31, 2003, as compared to 42 at September 30, 2003, andthe number of full-time equivalent employees increased 18.16% from 391 atSeptember 30, 2003 to 462 at September 30, 2004.  These increases in personnel costs, number ofbranches and employees are primarily the result of the IBC acquisition.  The Company expects that personnel costs willincrease following the acquisition of the three branches in Lawrence County,Tennessee which is expected to close in the fourth quarter of 2004.

 

Primarily as aresult of this overall increase in non-interest expense, the Company’sefficiency ratio was negatively affected, as the ratio increased from 57.79% atSeptember 30, 2003 to 58.81% at September 30, 2004.  The efficiency ratio illustrates how much itcost the Company to generate revenue; for example, it cost the Company 58.81cents to generate one dollar of revenue for the nine months ended September 30,2004.

 

**Income Taxes.** The effective income tax rate for the three and nine months endedSeptember 30, 2004 was 37.72% and 37.63%, respectively, compared to 36.32% and36.19% for the same period in 2003. The lower effective rates in 2003 resultfrom the Company’s analysis of its tax accruals and attendant adjustmentsduring the three months ended September 30, 2003.

 

**Changes inFinancial Condition**

 

Total assetsat September 30, 2004 were $1,120,228, an increase of $11,706, or 1.06%, fromtotal assets of $1,108,522 at December 31, 2003. The increase in assets wasprimarily reflective of the $28,995, or 3.09%, increase, as reflected on theCondensed Consolidated Balance Sheets, in net loans, excluding loans held forsale, and

 

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was funded by a combination ofsources. Declines in cash, cash equivalents and investment securities(excluding FHLB, Bankers Bank and other stock) totaled $16,920, as the Companyelected to channel additional liquidity into higher-yielding loans. Inaddition, while deposits declined by $29,027, as the Company elected to reduceits higher-costing deposit liabilities, the $37,727 increase in FHLB advancesand notes payable more than offset the deposit decrease and primarilyrepresented additional short-term borrowings from the FHLB. Management believesthat both of these changes in liability funding sources will enhance theCompany’s net interest margin and are appropriate based on the Company’sasset-sensitive position with respect to interest rate risk.

 

At September30, 2004, loans, net of unearned income and allowance for loan losses, were$966,656 compared to $937,661 at December 31, 2003, an increase of $28,995, or3.09%, from December 31, 2003. The increase in loans during the first ninemonths of 2004 primarily reflects an increase in commercial real estate loans,residential real estate loans and commercial loans. Non-performing loansinclude non-accrual loans and loans 90 or more days past due. All loans thatare 90 days past due are considered non-accrual unless they are adequatelysecured and there is reasonable assurance of full collection of principal andinterest. Non-accrual loans that are 120 days past due without assurance ofrepayment are charged off against the allowance for loan losses. The Companyhas aggressive collection practices in which senior management is heavily involved.Nonaccrual loans and loans past due 90 daysand still accruing increased by $3,664, or 80.59%, during the nine months endedSeptember 30, 2004 to $8,193. The increase is mainly attributable to fourcommercial real estate loan relationships and one consumer real estate loanrelationship, discussed in the earlier section entitled “Provision for LoanLosses”.  At September 30, 2004, theratio of the Company’s allowance for loan losses to non-performing assets(which include non-accrual loans) was 120.52%.

 

The Company maintains an investmentportfolio to provide liquidity and earnings. Investments at September 30, 2004with an amortized cost of $31,962 had a market value of $32,239. At year-end2003, investments with an amortized cost of $38,531 had a market value of$39,045. This decrease consists primarily of the excess of called and maturedshort-term agency and municipal securities over the reinvested proceeds.

 

**ITEM 3.****                             QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

A comprehensivequalitative and quantitative analysis regarding market risk was disclosed inthe Company’s December 31, 2003 Form 10-K. No material changes in the assumptions used or results obtained from themodel have occurred since December 31, 2003.

 

Actual results for the year ending December 31, 2004 will differ fromsimulated results due to timing, magnitude, and frequency of interest ratechanges, as well as changes in market conditions and management strategies.

 

**ITEM 4.****                             CONTROLSAND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

The Companymaintains disclosure controls and procedures, as defined in Rule 13a-15(e)promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”),that are designed to ensure that information required to be disclosed by it inthe reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms and that such information is accumulated and communicated tothe Company’s management, including its Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.  The Company carried out anevaluation, under the supervision and with the participation of its management,including its Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of its disclosure controls andprocedures as of the end of the period covered by this report.  Based on the evaluation of these disclosurecontrols and procedures, the Chief Executive Officer and Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective.

 

**Changes in Internal Controls**

 

There were nochanges in the Company’s internal control over financial reporting during theCompany’s fiscal quarter ended September 30, 2004 that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.            Legal Proceedings**

 

The Bank is aparty to the lawsuit styled *Jimmy HollandBoyd and Spring City & Co. v. Town of Jonesborough, Tennessee, et al.*CourtNo.:2:04-CV-71, now pending in the United States District Court for the EasternDistrict of Tennessee, Greeneville Division. The plaintiff alleges, among other claims, that the Bank, along with theother defendants, violated his civil rights in connection with the repossessionof certain collateral of a Bank borrower in default on its loan.  The collateral was then in the possession ofplaintiff who claims to have had an agreement with the borrower which entitledplaintiff to the collateral.  When theBank attempted repossession, plaintiff disputed the Bank’s rights to thecollateral and was thereafter arrested. The plaintiff seeks from the defendants, jointly and severally,compensatory damages of not less than $10 million and punitive damages of notless than the greater of $10 million or 5% of the net worth of all defendantsand the Bank.

 

The Bankcontinues to believe that the plaintiffs’ claims are without merit as to theBank and will continue to vigorously defend this lawsuit.  The Company does not believe that thislitigation will have a material adverse effect on the Company’s results ofoperations.

 

The Companyand its subsidiaries are also subject to other claims and suits arising in theordinary course of business.  In theopinion of management, the ultimate resolution of these pending claims andlegal proceedings will not have a material adverse effect on the Company’sresults of operations.

 

**Item 2.            Unregistered Sales of EquitySecurities and Use of Proceeds**

 

TheCompany made no repurchases of its common stock during the quarter endedSeptember 30,  2004.

 

**Item 3.            Defaults upon Senior Securities**

 

None.

 

**Item 4.            Submission of Matters to a Voteof Security Holders**

 

None.

 

**Item 5.            Other Information**

 

None.

 

**Item 6.            Exhibits**

 
| (a) Exhibits |              |
|--------------|-------------------|
|         |              |   |
|         | Exhibit No.  10.1 | Non-competition  agreement dated August 10, 2004, by and between the Company and Kenneth R.  Vaught |
|         |              |   |
|         | Exhibit No.  31.1 | Chief  Executive Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a) |
|         |              |   |
|         | Exhibit No.  31.2 | Chief  Financial Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a) |

 

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|   | Exhibit No.  32.1 | Chief  Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|--------|-------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|   |              |                                                                                                                                             |
|   | Exhibit No.  32.2 | Chief  Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|   |              | Greene  County Bancshares, Inc. |                                               |
|--------|-------------------|---------------------------------|----------------------------------------------------|
|   |              | Registrant                      |                                               |
|   |              |                            |                                               |
|   |              |                            |                                               |
| Date:  | November 5,  2004 |                            | By:                                                |  /s/ R.  Stan Puckett |   |
|   |              |                            | R. Stan Puckett                                    |
|   |              |                            | Chairman of the Board and Chief Executive  Officer |
|   |              |                            | (Duly authorized representative)                   |
|   |              |                            |                                               |
|   |              |                            |                                               |
| Date:  | November 5,  2004 |                            |                                               |  /s/  William F. Richmond |   |
|   |              |                            | William F. Richmond                                |
|   |              |                            | Senior Vice President, Chief Financial             |
|   |              |                            | Officer (Principal financial and accounting        |
|   |              |                            | officer) and Assistant Secretary                   |
|        |                   |                                 |                                                    |  |  |  |

 

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